Community Financial System, Inc. (CBU) Earnings Call Transcript

Good day, and welcome to the Community Financial Systems, Inc.'s Third Quarter 2026 Earnings Conference Call. [Operator Instructions] Please note that this event is being recorded and discussion may contain 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. These statements involve risks and uncertainties that could cause actual results to differ materially from the results discussed. Refer to the company's SEC filings, including the Risk Factors section for more details. Discussion may also include references to certain non-GAAP financial measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures can be found in the company's earnings release. I would now like to turn the conference over to Dimitar Karaivanov, President and CEO. Please go ahead.

Thank you, Chloe. Good morning. Thank you for joining us today. Our company performed very well in the third quarter. As expected, our results accelerated with operating diluted earnings per share increasing 16.5% year-over-year and 9.5% quarter-over-quarter, representing our sixth consecutive quarter of record results. Record revenues and profitability in banking, recurrent revenues and profitability in insurance services, record revenues and profitability and wealth management services. [indiscernible] revenue performance in Employee Benefit Services which was challenged by elevated expenses due to start-up legal costs associated with a number of new fund launches in our collective investment trust business. A couple of items of note. Wealth Management revenue was up 41% year-over-year and pretax earnings were up 42%, driven by both very strong organic performance and the addition of ClearPoint -- we remain very excited about the opportunities ClearPoint is providing us, and we are already seeing tangible client cross-service opportunities with banking. Insurance services revenue was up 8.9% year-over-year, while keeping expenses basically flat, resulting in pretax earnings growth of 41%. As previously mentioned, the M&A activity is really strong, and these results do not yet incorporate the more sizable opportunities we're working on this quarter should they come to fruition. Employee Benefit Services revenue was up 5.6% year-over-year, while pretax earnings were down 3.5% predominantly due to the aforementioned legal expenses. Banking had a very strong quarter with both margin expansion and organic growth. Commercial and consumer lending were all strong. Deposits experienced typical seasonal fluctuations, while liquidity and credit remains a source of strength. I would expect some seasonal slowdown in consumer lending in Q4, plus the impact on demand of higher rates in mortgage and auto lending. The commercial pipeline remains strong, but we also expect some larger payoffs so I wouldn't extrapolate from Q3. As noted, we pulled forward our December securities maturities as we took advantage of the shape of the curve and our own liquidity needs and produced a positive net present value transaction. In addition, we believe that this illustrates the positive dynamics embedded in our balance sheet with over $600 million of securities maturities coming due in 2027. I will now pass it to Marya for more details.

Thank you, Dimitar, and good morning, all. As Dimitar noted, the company's operating performance accelerated in the third quarter. GAAP earnings per share of $1.16 increased $0.12 or 11.5% from the third quarter of the prior year and was consistent with linked second quarter results, including the loss on sales of investment securities recognized in the third quarter in connection with our decision to pull forward our December investment security maturity. Operating earnings per share and operating pretax preprovision net revenue per share were record quarterly results for the company. Operating earnings per share were $1.27 in the third quarter, as compared to $1.09, 1 year prior and $1.16 in the linked second quarter. Third quarter operating PPNR per share of $1.77 increased $0.21 from 1 year prior and increased $0.15 on a linked-quarter basis. These record operating results were driven by a new quarterly high for net interest income and operating noninterest revenues. The company's noninterest income was $143.5 million in the third quarter. This represents a $4.4 million or 3.2% increase over the linked second quarter and a $15.4 million or 12% improvement over the third quarter of 2025 and marks the tenth consecutive quarter of net interest income expansion. The company's fully tax equivalent net interest margin increased 7 basis points from 3.49% and in the linked second quarter to 3.56% in the third quarter, reflective of higher interest earning asset yields and lower funding costs. The increases in net interest income and net interest margin included the accretive impact of the paydown of higher cost overnight borrowings using proceeds from the August 3 sale of $296.8 million of lower-yielding U.S. treasury securities. During the quarter, the company's cost of funds was 1.16% and a decrease of 2 basis points from the prior quarter, primarily driven by lower deposit costs. Operating noninterest revenues increased $8 million or 10.2% compared to the prior year's third quarter and increased $7.4 million or 9.3% from the linked second quarter. The quarter-over-quarter and year-over-year decreases in operating noninterest revenues was reflective of increases in employee benefit services, wealth management services, insurance services and banking noninterest revenues. Our recent acquisition of ClearPoint Trust contributed $2.1 million of noninterest revenue during the third quarter and $2.9 million year-to-date. Operating noninterest revenues represented 38% of total operating revenues during the third quarter, a metric that continuously emphasizes the diversification of our businesses. The company recorded a $5.6 million provision for credit losses during the third quarter. This was consistent with the prior year's third quarter and compares to $4.6 million in the linked second quarter. During the third quarter, the company recorded $141 million in total noninterest expenses, an increase of $3.3 million or 2.4% and from the linked second quarter, an increase of $12.7 million or 9.9% from the prior year's third quarter. The increase from the linked second quarter was due in part to a $1.5 million increase in salaries and employee benefits, driven by 1 additional payroll day and incremental expenses associated with ClearPoint as well as a onetime $0.8 million consulting expense related to the renegotiation of a debit card branding contract. $7.4 million of the increase in total noninterest expenses from the third quarter of 2025 was attributed to salaries and employee benefits primarily due to the incremental costs associated with acquisitions completed between the periods, higher performance-based incentive compensation and medical costs along with the impact of annual merit-based increases. Occupancy and equipment expenses increased $2.6 million from the prior year's third quarter, driven by incremental costs associated with the opening of 7 de novo branches and 3 regional headquarters over the last 12 months along with the 7 branches acquired from Santander in the prior year's fourth quarter. Excluding operating expenses related to acquisitions completed in the last 12 months, Year-to-date, operating noninterest expenses increased $18.7 million or 5.1% from the same prior year period. Ending loans increased $235.2 million or 2.1% during the third quarter and increased $767.8 million or 7.1% from 1 year prior. The increases reflected organic growth in the overall business and consumer funding portfolio. The company's ending total deposits increased $808.3 million or 5.7% from 1 year prior and increased $154.7 million or 1.1% from June 30, 2026. The increase in total deposits during the third quarter was primarily reflective of seasonal inflows of municipal deposits in September. The increase in total deposits over the past 12 months included $543.7 million of deposits assumed from the Santander branch acquisition and $120.1 million of deposits assumed from the ClearPoint acquisition. Moving on to asset quality. The nonperforming loans ratio increased 2 basis points and the loans 30 to 89 days delinquent ratio increased 9 basis points from last quarter, but remained strong compared to the industry. The net charge-off ratio increased 6 basis points from the linked second quarter due to $2.7 million of charge-offs recognized in the third quarter of 2022 and on 2 individually assessed business lending relationships for which specific allowance allocations had previously been established. The company's allowance for credit losses was $92 million or 80 basis points of total loans outstanding at the end of the third quarter, an increase of $0.3 million during the quarter. The allowance for credit losses at the end of the third quarter represented approximately 7x the company's trailing 12-month net charge-offs. Looking forward, we believe the company's diversified revenue profile, strong liquidity and historically good asset quality, provide a solid foundation for continued earnings growth. With that, I would like to provide an update to our expectations for full year 2026 as we enter into the fourth quarter. We continue to expect 3% to 4% growth in deposit balances. 6% to 7% growth in noninterest revenues and an effective tax rate between 23% and 24%. As Dimitar noted, we expect loan growth to moderate in the fourth quarter, driven by some seasonal slowdown in consumer lending as well as some larger commercial loan payoffs. As a result, we now expect full year 2026 loan growth of 5% to 5.5%. We expect the full year 2026 provision for credit losses to be in the range of $22 million to $25 million. Factoring in the accretive impact of the August sale of $296.8 million of lower-yielding U.S. treasury securities we now expect 11% to 11.5% growth in net interest income and for net interest margin to exit 2026 in the mid- to high 3.5% range. Near-term margin pressure is possible if higher market rates dampened loan demand and pressure deposit rates. Core noninterest expenses are expected to be in the range of $553 million to $557 million or an increase of 7% to 8% from 2025. This includes approximately $8 million to $9 million of incremental expenses associated with the branches acquired from Santander and approximately $4 million to $5 million of incremental expenses including nonoperating intangible asset amortization and the impact of certain onetime items. These estimates do not include the impact of pending or future acquisitions. That concludes my prepared earnings comments, and Dimitar and I will now take questions. Chloe, I will now turn it back to you to open the line. Thank you.

[Operator Instructions] The first question today comes from Steve Moss with Raymond James.

Maybe start off on loans here. Just kind of curious, I hear you on moderation in auto and mortgage. Just curious with regard to how to think about the commercial loan pipeline and what you're seeing for strength or weakness there just given larger costs.

Yes. Steve. The pipeline is strong. It is pretty comparable to where it was last quarter, which means that it's close to its Primark. Activity is solid. So there's really -- just in terms of origination, there's really nothing to be concerned about. We just know that we've got a couple of larger payoffs, which is not the worst thing that can happen to a loan. So we're going to absorb those and we're going to replace them in the fourth quarter. And depending on timing, depending on closings, we feel that the ranges we provided is the operating range.

Got it. And then also just curious, what are you guys seeing for loan pricing these days and competition in the market?

Yes. So I think in the last couple of months, our blended originations have been right around 6.6%, and this is kind of across all portfolios. We talked about earlier this year that the pricing and auto was just frankly silly and we didn't participate as much -- it's gotten a little bit better. It's not exactly where we want it to be, but it's a little bit better. So we're not probably going to see much growth in that side of the house. mortgages are certainly -- you're seeing things in high 7s and even and mortgage products that has an impact on demand -- we've seen that. I think it's across the board. I'm confident we're going to do better than most other folks. We are very purchase-focused shop, and we have multiple products and solutions for folks. But ultimately, the payment does go up as rates go up. So that will be quieter than expected, certain the pipeline is lower than it was kind of at the end of the second quarter, and it's not also the best season for for mortgages. And then on the commercial side, I think trending kind of in the high 6s, we've had to reintroduce #7 in certain situations. It is competitive, but we feel like we've got a very nice broad footprint and multiple products to be successful and originate a good pace.

Okay. Great. Appreciate all that color there. And then maybe just on the fee-based businesses. Dimitar, you hinted at the potential acquisitions -- just kind of curious, is there any particular line of business you guys are maybe more focused on at the moment for acquisitions? Or any color you could shed there?

Yes. Our acquisition pipeline is robust as it relates to insurance, in particular. And we've talked about this a little bit from the prior calls. This year, while the organic growth has been challenged for multiple reasons. We've both seen some kind of sanity return in terms of pricing on the MA side. And we've made up some ground year-to-date. We were down in the first quarter of almost 10% year-over-year. We narrowed down to 6.5%. Now we're kind of in the low 3% year-over-year, and we think we've got good opportunities to continue both on the M&A side and the organic side in the fourth quarter and narrow that gap. So I mentioned last quarter that if everything that we're working on transpires we're going to be very well positioned for 2017 on the insurance side. And knock on wood, I think we're still on very good track there for robust growth in '27.

The next question comes from David Konrad with KBW.

Quarter. A lot to talk about the balance sheet and maybe embedded in your NIM guide for the fourth quarter. I mean, it looks like on an average basis, you brought cash down, which may have may have helped funding costs, but now post-security sales, cash is pretty elevated versus last quarter. So I guess the first question is what do you think the use of cash will be in the fourth quarter? And then maybe also, what do you anticipate the deposit beta being?

David. So I think what you're seeing on the balance sheet as it relates to the cash position, it's really more driven by the seasonality that we have in terms of predominantly in the municipal side of our deposit base -- there is some seasonality clearly also in the general deposit basis, people spend money for vacations during the third quarter. So Usually, in the third quarter, we see the kind of the -- some of those personal deposits flow out and certainly the municipal deposits flow out in the third quarter. then they come back at the end of the third quarter and into the fourth quarter as people are making their payments across our footprint. So that's really what's driven that cash position. We talked last call that we expect it to be in a higher wholesale borrowing position that didn't transpire during the quarter to your point because we sold off some of our security maturities -- so we funded that position and growth during the quarter for our securities portfolio. And then in terms of beta, David, really hard to tell. -- it's very early. This is the kind of the -- I don't know if we're going to have more rate hikes. Is this going to be 1 and done. It's going to be a couple, when they're going to happen. I think just in terms of how we've been approaching it throughout the year, you can see we have driven costs down as we've optimized volume versus rate -- on the deposit side, we certainly have a lot of strength in our liquidity position to allow us to do that. We have reengaged a little bit on some of the CDs this quarter -- so that might push the numbers up a little bit. We'll see we're by far not the most aggressive person in that market, but it's higher than before. At the same time, we kind of on the core accounts, we haven't really touched any rates -- so very hard to tell how it's going to shake out during this quarter.

Okay. And then second question with the going into next year with the $600 million of cash flows off the bond book. Would that be more -- would you more like to optimize that and the loan -- funding loan growth and maybe further reducing borrowings? And I guess, remind me where you would prefer securities any assets fee as a target?

Yes, I think if you just kind of look at what our balance sheet needs are, we would probably target to have securities to assets closer to kind of high teens to 20% as opposed to where they are today. So as you can do the math, that's a lot of securities current on the balance sheet that will be used in much more productive ways going forward. As it relates to the maturities in 2027, we have about $150 million of borrowings that are going to mature as well. [indiscernible] be borrowings kind of in the middle of the year. So that will be a use for some of those cash flows, certainly loan growth. And just to provide a little bit more color on how we think about what we did this quarter versus opportunities going forward in terms of accelerating some of those maturities. It has to be a positive present value transaction for us, right? So if you think about what we did in August, -- we had 5 months left on those treasuries until they mature. So in other words, can we do cash flows sooner than the $3 million loss and the math just worked and actually got even better as rates went up. So we think that open period is much tighter than the 5 months of maturity. So if we have similar opportunities in 2027. We're certainly going to keep an open eye towards those to fund growth and maybe not have to be as active on some of the more pricey deposit side.

The next question comes from Manuel Navas with Piper Sandler.

So you have deposits coming from ClearPoint Santander over the year. You had some seasonality this quarter. How has the de novo branches doing? Can you just have a kind of an update there and what type of costs are coming in from there. [Technical Difficulty]

Pardon ladies and gentlemen, it appears we have lost the connection to our speaker line. Please standby while we reconnect. Thank you. Pardon me, I have rejoined our speakers. You may begin again.

Okay. Thank you, Chloe. Apologies, everybody, we got disconnected somehow. Manuel, you we were just in the midst of your question, so sorry for that.

Sorry. So I was kind of asking for an update on the de novo branches. You've seen a lot of that year-over-year deposit growth was Santander and ClearPoint -- just kind of wanted to 0 in on how the Denovo branches are doing? What's kind of the deposit costs there? Any kind of update there?

Yes. So on the de novo branches, as of basically yesterday, we said that roughly $175 million in deposits in those. So we're very encouraged -- we've mentioned previously that our goal for here was to get to $200 million. And I think we're going to have a pretty good shot of being somewhere around there. The majority of the deposits in those branches have been and continue to be and likely will be for a little bit commercially focused. So I don't have the exact number, Manuel on costs, but you can imagine that some of those are higher cost than the traditional retail. The retail is going to build over time. But more importantly, as we look at our aggregate deposit costs, you've seen those have continued to come down.

All right. That's great. You gave a little bit of color that the insurance business is catching up. You have some M&A possibilities there all kind of drive to potentially a better outlook for next year in insurance. Can you just talk through employee benefit services and wealth management into next year as well?