Community Financial System Inc (CBU) 2019 Q2 法說會逐字稿

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

Please note this presentation contains forward-looking statements within the provisions of the Private Securities Litigation Reform Act of 1995 that are based on current expectations, estimates and projections about the industry, markets and economic environment in which the company operates.

Such statements involve risks and uncertainties that could cause actual results to differ materially from the results discussed in these statements.

These risks are detailed in the company's annual report and Form 10-K filed with the Securities and Exchange Commission.

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, April.

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

We're very satisfied with Q3 results, which were largely expected.

Operating earnings were flat with last year excluding the Durbin impact of $0.05 to $0.06.

The margin's hanging in, loans and non-municipal deposits were up a little, asset quality is really good and our nonbanking businesses continue to grow and perform extremely well.

All in all, it was a reasonably stable and solid quarter.

We're very pleased that the Kinderhook Bank Corp.

transaction, announced in the first quarter, closed on July 12, adding $650 million of assets and 11 branches across the greater Albany, New York market.

The closing, systems integration and operating transition went extremely well.

According to our team, it was our best ever.

So we're off to a very good start in this market and excited about the growth opportunities that lie ahead.

As previously disclosed, we expect this transaction to be $0.08 per share accretive on a full year basis.

Looking ahead, our operating momentum and capital accretion continue to be strong, which positions us very well for the remainder of 2019 and into the future.

Joe?

Thank you, Mark, and good morning, everyone.

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

The company reported GAAP net income of $45 million and earnings per share of $0.86 during the second quarter of 2019.

This compares to net income of $44.6 million and $0.86 in GAAP earnings per share for the second quarter of 2018.

On a comparative basis, the second quarter of 2019 earnings were favorably impacted by $4.9 million of realized gains on the sale of investment securities and unfavorably impacted by a $1.1 million increase in acquisition expenses due to the Kinderhook acquisition and a $3.5 million estimated reduction in noninterest revenues due to Durbin-related debit interchange price restrictions imposed on the company between the periods.

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

We closed the quarter of 2019 with total assets of $10.75 billion.

This is down $171.1 million or 1.6% from the end of the first quarter of 2019 due to the seasonal net household municipal deposits.

Total assets were up $138.1 million or 1.3% from the end of 2018 and $112.3 million or 1.1% from 1 year earlier.

Average earning assets for the second quarter of 2019 of $9.43 billion were up $53.5 million or 0.6% when compared to the linked first quarter, but down $27.8 million or 0.3% when compared to the second quarter of 2018.

Average loan balances in the second quarter of 2019 were up $21 million or 0.3% when compared to the linked first quarter of 2019, and up $44 million or 0.7% when compared to the second quarter of 2018.

On the linked quarter comparative basis, average balances in the business lending portfolio, the consumer mortgage, consumer indirect and consumer direct portfolios were up.

These increases were offset, in part, by decrease in the home equity portfolio.

Total ending loans were up $18 million or 0.3% on the linked quarter basis despite of a $39.9 million decrease in municipal loans, as seasonally expected.

Average total deposits increased $92.3 million or 1.1% on a linked quarter basis, but ending deposits decreased $131.5 million or 1.5% due to the net outflow of municipal deposits, as seasonally anticipated, and consistent with prior year's annual cycles.

At June 30, the book value of the company's investment portfolio stood at $2.37 billion.

This is down $593 million from the end of the first quarter.

During the second quarter, the company sold $590.2 million of treasury securities with remaining maturities of 2 to 5 years at a weighted average market yield of 2.09%, and reported net realized gains of $4.9 million.

These securities were temporarily reinvested in overnight federal funds at approximately a 2.35% yield.

And management is in the process of evaluating market opportunities for reinvesting these proceeds in securities with longer weighted average lives.

Accordingly, at the end of the second quarter, the company's cash equivalents stood at $707.1 million.

The second quarter 2019 tax equivalent yield on the investment portfolio, including cash equivalents, was 2.69%.

Exclusive of cash equivalents, the effective duration of the investment securities portfolio was 2.7 years at June 30, 2019.

Shareholders' equity increased $152.6 million or 9.2% between the end of the second quarter of 2018 and the end of the second quarter of 2019, due largely to an increase in retained earnings.

Our capital ratios also remained strong in the second quarter.

The company's Tier 1 leverage ratio was 11.54% at the end of the quarter, over 2x the well-capitalized regulatory standard.

Tangible equity to net tangible assets ended the quarter at solid 10.56%.

Our asset quality remains strong at the end of the second quarter 2019.

Nonperforming loans, comprised of legacy and acquired loans, totaled $24.5 million or 0.39% of total loans.

This is the same as the ratio reported at the end of the linked first quarter of 2019, and 8 basis points lower than the ratio reported at the end of the second quarter of 2018.

Our reserves for loan losses represented 0.78% of total loans outstanding and 0.93% of legacy loans outstanding at the end of the quarter.

We reported net charge-offs of $1.2 million or 8 basis points annualized on the loan portfolio during the second quarter of 2019.

This compares to net charge-offs of $0.9 million or 6 basis points annualized during the second quarter of 2018.

At the end of the second quarter, the company's total OREO properties were less than $2 million, and the internal risk loan ratings portend stable asset quality.

I will now redirect my commentary to second quarter earnings results.

Although GAAP earnings per share matched the second quarter of 2018 at $0.86, operating earnings per share, which excludes acquisition-related expenses net of tax effect and net realized gains on the sale of investments net of tax effect, were down $0.06 to $0.80.

This decrease in operating earnings was driven by Durbin-related debit interchange price restrictions estimated at $0.05 to $0.06 for the second quarter and a higher effective tax rate.

Total revenues for the second quarter of $149 million were up $5.6 million or 3.9% over the second quarter of 2018.

This included a $1.5 million or 1.7% increase in net interest income and a $4.1 million or 7.3% increase in noninterest revenues despite the decrease in banking revenues due to Durbin.

On a linked quarter basis, total revenues increased $6.5 million or 4.5% driven by the recognition of $4.9 million of net realized gains on the investment securities portfolio and a $1.4 million or 1.7% increase in net interest income.

We recorded $88.3 million in net interest income in the second quarter of 2019 as compared to $86.8 million in the second quarter of 2018.

Between comparable quarters, the company's net interest margin increased 7 basis points from 3.73% in the second quarter of 2018 to 3.80% in the second quarter of 2019.

The company's yield on average earnings assets increased 15 basis points while funding cost increased 9 basis points.

The company's net interest margin for the linked first quarter was also 3.80%.

On a comparable annual quarter basis, net interest income recorded on loans was up $2.9 million and the tax equivalent yield on the loan portfolio increased 15 basis points from 4.58% for the second quarter of 2018 to 4.73% in the second quarter of 2019.

During the second quarter, the weighted average net yield on new loans exceeds the net yield on the total loan portfolio by approximately 20 basis points.

This compares to approximately 50 basis points during the first quarter of 2019.

Investment income, including revenues earned on investment securities and cash equivalents but exclusive of net realized gains of $4.9 million, was up $0.4 million over the second quarter of 2018.

The company received $0.9 million semiannual dividend payment from the Federal Reserve Bank in the second quarter of 2019 as compared to a semiannual dividend payment of $0.4 million during the second quarter of 2018.

The net gains on the sale of investments were realized late in the second quarter when the treasury yield curve inverted.

The company's total cost of funds increased 9 basis points between comparable annual quarters from 19 basis points in the second quarter of 2018 to 28 basis points in the second quarter of 2019.

The total cost of deposits remains well below peer and industry averages for the second quarter of 2019 at 22 basis points, reflective of the company's very solid base of core deposits.

Checking and savings account balances represented 69.1% of our total deposits at June 30, 2019.

This is up from 67.4% 1 year prior.

Noninterest revenues in our financial services businesses, including employee benefit services, insurance services and wealth management services, were up $2.2 million or 6.1% between comparable annual quarters, but were offset by a $3.1 million or 15.3% net decrease in banking-related noninterest revenue due to the Durbin Amendment, becoming effective for the company in the third quarter of 2018.

Despite Durbin, noninterest revenues, exclusive of the investment securities gains realized during the quarter, contributed 38.8% of the company's total operating revenues, similar to the first quarter of 2019 and full year 2018 results.

Total operating expenses, excluding acquisition expenses, were up $3.9 million or 4.6% on an annual quarter comparative basis.

The increase in operating expenses between comparable quarters was due to increases in compensation expense, including higher employee benefit cost and increase in business development and other administrative expenses.

We recorded $1.4 million in the provision for loan losses during the second quarter of 2019.

This compares to $2.4 million recorded in the provision for loan losses in the second quarter of 2018.

A $1 million decrease between comparable periods.

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

The effective tax rate for the second quarter of 2019 was 20.2% up from 18.7% in the second quarter of 2018.

The company recorded greater amounts of income tax benefits related to stock-based compensation activity in the second quarter of 2018 as compared to the second quarter of 2019.

Exclusive of stock-based compensation tax benefits, the company's effective tax rate was 21.3% in the second quarter of 2019.

We look forward to fully integrating the former Kinderhook Bank into Community Bank in the months ahead.

We also expect to fully realize the projected annualized noninterest expense savings of 30% and achieve earnings per share accretion of $0.07 to $0.08 in the first full year following the acquisition.

Kinderhook's total assets at the time of acquisition were approximately $650 million with total loans of approximately $480 million and total deposits of $570 million in line with our expectations.

Looking ahead, we do not anticipate any significant deviations from recent trends around the company's asset quality.

Core net interest margin is anticipated to decrease from the mid-3.70s to about 3.70% with the inclusion of the Kinderhook portfolios.

If The Federal Open Market Committee lowers the federal funds target rate by 25 basis points in the third quarter, it will unfavorably impact loan yields, including total variable rate loans of approximately $1 billion.

We also anticipate redeploying significant portions of our overnight federal funds sold position into longer-term securities in the months ahead.

Operating expenses are expected to reset after the full integration of Kinderhook at a quarterly run rate of approximately $93 million to $94 million, a net increase in line with general inflationary trends.

In summary, we believe the company remains very well positioned for the future.

The company's strong asset quality, capital reserves, liquidity, core funding base and a strong nonbanking business revenues provide a solid foundation for continued growth and dividend capacity.

The company's market valuation also provides an excellent currency for potential future mergers and acquisitions.

Thank you.

Now I will turn it back over to April to open the line for questions.

(Operator Instructions) And we'll take our first question from Austin Nichols (sic) [Nicholas] with Stephens.

Maybe just on the charge-offs, you had a good quarter obviously of credit quality.

Any recoveries in there that were driving that down a little bit from kind of where it's trended over the last couple of quarters?

Yes.

We typically have some units that we took into possession in the fourth and first quarter sometimes go to auction in the second quarter.

And we do report occasionally some recoveries if the market pricing is there for those units.

And so we did recover on some units in the second quarter.

Okay.

That's helpful.

And then maybe just on the expenses.

Can you maybe -- you may have mentioned this in your prepared remarks, but can you maybe refresh my memory on what drove maybe the increase in the other expense line item?

And then kind of just how to think about that line item kind of going forward?

Sure.

During -- well, let me go back to the second quarter of 2018.

The second quarter of 2018 was, I guess, a very low-expense quarter for us.

We had a couple of items that kind of went our way in the second quarter of 2018 that didn't necessarily go the same way in the second quarter of 2019.

But we did increase some of our business development and marketing expenses on an annual quarter comparison basis.

We did some refresh on rebranding and that drove a little bit of the expenses in the quarter.

We also had some, I'll call them, normal-related expenses to property type pre-foreclosure expenses in the quarter, which we actually had some recoveries back in the second quarter of 2018.

So just more reflection of some of the favorable variances in the second quarter of 2018.

We also had, on the salaries and compensation line item, we also had some increases.

We do have a little bit of wage pressure.

So that drove up the salaries a bit.

And we also had higher employee benefit costs in the quarter, including some increased costs on our medical-related type benefits.

We had an extraordinary year in 2018 on some of our health-related costs, and we're sort of back to the normal run rate in 2019.

Understood.

Okay.

And then maybe just on the margin.

I appreciate your comments there.

But maybe just more specifically, how we should think about, I guess, the impact to the margin from a potential rate hike coming up here in the next couple of days?

And then, I guess, beyond that, any commentary you have on how we should think about your excess kind of cash position?

Should that continue to grow a little bit?

Or are you actively seeking to kind of deploy that cash?

Yes.

And Austin, you said rate hike?

Excuse me, rate cut.

Yes.

Okay.

I just want to make sure we're on the same page there.

Yes, we have about $1 billion in variable rate loans.

So an annualized impact of $1 billion, a 25 basis point reduction doesn't affect us favorably.

There is some modest room on the liability side for a potential funding cost decreases in the future.

But as you know, we -- our beta in rates up was for full cycle was about 5%.

So there's not a lot of room on the deposit side to pick up some expense savings.

So the expectation if we do get a 25 basis point cut is, I'll say, modestly down from the interest income perspective.

And I'm sorry, Austin, could you repeat your second question?

Sure.

It was related to your excess cash position that you've been building over the last couple of quarters or as you've sold off some securities.

And maybe just any commentary on how you're thinking about redeploying that?

And what would trigger you to be more aggressive or less aggressive?

Yes.

Absolutely.

So we started to identify that we had significant maturities and capital expectations from our investment securities portfolio basically from the second half of 2020 through 2023.

In fact, we were looking at potentially $2.5 billion of cash flows and maturities.

And so we wanted to, I'll call it, potentially reduce some of the reinvestment risk associated with that much in cash flows in that period of time.

And so we had kind of indicated in prior calls that we might reinvest or preinvest some of that cash flow.

We have inversion in the yield curve.

We happen to see that in kind of the 2- to 5-year range.

We had an opportunity to pull some of those securities out, temporarily put them in cash equivalents at actually about a 25 basis point pickup in yield.

And then -- we then have opportunities to redeploy it kind of on a little bit longer-term basis.

And I would expect that in the coming months that we would redeploy most of the cash that was sitting in cash equivalents at the end of the quarter.

And in terms of yield expectations, the yield expectations are comparable to probably what we're seeing in terms of current cash equivalents except for we'll extend the maturities a bit.

Got it.

Okay.

That's helpful.

So more or less not expecting a big yield pickup, just kind of matching your current yield with longer durations?

Correct.

Okay.

And then maybe just one last one on the Fed dividend.

I know that is expected to decline kind of as you're getting into the large bank -- larger bank territory.

Can you just maybe give us some commentary on where we should think about that number going that was kind of that $900,000 number this quarter?

So we had qualified for the current semiannual dividend as a bank -- less than $10 billion because of the inflationary component that the Fed allows.

The dividend payment rate was 6% for the semiannual period.

With the Kinderhook transaction, we will pass back over the $10 billion mark even for the inflation, inflation-adjusted, $10 billion mark.

And the dividend rate is typically -- or it is the equivalent of the 10-year treasury rate at the time it is declared.

We'll take our next question from Russell Gunther with D.A. Davidson.

I wonder if we could start please on some of your niche fee businesses, if you guys could provide us an update in terms of how that revenue growth is tracking into the back half of the year.

Would be particularly interested in the employee benefits business and insurance as well?

The -- we've been kind of achieving single-digit -- mid-single-digit growth rates in that business.

I would expect that, that would continue in the back half of the year as compared to the second half of 2018.

We continue to just see a general growth in the number of participants and the related revenues around that business.

So I would expect that to continue kind of along its recent trend lines.

Yes.

One of the challenges on the employee benefit services business is, it's got to be pretty substantial -- the run rate on that.

It will probably do $100 million of revenue this year and the markets are very good.

So we'll take all we can get of that.

But it makes a little bit harder growing mid-single digits.

It's a pretty good lift.

But there's some kind of businesses within the broader employee benefit services that are growing a little bit faster than mid-single digits.

Wealth management and insurance.

The insurance is doing very well.

Good growth year-over-year in the insurance business.

Pretty good growth in wealth management too.

They're all doing okay.

None of them are really at double-digit pace right now but they're all in between kind of 4 and 9, 5 and 8 kind of range in all those businesses.

Margins are actually going up, which is good.

So revenues are growing faster than expenses.

So I think we expect those businesses could continue to be pretty substantial contributors going forward as they have been in the past.

That's great color.

I appreciate it, guys.

Just the last question for me with the Kinderhook now closed, I know you're going to be focused on integrating that.

But any updated thoughts in terms of future M&A on the depository side?

Just how active you remain?

And what's of interest to you at this point in the cycle?

Sure.

I think we're always interested.

I think the cycle is maybe a bit less relevant to us than it is to some others who maybe operate outside our markets in more volatile market conditions.

So for us, M&A is an ongoing element of our strategy, as everyone understands.

In our markets, they're only growing -- if you can get 3% to 4% organic growth a year, that's pretty good.

That's not enough if you want to deliver double-digit returns to shareholders.

So disciplined, high-value M&A has long been an important element of our shareholder return strategy.

So we will continue to look for opportunities on an ongoing basis.

That continues at the current time.

I expect that will continue into the future.

We're unlikely to do anything significant in terms of size.

I think, for us, anything between $0.5 billion and $2 billion is really kind of where we want to be.

It's got to be high-value opportunity in terms of ultimate shareholder benefit.

It's got to be something that's either within or contiguous to our existing market footprint.

So those are kind of parameters, for the most part, that we look towards in terms of our valuation.

I think Joe had mentioned this earlier relative to our market multiples, which gives us a significant opportunity.

But we as always are very disciplined about what we do and who we partner with, and we'll continue to use that discipline to identify those high-value acquisition opportunities that we know can be solidly accretive on a sustainable basis for shareholders.

And we'll take our next question from Erik Zwick with Boenning and Scattergood.

Maybe just first with regard to the Kinderhook transaction closing, I'm curious whether you had any current advertising campaigns running or anything planned for the Capital District?

And if so, would those be kind of standard branding efforts?

Or do you have any kind of loan or deposit specials currently running or planned for the market?

Well, we have usually -- kind of a new market, it's not a completely new market.

We started in the Albany market in the beginning of 2018 with a commercial banking office and it's done extremely well.

So we're already doing a fair bit of marketing and branding and advertising, some of those kind of things in that market.

I suspect that will pick up a little bit between now and the end of the year as we continue the integration and transition process, which I think is fairly standard operating procedure.

And then I know it's still relatively early, but are customer and deposit retention kind of tracking consistent with your expectations at this point?

It's been a week.

So far, so good.

Got you.

Yes, a week since closing, I guess, several got happier since the deal was announced and certainly -- certain customers I'm sure are aware of that.

But it sounds like everything is going on track.

Yes.

And Erik, prior to the conversion date, Kinderhook had done a pretty good job of holding in the customers with regard -- there were announcements, obviously, that there was going to be a merger on -- in early July.

And the balances would indicate that those customers for the most part have held in with us right up through the conversion 2 weeks ago.

As I recall from looking at their June balance sheet, loans were down just a hair and deposits were up a little bit, as of June.

Yes.

That's good.

I appreciate the detail there.

And then on the tax rate, as I just kind of think about modeling for the second half of the year, can you remind us about your expectations for the effective tax rate?

Yes.

So the effective tax rate range is about 21.3% up to about 22% for the quarters looking forward.

If some of our municipal or reinvestment winds up in the municipal securities portfolio that could drift down a couple of basis points.

But generally, 21% to 22% is the range.

And then just one last one for me.

Just wanted to make sure I understood the expectations for the net interest margin going forward.

Sounded like you expect it to kind of decrease from the mid-3.70s to closer to 3.70%.

Did that include the expectation for a Fed funds rate cut?

Or would the kind of decrease from that cut be in addition to that range that you professed?

Well, we kind of provided around 3.70s because 25 basis point rate cut, although our prime-based loans would reprice.

It's not a significant impact on kind of a quarterly run rate basis.

So we kind of estimated that kind of 3.70% mark inclusive of Kinderhook and also expecting a 25 basis point decrease.

But we want to give ourselves some room on each side of that estimate around 3.70% just because things -- we don't know until we know at the end of next quarter.

And we'll go on to our next question from Brody Preston with Piper Jaffray.

I guess I just wanted to touch on Kinderhook.

Now with the Kinderhook in the fold, just wanted to get a sense for the loan growth outlook moving forward?

And better understand if there were any industries or any other areas of opportunity that you think you could take advantage of with the addition of Kinderhook?

Sure.

I think I'll start with, it's a somewhat larger market than our average markets just in terms of demographics and population.

It's a good market if you look at relative to other upstate New York cities.

It's fairly vibrant.

There's still a fair bit of development and growth in different ways happening in that market.

And we've been able to capitalize on that since the beginning of last year when we put in place a commercial banking office there.

I think the opportunities are broad in the sense that there's a fair bit of commercial real estate opportunities, there's C&I opportunities, there are mortgage opportunities there.

And so, I think, it's a broad-based set of opportunities that we expect to be able to capitalize on.

We've also -- we haven't been there that long in that market, 1.5 years now.

Certainly the addition of Kinderhook will be an advantage.

We've been able to do, I would say, an above average job of leveraging some of our nonbanking businesses into those markets as well.

So I think that's been good.

We've established wealth management office there also recently, which is also off to a very good start.

Our benefits business has done a fair bit of work in Capital District for some of the larger companies and businesses in the Capital District.

So I think the other thing is that, if you look at our legal lending limit, there is almost nothing we can't really participate in, in that market.

So I think -- we think that there's a lot of breadth of opportunities across the spectrum of commercial and consumer opportunities.

There is also from kind of the bottom -- the top of the market, vertically, there's a lot of opportunities there for us to penetrate that market as well.

And as I said, we met with a great deal of success in 18 months that we've been in that market.

We think the Kinderhook market is going just extend our opportunities that much more in that market.

So in terms of growth opportunities, it's hard to put a number on it.

Our existing organic markets grow at 2, 3, 4 points a year.

I would expect to do a little bit better than that in the Capital District.

Okay, okay.

Great.

That's good color.

And then on the treasury sale and the cash redeployment, I'm taking some of your comments from earlier, it sounds like the yield on the redeployment won't necessarily be too much higher than what you're currently earning on cash equivalents.

So I guess I wanted to better understand what the duration -- I guess, what market you're looking in, in terms of duration?

And if there's any opportunity to redeploy into different asset classes to maybe pick up a little more yield?

Right.

I mean, we are looking at additional or I should say reinvestment of those proceeds.

We've got a couple of different options on the table relative to where we wind up from a weighted average like basis.

We have typically invested some of our -- or a significant portion of our securities in longer-term treasuries.

We've viewed -- we're looking at other assets as well that potentially put the average lives in a range of 4 to 7 years, maybe a little bit longer if the opportunity presents itself.

One of the -- I think we have -- we feel like we had an exceptional opportunity we've kind of been talking about stretching out as the maturity of the weighted average life of the portfolio came down.

We talked about trying to stretch it back out a little bit just to diversify some of the lumpy cash flows over the next handful of years.

As we were kind of having those conversations and look at the market, the yield curve inverted and -- pretty significantly, and it just created this opportunity for that particular tranche of securities for us to sell it, reinvest and actually at a higher book yield than those securities basically generate capital.

I mean, I know The Street investors don't give you credit for the gains which they shouldn't.

But still, it was a capital generation event and we're pretty confident that we're going to have the opportunity to reinvest in slightly longer maturities.

The yield curve has only inverted a few times in the last 20 years.

This was a good opportunity for this particular tranche of securities.

It won't stay inverted forever.

At least it never has, if history is any indicator.

So we're pretty confident we'll have an opportunity to reload on some of that liquidity at a yield.

And we're looking at securities -- on treasuries but also potentially some mortgage backs as well maybe a mix of those depending on where the spreads are there as well.

So we're pretty confident that we'll have the opportunity to redeploy at some juncture here certainly before the end of the year at a much more attractive yield than what those securities were yielding before we sold them.

In fact, because of the yield curve inversion, the short-term yield is actually higher than what the book yield of those securities were.

But we think we're going to be able to reload at a rate even higher than that between now and end of the year.

So it's just a -- because of the inversion of the yield curve in that particular tranche of securities just gave us an opportunity to do something that we felt was a kind of onetime capital creation opportunity.

So that was kind of the thinking behind the whole trade.

But the plan is to redeploy that liquidity at some point between now and the end of year when the market provides that opportunity.

Okay, okay.

Great.

And then wanted to maybe get an update on CECL?

And any of your thoughts around the potential impact from CECL to some consumer lending just given the longer duration nature of consumer loans relative to some commercial loans?

Sure, Brody.

We -- first of all, we're not in a position yet to put any sort of range out around CECL, but I can assure you, we're working very diligently on running our CECL models and looking to have those models validated.

We do have some consumer portfolios, as you mentioned, home equity and residential mortgage portfolios with longer average lives.

With that said, the charge-off levels in those 2 portfolios on -- looking back, have been very low.

So the expectation around future charge-offs, based on at least the economic outlook today, would not probably require that we significantly change those expectations on -- from a historical loss perspective.

So on balance, I think we're pretty well positioned for CECL.

Part of that is just the historical charge-off levels had been low for us.

Okay.

And then last one for me.

It's a little bit more of a 2-part question.

When I look back at CBU's performance from a funding perspective in this interest rate cycle relative to the last interest rate cycle, particularly with regard to deposits.

And you guys have certainly outperformed relative to last cycle.

The cycle-to-date deposit beta is

5% versus 28% last time, and the cost of funds is dramatically lower, which obviously is due to a lower level of -- absolute level of interest rates.

But you guys have had a big mix shift in deposits that have occurred since last time, which I'm assuming is a big driver of the current success you've had.

So I guess I wanted to better understand 2 things.

In your view, what's been a driver of CBU's success from a deposit gathering perspective over the last decade that's allowed you guys to sort of mix shift into DDA and away from time deposits?

And secondly, given the deposit mix is so different this time around, what would be your expectations around deposit cost moving forward in a 1 to 2 rate cut scenario?

Sure.

I think it's the reality that you want low-cost deposits and not higher-cost deposits.

And I certainly acknowledge there's 2 strategies here: you can run very lean and efficient branch network and gather deposits based on rate.

But you save on the operating expense side.

Our strategy has always been because we're in a lot of smaller markets is to gather those core checking and savings accounts.

We've been doing that obviously very well for 15 years.

So if you look back historically, you can see our mix of checking and savings accounts just grown over time.

It used to be somewhere in the half range and now it's 70%.

So I think that's pretty consistent with our retail banking strategy overall.

I think that's been the reason for this -- the success in this last cycle.

I think you can -- it's difficult to distinguish yourself on the credit side in terms of economic value, earnings performance, shareholder value.

I mean, we're all doing the same stuff in the market, same rates, same, for the most part, credit structure.

Some take different risks in different ways, but on the asset side, there's not a lot you can do to really to distinguish yourself longer term in terms of Main Street banking and creating shareholder value.

That's not true on the funding side.

I mean, you can work at having a really strong foundation of core funding that will serve your interest well over time.

So that's essentially been the model for us for the past 15 years.

It's worked out pretty well.

Clearly, it's created a balance sheet though that's asset-sensitive.

And rates up is better for us than rates down.

But I think even in the periods of rates down, we do better on average than the industry as a whole because of our funding mix.

So it's the kind of a win-win.

When rates go up, we do really well.

And when rates go down, we don't do quite as badly as others.

So it gives us a lot of flexibility.

And I think it's consistent with our business model.

We work hard at it.

We run our retail banking business like it's a business.

We measure profitability, we measure earnings performance, we measure returns, we measure growth, all those kinds of things.

So we don't run it as a funding mechanism for our asset gathering businesses.

We run it as a standalone business that we expect to perform well.

We'll take our next question from Collyn Gilbert with KBW.

Just want to clarify a couple of points on the NIM.

So number one is, in your guide for maintaining around that 3.70% NIM, how much do you all anticipate to derive from accretable yield?

I know Kinderhook is not a huge obviously deal, but just from...

Yes.

So the run rate this quarter was $1.3 million and it was very similar to last quarter.

I would expect that portion of the existing acquired accretion to sort of drift down a couple hundred thousand on that -- on a prospective basis.

And you're right, Kinderhook is relatively small.

And we don't have a number per se for the adjustment.

But I would not anticipate that being more than a hundred thousand or a couple of hundred thousand on a quarterly basis.

Okay, okay.

And then -- got it.

Okay.

And then just on prepays, so I know last quarter you guys saw elevated prepays, looks like you had one again this quarter.

Can you just talk about -- I know those are obviously hard to predict, but just sort of what you're seeing within the pattern of your borrowers?

And maybe if you have a sense at all on how that could slow during the back half of the year?

Sure.

I know it doesn't look like our commercial lending was up very much this quarter, we actually had a really good origination quarter.

The pipelines are bigger than they were last year.

We were having a very, very good quarter.

We did have some pay-downs in June, actually a couple of them came at like the very end of June.

We had, I think, Joe made reference to the $40 million of municipal loans, which pay down every June 30 and then they reload.

So that was $40 million of it.

We also had about $36 million of other credits that were over $1 million apiece.

Anything over a $1 million is totaled about $36 million in quarter that paid down early.

That was a little more than the first quarter.

So we had a little kind of better experience the first quarter.

We had 2 significant credits, about $25 million that paid down literally the last week in June, plus the $40 million of municipals which we'll reloan.

So if you take it all in, look, I understand that things prepay, and that's the business we're in.

You lend money and sometimes people pay it back early.

But from the origination standpoint, we had a really strong second quarter.

And again, the pipeline is pretty good on commercial.

The mortgage pipeline is also up.

The mortgage is a bit more predictable, let's say, than the commercial business.

We had some growth in mortgage.

I expect we'll have some growth next quarter.

That portfolio pretty much grows over time generally in a kind of a lower single-digit rate.

And I would expect that to continue into the third quarter.

The fourth quarter is usually more difficult just from a seasonal standpoint.

But I think the pipelines are actually in better shape than they were last year at this time.

And we had a really good origination quarter this quarter compared to last year.

Okay.

That's helpful.

And then that kind of ties into my next question in terms of the expenses tied with the business development efforts that you said.

Anything specific there?

Is that related to hires?

Is that related to systems?

Or maybe just talk a little bit more about those investments and what you expect to get from them?

Yes.

So we had a -- we had, and just by way of example, and my apologies if this is low into the weeds, but we had some television commercials, for example, that were a little bit older.

We refreshed them, we -- which you have to basically incur that expense as you produce and air those spots.

Those types of items that drove it, not individuals in the business development area, just more of a marketing expense.

Nothing significant, Collyn, other than what Joe just said.

We made some commercials in the fourth quarter.

They were expensive.

You have to expense those off when you start running them, which we did in the first quarter.

So the first couple of quarters, you're expensing off the cost of those TV commercials, which the last, I don't know how often we do that, but maybe once a year at the most, I'm not even sure.

So -- but other than that, there was no significant marketing rebranding.

I would say, maybe marketing's running a little bit higher, a bit run rate than it has in the past, it was nothing, I don't think significant beyond just the accounting for those TV commercials that we remade.

Okay.

I think I was also just maybe trying to drill into the other expense line too that was -- it looks like maybe just under $3 million increase year-over-year and then about $2 million higher than the first quarter.

So I was just trying to get a little bit of better sense of what that was.

Yes.

Well, Collyn, I think I was trying to indicate kind of in an earlier question that we had really -- I'll call it, a very good expense quarter in the second quarter of 2018.

We just had a couple of items that effectively were -- went our way.

We had reductions in certain expenses.

And we basically had more of a -- I'll call it, more of a normalized quarter this quarter.

But when you look at on an annual quarter comparative basis, they do look a little bit high.

But that's largely because the second quarter of '18 was a very good quarter from an expense run rate perspective.

But just some other kind of some various little administrative expenses that just resulted in a net increase on an annual quarter comparison basis.

That was a little bit above our historical run rates.

There are no further questions in the queue.

At this time, I would like to turn the conference back over to today's presenters for closing and additional remarks.

Great.

Thank you, April.

Thanks, everyone, for joining the call, and we will talk to you again next quarter.

Thank you.

Ladies and gentlemen, this does conclude today's presentation.

We thank you for your participation.

You may now disconnect.