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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
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 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 started the Passover.
We are very satisfied with the quarter, that was about as expected. Our earnings up a little, loan flat, deposits up, the highpoint take away from me for the quarter was that we more than offset a $0.05 per share Durbin hit compared to last year’s Q1.
Our margin was up a couple of bps, operating expenses were a bit better than we expected, non-banking revenues grew 3% and asset quality metrics were very good.
Loan growth was flat given the seasonal runoff 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 are excited about the future opportunity when we closed the Kinderhook transaction in the first half of July.
Looking ahead, we have strong earnings and an operating momentum across the business, which should position us well for the remainder of 2019. We continue to improve 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 of 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 non-interest 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 earnings assets of $9.38 billion. The growth in the company’s balance sheet during the quarter was largely attributable to the seasonal inflow of municipal deposits.
Average loan balances for the first quarter of 2019 were essentially flat to the linked fourth quarter of 2019, 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 represent 68.4% of total deposits at March 31, 2019, a solid increase from 66.6% one year prior. Our 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 equivalence 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 non-interest 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 of 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. Comparably the total loan yield in the linked fourth quarter was 4.65%.
During the first quarter 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.
Non-interest revenues and non-banking businesses were up $1.2 million or 3.2% but were offset by a $3 million or 14.8% decrease in banking related non-interest revenues due to a decrease in debit interchange fees in connection with the company being subject to the Durbin amendment in the third quarter of ’18. Despite the Durbin reduction, non-interest 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 $0.2 million, a 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 from 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 capital periods. The decrease in the provision for loan losses was reflective of an improvement in the company’s assets 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 for operating earnings per share for the first quarter of 2019.
Our asset quality remains strong. At the end of the first quarter of 2019 non-performing loans comprised of both legacy and acquired loans totaled $24.2 million or 0.39% of total loans. This is 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 for 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 four quarters of charge-offs by a multiple of five.
The allowance for loan losses to nonperforming loans was 202% at March 31, 2019. This compares to 197% at the end of the linked fourth quarter and 162% at the end of the first quarter of 2018.
We recorded net charge-offs of $2.6 million or 17 basis points annualized in the loan portfolio during the first quarter of 2019. This compares to net charge offs of $3.2 million or 21 basis points staring the first quarter of 2018. We do not currently have any commercial ORE properties and the interim of loan risk rates present stable asset quality.
Shareholders' equity increased $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 due to increase in retained earnings. Our capital ratios also remained strong in the first quarter. The company's Tier 1 leverage ratio was 11.27% at the end of the quarter, over 2x the well-capitalized regulatory standard.
Tangible equity of the net tangible assets ended the quarter at a solid 9.83%. This was 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 interim 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 forecasts a setback in the economy and could begin to impact margin results that should persist several more quarters. We remain cautiously optimistic about the commercial loan pipeline and potential opportunities for continued revenue growth in our non-banking businesses.
Since the Durbin restriction 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 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 result on a full year basis.
Thank you. Now I'll turn it back to Jenny to open the line for questions.
Thank you. [Operator Instructions]. And we will hear first from Austin Nicholas of Stephens.
Hey guys, good morning.
Good morning, Austin.
Good morning, Austin.
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 maybe 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 any guidance on how you see that trajectory through the course of the year given where the yield curve is and kind of no further rate hikes, you know on the horizon?
Yeah 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. You know obviously if the yield curve stays flat we would expect that you know competitors would sort of put a cap or potentially start to lower some of those rates, but you know that yield curve would have to persist for an extended period of time for you know 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 are going to continue to see that pressure, you know perhaps you know able to continue to maintain a deposit beta that’s similar to say the fourth and the first quarter, fourth quarter ’18 and first quarter 2019 as we look ahead and into the rest of the balance of the year.
We have not seen you know a large, a very large market competitors put out extremely aggressive rate in the deposit side, but with that said we are 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 kind of the duration, or I guess how long does municipal deposits stay on the balance sheet and kind of what that 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?
Yeah, 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 an increase in those deposits, typically a couple of 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 the 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 of 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 you know on the kind of non-bank side? Any changes in what you're seeing in the market from opportunities in the employee benefits business or also on the investment management or the kind of insurance side of the business?
Sure. I think it's alright to say our strategy really hasn’t changed much, it’s pretty consistent, which is try to identify high opportunity, high value acquisition targets, whether its banking or non-banking 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 strategy hasn’t changed much. I mean we continue to be actively engaging in opportunities across that spectrum and I think I would say that maybe recently there has been more of an uptick, a slight modest uptick in potential opportunities and activity just you know 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 good news.
You know I think on the non-banking 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 six months or so.
And with respect to the benefits business, you know we're always looking for good opportunity there. We have a significant benefits business that’s national in scope. I think we are – in the leadership are pretty plugged into the opportunities that evolve there. You know the interesting development I think or commented, and this is in the past relative to the benefits related businesses 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 often and continued to see opportunities. I would say not really any significant change in the market really; maybe marginally better than a 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, you know fee income growth range, you know barring any kind of major market downturn that could you know impact kind of asset values?
Yeah, I think you nailed it, I think mid-single digits. Some of those businesses are growing you know at twice that pace and some of them are growing at less than that. So over time I think together I would say mid-single digits is a good number?
Okay, great. Thanks for taking my question.
Thank you, Austin.
And we will hear next from Alex Twerdahl of Sandler O'Neill.
Hey, good morning guys.
Good morning, Alex.
Good morning, Alex.
First off I just wanted to drill in a little bit on some of the loan growth trends that we saw during the quarter. I assumed from the large level of prepaid fees that there was some significant commercial pay downs during the quarter that maybe hindered 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 wasn’t – I think it was $25 million range or somewhere around there which has led to kind of what we’re seeing here trending historically. The big prepayment fee was really related to one significant credit pay down in the quarter. So the experience on the prepayments overall is actually okay for the quarter.
Okay, and then just maybe elaborate a little on the outlook for some of the different portfolios as the year progresses?
Sure, you know obviously the first quarter is always really difficult in the auto book, you know the cash flow and net portfolio and short duration average of you know 30-something months, so it throws off about $30 million plus a month in cash flow. You know 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 you know historical. So I'd expect the auto book to grow in the second and third quarters as well.
The mortgage, mortgage business is good. The pipeline is up. We are turning them around faster as well which is good. We're starting to see you know a lot, a greater mix of purchase mortgages as opposed to refi’s which is also good. So you know I mean the fact that we actually, we are up in the mortgage book in the first quarter is also pretty good, because there is also not that much real estate activity in the first quarter if you look at the financials.
So that was good, and we would hope that the second and third quarters are good and that business is well. I think we are doing a good job in that business in terms of some of the marketing efforts that we are undertaking across the business, so I expect that would be additive. So I look forward to you know a productive outcome in the mortgage business in the second quarter.
Commercial, you know 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 you know on the commercial side. I'm hoping that the trend of lower prepayments continues in the second quarter, that would be good. So I would also expect that – you know we’ve got – the pipeline is really strong in some parts of our franchise. Pennsylvania is really good, Central and Western New York is good, capital district is really good. So you know I hope that we have a continuation of the 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 a kind of drill down a little bit more just on the moving parts of the margin, Joe in the last couple of quarters you 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 are 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 you know 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 that pre-investment?
Yeah, at this point – well, let me back up a little bit. So in the third and fourth quarter we had you know a little bit more opportunity in the yield curve you know to go out a little bit, you know certainly on the treasury curb. The mortgage backed securities were – you know we had decent returns there. That's backed-up a little bit, so you know that opportunity hasn’t been there in the – you know it wasn't there in the first quarter.
But with that said, we do have $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, you know let me get a little bit inflected in the curve throughout the – you know to a little bit of steepness throughout the year and we can pick our spots. But we also you know 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.
Yeah, we just did Alex. I think if the tenure gets to three, that's probably a trigger point to start looking at what the opportunities might be. We also are investing a little bit in the small securities market right now. The curves are better there and the spreads are a little bit better, so that's just really not to kind of refill the bucket from the 160 which is going to mature otherwise in 2019.
The other thing is that we're set from an interest rate risk perspective. We have more risk to falling rates than rising rates, so we just want to make sure that our balance sheet is you know properly positioned. We're not going to put ourselves in a position to – if there is a significant you know reduction in the rate environment like you saw you know a couple of years ago that you know we're well positioned in terms of managing the risk to a lower rate environment. So just to I guess follow-up on it.
Okay, and then perhaps you can give us a little bit more color and outlook on how you are 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 you know in terms of cost savings for Kinderhook, I am not sure you ever gave a formal number, but kind of how should we be thinking about overall expenses for the year?
Okay, relative to the, you know 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 a – you know that the first quarter is a reasonable expectation for the future quarters for 2018 exclusive of Kinderhook.
Kinderhook has an operating expense run rate of about $16.5 million in 2018. We had modeled a 30% reduction in the operating expenses, which you know right now we're anticipating that to hold, you know borrowing in some sort of unforeseen circumstance. So I think you know that's kind of the expectation on operating expenses looking forward.
Great! Thanks for taking all my questions.
Thanks Alex.
Thank you.
And moving on, we have a question from Russell Gunther of D.A. Davidson.
Hey, good morning guys.
Good morning Russell.
Good morning Russell.
I just want to follow up on that comments about the commercial pipeline pulling through here. If you could characterize it, is it more of an expectation for originations to pick up and increase the activity or pay down headwinds to ease or if it's some combination of the two you know how would you rate that?
I'm hoping for both.
Got it, and any color you could provide – yeah. 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 you don't pay down less, then that's kind of the nice you know extra tailwind to you there or is it really more – you'd expect pay downs to ease and let things kind of flow through.
Yeah, I would hope pay down’s would ease. I mean one quarter doesn’t have to do the trend, but it was good that it was down instead of up, so you know hopefully we’ll get that. We obviously have less control over you know pre-payments than we do originations. I think you know in our markets we got to work pretty hard to grow at 3% or 4%, that's tough. So you know I don't want to put too much pressure on our commercial team.
You know we're also – you know one, we're in a lower growth markets and number two, we’re very conscious of credit qualities. So you know we’re never going to – it’s very unlikely that we’re ever going to you know deliver commercial loan growth of you know 10% or 80% or 90%. So you know if we can get even 2%, 3% or 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, for the 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 are hoping to pull through, whether you know it’s a 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 – or purchase that syndication for participations. So you know they tend to be high quality credits; they tend to be lesser spreads in very you know high quality customer in business relationship opportunities. So that you know we put our best foot forward and hope for the best and, but if you look at it and 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 you know two or three you know larger credits.
Very helpful. Thanks guys, that’s it for me.
Thanks Russ.
And we'll go to our next question from Erik Zwick of Boenning and Scattergood.
Good morning guys.
Good morning Erik.
Good morning Erik.
First maybe just a follow up on the deposit pricing, our conversation. Are you guys currently running any deposit specials in your markets, and if so what products and at what rates and maturities?
Yeah, we are kind of looking at our customer base and looking at the competition and you know on the retail side we have a couple of you know products that we are offering to our retail customer base and we've been successful holding those in.
You know relative to the rates, you know our cost of funds was up 4 basis points, so you know we're trying to put rates out here that are basically in the market. We don't necessarily – haven’t typically been at the absolute high of the market and you know across all markets we have a pretty broad geography. So you know we're putting our competitive rates out into the market right now and I think we're doing a pretty good job of you know maintaining that deposit base.
The other thing just as a reminder Erik, about two-thirds of our total deposit base is checking and savings accounts that have a cost of funds that round to zero, so you know 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 – an aggressive full scale retail basis, like compete on rates to hold in the majority of our deposit funding, we don't need to do that.
So that’s I guess a benefit and an advantage and what we’ve typically done with kind of the, some of the 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 you know higher rates. We're doing it selectively, but starting from a strong position, the two-thirds of our deposits are checking and savings accounts.
Understood, and then just kind of a record keeping 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?
You know, I would expect 2Q to be not just similar from Q1. You know the slowing in the pre-payments on that portfolio certainly created a little bit of a decrease in the accretion and you know we liked the level of pre-payments knowledge that slowed a bit with that will also you know negatively impact the accretion.
And then just one more for me. With regard to Kinderhook I appreciate the updates on the regulatory and the shareholder approvals. Could you provide any commentary on your expectations for a deposit retention, as well as any – maybe some color on the efforts you’ve made to [Audio Gap] relationships both on the loan and deposit side?
Sure. You know 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 the market. We have spent a lot of time, our people, our team, our leadership, you know in that market getting to know people, getting to meet people, their customers, you know 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 run off in either the deposit franchise or the loan book.
Great, I appreciate the color. Thanks for taking my questions.
Thanks Erik.
And we’ll hear next from Collyn Gilbert with KBW.
Thanks, good morning guys. I just wanted to start off on the gross discussion. You know 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 you know 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 I – you know the first quarter, if we can be flat in the first quarter, I think if you look historically, generally we're kind of flat. Sometimes we're down – actually this time of the year is where we’ve been up a little bit, but I think this year at last is pretty typically historically. You know given where the pipelines are and kind of what I see is the trajectory and the business in our market, I you know would hope that we get that you know lower single digit growth in the organic loan performance you know for the year.
If we can get all in 4% for a year, that’s a pretty good year for us. 2% to 3%, I 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 what 2% to 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 pre-payment. I think we had such, I would say above average prepayments last year than it would seem to me that it almost has to revert to the mean, but that’s not a prediction because I can't predict that, but you know the first quarter was good. Hopefully we get a continuation of that into the second and third quarters where we usually you know 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 – you know if we started flat after the first quarter, you got to grow a little more to get to 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 you know 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 the sort of consumer retail side where you are seeing some opportunities for growth?
Consumer retail, so I'm assuming its more mortgage right, the indirect auto book, it depends on the market. We don’t usually outperform the market and we try not to because that means you are over competing on rates I think.
You know 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 is a lot of opportunity in Vermont also and you know 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 you know $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 that actually is already starting to improve. So I would say that's kind of, I don’t know your question Collyn was beyond the mortgage business, but...
Well, that's helpful and I know on the indirect side right of course the mindfulness to risk and credit, I get it. I just didn't know if there were any you know markets where there is an opportunity for you to you know take share, if the competitive landscape is changing or yeah just thinking more structurally where you can go with some of your businesses from a geographic perspective?
Yeah, I think we have more opportunity in Pennsylvania and I think we'll continue to do better there. The market isn’t growing rapidly. In fact it’s kind of a low single digit growth market, but I think we are executing better in Pennsylvania so we are 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 like I said, we are already starting to do that and I think that the capital district in Albany in that marketplace, we have tremendous opportunity there as well.
So I think there's pockets of opportunity for us you know across the footprint as it relates to mortgage lending and honestly we’ve upped our game in terms of executing across all our markets in that business. So I am hopeful that we will have a productive year in mortgage lending in 2019.
Okay, that's really helpful and then Joe just in terms of the min outlook, so I just 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, that you guys had six basis points of prepayment income?
Yeah, that’s correct. There was a one-time you know fee associated with a particular borrower that was about a $1 million, which was a 6 basis point effect on the loan yields.
Okay, and then if we kind of think about the NIM trajectory kind of for the full year, you know bringing on Kinderhook, I think they were operating close to like a 350 NIM or a little bit 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 370 NIM, that assumed two hikes, two rate hikes. So I just want to kind of get all the blendedness here of some of these moving parts and where you are thinking the NIM will shake out for the full year?
Yeah, I mean, the mid-370s prior to the Kinderhook transaction I think is still a reasonable expectation. You know 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 it’s not off the table yet relative to rate hikes and the impact that we 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, you know that mid-370s range.
You know your right, Kinderhook’s current margins, almost recent margins are a bit lower than ours. It adds about 5% or 6% to our earning asset base, so there is some potentially net reduction in the core margin relatively to the inclusion of Kinderhook. So I think that’s a fair expectation, but it's, you know it's also 6% of our earning assets.
Yeah, okay, okay, that's helpful. And then just finally Mark just back to you on the kind of tying into the growth outlook and you know obviously your capital’s been building you know a little dip post Kinderhook, but then rebuild pretty quickly there after you had indicated you know giving you a lot of capital flexibility. You also outlaid you know thoughts on M&A.
What – is there a trigger or how – you know 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 go back a few years, we were at a similar situation, we were building capital rapidly. And we said at that point in time, that's one of our kind of strategic focuses was effective deployment of that, but I would consider excess capital relative to the, you know the quality of our balance sheet, but we were not going to be in a hurry to do something with it. That we would be patient and disciplined and you know along came the opportunity for merchants and NRS where we deployed $150 million or so of that surplus capital.
I would give the same answers a couple years ago Collyn, which is we are going to be patient and we are going to be disciplined and we are not going to squander the opportunity that we have because we're in the fortunate position of having a surplus capital that continues to accrete and generate you know every day in every quarter, but will 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 a lots of you know dividend capacity as well and if you look at our you know payout ratio right now, despite the fact that we’ve grown the dividend every year for 26 years, you know our payout ratio still you know is not that high relative to you know the organic growth part of our strategic bottle. So between you know dividend capacity and you know M&A capacity, and if you noticed the last three 3 transactions and you know Kinderhook was all cash, just a great utilization of capital. Merchant was 30% cash, about $100 million and NRS was about $70 million in cash.
So even with all that said, if you look at the current capital ratios and metrics, we are still and remain beyond well capitalized, but I would say beyond well capitalized even relative to our balance sheet. So we’ll continue as we do and have for a need to do frankly, because you know it really is all about that, above the average returns shareholders and we're not deploying that capital productively. It’s 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, you know we've been sufficiently active over time in terms of high value M&A opportunities that you know I think we have the model and the ability to execute and identify and effectuate you know those high value transactions over time.
You know we get and I've said this in the past, but we get a lot of looks at a lot of things. Almost everything that comes up, you know within you know a couple of states of us. We kind of know about and get a look at it and those opportunities continue even you know right now. There is also those where we understand our very high value opportunities for us as an institution, so we are more active in our outreach efforts to have that dialogue with others.
So that will continue. We are 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 and deploy that capital in the way that we believe will help further our strategic effort to create growing and sustainable cash flows per share for our shareholders.
Okay, that's great. That's all I had. Thank you.
Thanks Collyn.
Thank you.
And we’ll hear next from Matthew Breese with Piper Jaffray.
Good morning everybody.
Good morning Matt.
Good morning. I just want to follow-up on the NIM discussion. Just I know the outlook is for the mid 370s ex the loans fee, but just think about the moving parts there. I mean a four basis point increase in the cost of deposits are still relatively modest and your new loans that are coming onboard are 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 next 12 to 18 months, at least organically. Is that the right way to think about it?
Yeah, well one comment I would add to that Matt is the – we book about $300 million to $350 million of new loans in the quarter if you look at kind of the historical average. So yeah, it fits nice to pick up you know that 50 basis points we have the last two quarters or so, whereas you know with $8 billion in deposits you know 4 basis points is a bit more meaningful. So I think we have, you know look at the ratio of total deposits versus just the opportunity on new loans; that’s why we are sort of that range of mid 370s.
Right, okay. So you know think the 370 rang is there to hold all else equal, at least for the next few quarters?
Yeah, I mean obviously the changes or you know we have an yield curve that’s kind of static and stays where it is, you know that’s get a little bit more difficult in future quarters, but right now we’ve had some momentum on the loan side of the equation and if we can maintain pricing relative to our competitors you know our expectations are that we will 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 two or three quarters do you think at this point?
Well, we have in variable rate loans, assets, just around a $1 billion. So the impact of the – no, it's a 25 basis point decrease. We would see pretty significant immediate impact to that portfolio. You know obviously we’d have to sharpen the pencil around the entire you know pricing for loans and deposits, but yeah immediately there would be you know a negative impact to those variable rate loans.
Okay, and then just thinking about your deposit based Mark, I think you mentioned two-thirds are checking and savings and if we are at the end of the fed hike cycle, I think you guys have done quite well from deposit beta standpoint.
Just thinking about what's new technology wise this cycle than in past ones. You know one would think that the real deposits might be more at risk, but you guys have clearly demonstrated that you know you can perform very well.
So I guess the question is why might there be more of a mote around your deposit base versus some of the tech -- you know 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, the technology. I would start by saying if you look at – if you look at the things that you know J.P. Morgan can do and Bank of America, and the big Wells Fargo, some of the big you know retail banks, the biggest retail banks in the country.
I think I said this before but if you look at our platform for online and mobile and cash management, there’s very few things that the big bangs can do for customers that we can’t do, you know peer payments and all that kind of things. You know we can do, we can do all that as well, so can a lot of others small banks.
You know I think there is a lot of noise, let’s call it that and excitement in the venture capital funding around kind of Fintech lets all it. To-date what that has involved is creating an online product and paying 235 for it. So you know ultimately your risk maybe because over time of the rates of those platforms, but I still think that certainly in our markets, and I wouldn’t argue with other markets as well that branches still matter.
If you look at J.P. Morgan and what they are doing, they are building branches all over the country. Yes, they are in select markets where they want exposure. But it’s the biggest and presumably best you know bank in the country is building branches all over, I mean what does that tell you about the – you know untimely the direction of these platforms. And I’m not suggesting that that – no, I'm not trying to be a lug eye or suggesting the technology doesn't matter, but I think there is a balance between you know 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 insuring that we are investing in those technology platforms that actually you know could ultimately be detrimental to us if we are not, if we are not participating in some of those kinds of platforms. So I think that – it’s going to have to play out.
You know we will see how it plays out over an extended period of time. You know 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 their online banking, which I think you were the first to came out with we’re 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 you know, I don't know, I think years or something like that. That will probably continue to decline, but I think there is still a very strong business model associated with branch bank. I just thinking you have to be overtime more you know prudent around what your branch 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. You know we don’t want to be first movers in some of these platforms. I don't think there are 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, you know branch part of our business and also relative to the you know the technology part of our business.
We introduced I think was last year a pure kind of outline deposit account opening platform as part of our website and to see really good uptick on that, you know pure online deposited account opening. So we are about to roll out this year a pure online lending platform, again as part of our kind of website not a separate you know platform or separate branded platform.
So our strategy has been to kind of invest in things that are core to our existing platforms, to be sure that yes you can open a deposit account at Community Bank in your pajamas, yes you can apply for a loan at Community Bank sitting in your pajamas at home, but almost 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 or invest or you know 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 you know it’s kind of fascinating that we are now at the end or perhaps at the end of the fed hiking cycling and your cost of deposits is 20 basis points.
The last question that I really had was just around CECL. Any updates were you are in the process and what we might see for that day one reserve, especially considering your loss history over the past 10 years has been very solid?
Yeah, and at this point we are in the process of you know still sort of building and confirming and validating our models. So we are not in a position yet to put out a number, but I think we did point out that you know our reserves are pretty strong at this point, relative to our historical losses. So yeah at this point yes, we are really going to put out, we need to get though our continuation of confirming the models and building out the models and validating it before we – you know we post the number.
Understood. Is it possible that given your loss history we could see your reserve release?
You know, 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.
That's all I had, thank you.
The only think 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 what we have CECL, either way it goes it would be probably less than the average in the industry in terms of the reserve adjustment.
Understood, okay. Thanks for taking my questions.
Thanks Matt.
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.
That does conclude the call. We would like to thank everyone for your participation. You may now disconnect.