Q4 2019 Earnings Call
Thursday Thursday
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Good day, and welcome to the financial institutions. Think fourth quarter 2019 earnings conference call and webcast. All participants will be in listen-only mode should you need assistance, please press conference specialist by pressing the star key followed by zero after today's presentation. There will be an opportunity to ask questions to ask a question. You may press * then 1 month only touch-tone phone to withdraw your question, please press * then two, please note this event is being recorded. I would now like to turn the conference over to Michelle off and director of investor and external relations Executive Vice President and general counsel, please go ahead.
Thank you for joining us for today's call providing prepared comments will be president and chief executive officer Marty Birmingham and Chief Financial Officer. Justin Bigham. They will be joined by Chief Banking and revenue officer Bill kreinberg director of financial planning and Analysis might Grover for the question-and-answer portion of the call. Today is prepared comments and Q&A will include forward-looking statements actual results. May differ materially from looking statements due to a variety of risks and uncertainties and other factors. We refer you to yesterday's Runnings release and historical SEC filings, which are available on our website for a safe harbor description and a detailed discussion of the risk factors relating to forward-looking statements. We will also discuss certain non-GAAP Financial measures intended to supplement and not substitute for comparable gaap measures reconciliations of these non-GAAP measures to get financial measures were provided in the earnings release, which was filed as an exhibit to a form 8-k. Please note that this call includes information is accurate only as of today's date, January 31st, June .
Well now I'll turn the call over.
Thank you. Shelly. Good morning, and welcome to the fourth quarter and year-end earnings call. We are pleased to report another strong quarter with net income of 13.1 million or $0.79 per diluted share pre-tax pre-provision income for the quarter was 16.1 million 2019 was a year of great accomplishment for our company with the highest. Net income and three tax provision income in company history results were driven by many factors, including growth and commercial and residential loans in a positive impact or a balance sheet repositioning including the rotation of Securities into loans and right-sizing our consumer indirect portfolio gains from a timely investment security sell our interest rate swap program expense control and benefits from tax credit Investments, which were a natural extension of our commercial real estate and Community Development programs. Yep.
focused on driving long-term
Little value and are continually seeking opportunities to improve profitability evident in diverse ways. We generated Revenue in 2019.
Growth in total loss was 2% in the quarter with a strong 6.8% increase in commercial mortgage loans and a 2.5% increase in residential loans partially offset by decreases in Commercial Business and consumer indirect.
Or quarter cni volume was lower than expected due to large commercial loans that were expected to close in the quarter, but did not close until after year end.
Consumer in Direct Loans continue to decrease as we maintain our focus on growing relationship based loan categories commercial and residential and scaling back consumer indirect Lending Club, especially outside of our footprint this portfolio decreased by 13.6 million or 1.6% from September 30th, and at quarter-end it comprised 26.4% of our total portfolio down from 29.8% one year ago yield on the consumer indirect portfolio for the quarter was 18 basis points higher than the third quarter of 2019.
totaled
We're Thirty 1 million lower than the end of the third quarter and $189 billion higher than the year-earlier. The decrease from September 30th 2019 was primarily due to public deposit seasonality partially offset by growth and the broker deposit portfolio deposit growth from December Thirty One 2018 was driven by growth in our own public non-public excluding CDs brokered and reciprocal deposit portfolios. We continue to lower our CD rates leading to approximately 15 million in Rome high-cost non-public CDs and quarter. We had another strong quarter of commercial lending interest rate swap transactions resulting in fee income of 1.3 million. This faith-based income category will fluctuate from quarter-to-quarter as is primarily based on the number in value of interest rate swap transactions.
This program was initiated in the fall of 2017 and performance reflects our continued growth in maturity of our Commercial Business.
And now like to take a few minutes to talk about the 2020 launch of two major initiatives first is what we are calling the Enterprise standardization program over the past several months. We've been working with proven wage earners who specialize in near-term self-funding business process Improvement to identify opportunities to improve efficiency while enhancing customer and employee experiences with a value waiting activities and functions across the organization focused on ways to improve operational efficiency and automate low-value repetitive activities using robotic process automation off at this time. I can tell you that we have invested approximately 1 million in professional service expanse in 2019 in connection with this initiative and expect to generate analyze annualized expense savings once implemented within a range of five to seven million. We expect that some of these cost savings will be reinvested in newly-created positions wage.
As we continue to grow and become more.
Sophisticated coupled with the intended build out of our Branch Network in the growth markets of buffalo in Rochester in the coming years. Next is the launch of Five Star Bank digital banking. This platform will completely replace our existing digital platform for Consumer and Commercial customers and will significantly improve the user experience across all devices off. We're working diligently on the project related to this initiative and we'll have more information to provide in the second quarter new features offered will include online account opening capabilities additional money transfer options and enhance and enhance cash Management Services for businesses of all sizes the cash management line of business is important to us and our commercial customers in our cake these reflecting Legacy Community Bank platform have have limited our ability to gather and service commercial deposits. We have developed tremendous sophistication and commercial lending and believed.
new digital platform will allow us to meet that sophistication on the cash management side, but
Yes on a par with much larger Banks.
Most banks of our size are dependent on core banking processors Five Star Bank digital banking is outside of core and represents our first meaningful fintech partnership partnering with a proven fintech provide a differentiated customer experience positioning us to be even more competitive. The digital platform will be more expensive than our existing system, but it is expected to have a payback of less than a year Enterprise standardization in the digital banking platform represent critical transformational and Technology Investments for our organization improving relationships with our customers and enhancing future profitability. Justin will include commentary on the financial impact of the initiatives when he provides our 2020 Outlook. I'll now turn the call back to Justin for additional details on our results in guidance, Justin. Thanks Marty. Good morning everyone. I'll provide commentary on a few key areas with compact.
since to the third quarter of two
The 19 and that interesting, was 33.2 Million up $690,000 compared to the link order.
This was primarily the result of higher average interest-earning assets combined with the impact of net interest. Margin expansion Nim for the quarter was 3.33% about four basis points from the linked quarter. The average yield on interest-earning assets was 4.22% A decrease of 7 basis points cost of funds wage was 89 basis points a decrease of 11 basis points.
Name was positively impacted by 2 basis points in the quarter as a result of unexpected commercial loan prepayments. The remaining name expansion was primarily the result of the October re-cut coupled with higher average public deposit balances that positively impacted our cost of funds as expected provision for loan losses was two point seven million in the quarter of $809,000 from the third quarter, but in line with historical experience and our expectations net charge-offs worth 3.5 million compared to last quarter's 4.6 million.
in the 4th
We had a 1.9 million dollar.
In Commercial Business charge-offs primarily due to 11.5 million dollar loan in the third quarter. We had a $3000000 partial charge off related to a commercial credit that was downgraded in the second quarter. Otherwise our asset quality has remained strong as evidenced by our level of non-performing loans and asset class ratios.
Non-performing loans were eight point six million in the quarter a decrease of 1.1 million allowance for loan losses to Total loans was 95 basis points at quarter-end down five basis points from last quarter and the allowance for loan losses was 353% of non-performing loans compared to 324% at 9:30. Nineteen. Am not interested in, was down 2.7 million in the quarter. The key drivers were first insurance was down $558,000 primarily due to seasonality and the loss of commercial accounts second. We included a net we incurred a net loss on tax credit Investments of 520000 months. And as a reminder, the benefit associated with these tax credit Investments is recorded below the line as a reduction of income tax expense.
next
Will recall that in the third quarter, we benefited from an investment security sale and reinvestment generating 1.6 million in gains compared to a small loss of 44,000 in the current course, these three factors were partially offset by another strong quarter of income from derivative instruments or swop fees, totaling 1.3 million and increase of $371,000 non interest expense was 26.8 Million an increase of $880,000 from the third quarter the largest contributors to this increase where Professional Services expense was up $278,000 because of Consulting and advisory projects primarily in connection with the Enterprise standardization project and digital banking platform and advertising and promotion expense was up $481,000 due to the timing of expenses related to the banks branding campaign.
income tax
Expense was $312,000 in the quarter representing an effective tax rate of only 2.3% expense was positively impacted by federal and state benefits income tax credit Investments placed in service during the quarter resulting in a 2.7 million dollar reduction in tax expense.
Our continued focus on Revenue growth and efficiency results and efficiency resulted in positive operating leverage for 2019.
Now like to spend a few minutes providing our outlook for 2020 in some key areas.
We expect low-to-mid single-digit growth in our total loan portfolio with commercial and residential Loan Production driving the growth.
We expect consumer indirect run off to continue to exceed production with a mid single-digit percentage decrease in the portfolio. We anticipate indirect to compromise between 24 and 25% of total loans by year-end.
We plan for low-to-mid single-digit growth in non-public deposits with growth assisted by the digital banking initiative. We also plan to supplement our deposit growth with a brokerage sweep deposit program.
That will free up collateral allow us to be less dependent on fhlb borrowings and improve liquidity in the form of unused borrowing capacity at the fhlb and what we are currently assuming will be a spot interest rate environment. We are anticipating a quarterly net interest margin of 3.30% to 3.40% resulting in slight expansion in full-year Nim from the fourth quarter of 2019. Run rate are Nim can fluctuate from quarter-to-quarter dead spot interest rate environment given the seasonality of public deposits and its impact on our funding mix.
in quarters, where are
Public deposit balances are higher due to seasonal inflows. Our cost of funds is lower. We also forecast a higher Nim in the latter half of the year as our interest earning assets improves with growth in the loan portfolio as a caveat r&m guidance is highly dependent on both the level of interest rates and the shape of the Curve.
We also project mid single-digit growth in non-interest income excluding gains on investment Securities. We expect the largest drivers of non-interest income to be service charges on deposits and debit card income with this growth supported by the digital banking initiative previously discussed.
We're targeting an increase in the mid single-digit range in not interest expense not interest expense is expected to be elevated in the first half of the Year by the two major initiatives previously discussed benefits associated with these initiatives are anticipated to begin in the back half of the Year. Additionally a full year of FDIC insurance premium is anticipated as FDIC Insurance credits were utilized in the second half of 2019. We anticipate quarterly nine interest expense within a range of 26 to 28 million per quarter with expenses being highest in the first quarter followed by reductions in each subsequent quarter as our birth process Improvement initiatives are implemented in phases over the course of the year.
we also
Expect to continue to see typical quarterly variability in expenses due to the timing of incentive compensation health care expenses and marketing costs long. We anticipate that our efficiency ratio will be within a range of 60 to 61% for the full year with a fourth-quarter efficiency ratio between $57 and 15% We expect our efficiency ratio to be higher in the first half of the Year given the timing of expenses.
We expect that the effective tax rate will be within a range of twenty to twenty 1% which includes the impact of of the amortization of tax credit Investments placed in service in 2019. We will continue to evaluate tax credit investment opportunities and our effective tax rate would be positively impacted by taking advantage of further investment opportunities. We currently expect a provision for credit losses of approximately two to three million per quarter based on current economic conditions wage guidance is based on assumptions for charge-offs and changes in our loan portfolio. It does not assume any changes in provision due to economic conditions under a provision expense will be subject to more volatility depending on changes in the economic forecasts as well as a variety of other factors.
in conclusion
Our 2020 Outlook reflects our continued focus on Revenue growth and expense control resulting in year-over-year positive operating Leverage.
Continuing the Cecil discussion. Let me provide an update on our status and projections for the implementation of Cecil while we are still in the process of validating and finalizing implementation. Our team made significant progress in the fourth quarter current estimates include the potential impact of unfunded commitments individually evaluated loans wage limit Mary qualitative factors and investment Securities as a result of our updated analysis. We estimate that at this point in time and based on current economic conditions and projections the January one twenty-twenty implementation of Cecil could result in an increase of 15 to 30% in our reserve for credit losses.
Given these ranges we would anticipate and after tax cumulative effect adjustment, which would be a reduction to retained earnings of between 4.6 and 9.1 million months just to reiterate we are still finalizing policies controls processes disclosures and other assumptions. These estimates are subject to change upon finalization of our procedures and execution of our internal control framework with that said, I'll now turn the call back to Marty for closing remarks. Thank you Justin. I'd like to propose an overview of the commercial loan and credit environment and our markets first off provide a few thoughts on the commercial real estate. We continue to see a steady and consistent pipeline because we focus on a fairly narrow type of commercial real estate customer with a track record of execution in a portfolio that consistently generates cash flow for our commercial team. It's all about consistency.
We're seeing increased paid on it.
Activity in commercial real estate primarily due to our unwillingness to compete on rate for permanent long-term loans. For example, we had an unexpected $11 payoff from a customer in the fourth quarter the customer refinance with Fannie Mae and a rate and term we would not match our overall cni pipeline remains steady in our expansion into Central New York Region continues to pay off as we now have to lenders there with growing pipelines regarding the credit environment. We are still seeing strong amount of activity quality remains good and we are picking our spots off a strategic Focus for our organization has been and continues to be on the importance of credit discipline and we have not eased our credit standards. We are also still experiencing the benefit of customers more business from virus Banks.
And lastly is important to note that we benefit from operating in a very stable Market not typically subject to cyclic causality.
Our performance ratios continue to strengthen the fourth quarter return on average assets was 1.21% 2 basis points higher than the third quarter of 2019 for the full year. It was 1.14% compared to 95% in 2018 return on average Equity was 11.8% Also two basis points higher than the third quarter for the full year or 11.61% compared to 10.18% in 2018 and RTC ratio increased to 8.5% up 6 basis points from September 13th, 2019 and 90 basis points from your end 18.
as I said my
Opening comments 2019 was a year of accomplishment for our company. We generated strong financial results invested in our customers are communities in our Associates reposition our balance sheet off of profitability and continue to diversify non-interest income. We also made strategic technology and transformation Investments that position us. Well for future success, we are looking forward with anticipation to the launch of both the Five Star Bank digital banking platform and the positive impact of Enterprise standardization initiatives. We believe these investments will help us continue to move our company forward to deliver more value for those we serve and for our shareholders.
Operator this concludes our prepared comments. We're ready for questions. We will now begin the question-and-answer session to ask a question. You may press * then 1 on your touchtone phone. If you were using a speaker phone, please pick up your handset before pressing the keys. If at anytime your question has been addressed and you would like to withdraw your question, please press * then two at this time. We will pause momentarily to assemble our roster. The first question comes from Alex portal of Piper Sandler, please go ahead.
Hey, good morning.
Morning, Alex first off line to ask a couple more questions about the Enterprise standardization program. I think I heard in your prepared remarks that you expect to see around five to seven million worth of savings. I I I'm not sure if that's this year or annually in in sort of the timing and when that's going to come into place and then it also sounds like at least some of that's going to be reinvested and I'm just trying to figure out how much of that overtime will actually drop to the bottom line.
So Alex what I can tell you is that the guidance that I provided incorporates our perspective on those benefits. I can also tell you that it's our expectation that about half of that range. We're going to see in 2019. I'm sorry 2020 with the remaining half in the following year. And as I said, our guidance has incorporated any reinvestment that that's required as a result of that initiative.
And that is also expected to provide additional revenues as well or is it primarily an expense initiative?
Okay.
Well, I think Alex is Bill kreinberg as an example. We expect to create a greater customer experience through this efficiency process. For example, we believe in our mortgage group we can cut down the time from application to Commitment improve communication with our customers, which mad example should drive more sales drive a better wage customer experience. So we will see outcomes like that throughout the standardization project.
Alex and I'll just reiterate from a guidance perspective to help you with your question a little bit further. We've only put an assumption in for what we feel confident we will get and so from a from the perspective of the 5 to 7. You should think about that as being primarily expense oriented.
Great, and then, you know based on kind of what you're saying in terms of the remaining half of the of this cost as being realized in 20 21. Should we expect further efficiency ratio Improvement took one as well down from that 57 to $59 range by the fourth quarter. We haven't we haven't looked at that yet Alex, you know as far as how you should think about it. I mean, every organization is going to experience some expense growth every year. So certainly there's there's going to be some benefit that will see in 2021, but we haven't modeled the impact of that yet.
Okay, and then Marty and your loan guidance commentary for 2020 does that include or or at least contemplate sort of similar levels of pay down to what you've been seeing recently bought a I think it does we have in our planning for 2020 Incorporated a lot of discussion from you know, our lenders up and it does incorporate the current market conditions in the activity that's going on out there.
Okay, and
And just final question for me just as we kind of think about Cecil conceptually over the next couple of years and and kind of coupling with the fact that you have this consumer indirect portfolio. That's becoming a smaller percentage of the overall pie long. Does that suggest that that may be all else being equal just that mix shift alone should cause reserves to come down under the Cecil model over time.
So I mean I think intuitively Alex the way you're thinking about it is the right way to think about it. But just remember that if total loans are growing then our Cecil provision will grow wage. Um, so it is, you know, a loan by loan analysis having said that I think you're right that in direct represents a higher Reserve rate in Cecil than our Commercials Suck. So from a weighted-average perspective, it could start to come down on a weighted-average basis, but the overall Reserve will likely continue to increase as long as we continue to grow our loan portfolio.
Okay, great. Thanks for taking my question.
If you Alex the next question comes from Damon Del Monte, please go ahead.
Hey, good morning, guys. How's it going today? Morning, Damon Damon great. So just a quick question on the margin, you know, Justin, I think you you know, you gave a good range there through Thursday 3:40. Could you just remind us a little bit about the the seasonality of the of the public deposits and when we may see a a little bit of a boost to the margin when you bring the have those lower cost deposits come in Monday sure I can I can help you with that. So our public deposit book as I look at the seasonality of that book. It happens to be we just obviously you've got the back half of the year. We are going to start to see it increase in February . It'll peek out in
March late, March a Peaks and then starts to come back down again. So that's more on a sort of spot balanced perspective. So obviously the average is Trail those those wage spot results, but that is the seasonality and and I think if you look at you know, the commentary we provided in each quarterly call this year. You can expect exactly the same types of seasonality as we've seen this year for future years. Okay, great. It's helpful. And then with regards to the the digital banking component of the two initiatives is the expected benefit from that implementation included in the non-interest income guidance this year. Yes it is. Okay. So when do you expect that up and fully running?
so we're describing it right now at the
Back half of the year. Um, you know, we don't have a specific date that we can disclose at this point. But we are that is what we're targeting right now is the back half of the year and we have put in as weird as we said some benefits associated with it in that time frame got it. Okay, and then just lastly is some modeling standpoint. So the the higher expenses, you know that you're going to see in the first half of the year or relate to these initiatives that's primarily going to be in the Professional Services line, or is it going to be spread into multiple categories like station go up. Are you bringing more people on Thursday things like that? So we're going to see our typical for think about it this way our typical seasonality that we have is going to continue to exist. So in the first quarter of you know, there's going to be increases to our salary and benefits line associated with Merit associated with extra tax expense as a part of the payouts of birth.
You know folks bonuses et cetera FD.
He's coming back as well. And then in addition we will stay at elevated levels associated with what we're paying for these Consultants.
Got it. Okay, great. That's all that I had. Thank you very much. Thank you. Again. If you have a question, please press * then 1 the next question, fenech of hold a group, please go ahead.
Morning, everyone Morning Joe my question on efficiency was answered. But just a couple of others here, I guess party or Justin with the TC ratio being over 8% That's a that's a milestone for you all. Can you talk about what you're thinking optimized ratio would be for you. And once you get there, would you reorder at all the cash management priorities that you have, you know all the things being equal like the price of the stock, you know, assuming that and then also, you know given a slower Pace a loan growth of you're projecting which I'm assuming it will translate to a faster pace of capital build any updated thoughts I guess on on on Capital Management. We've always been comfortable with capitalization of the company Joe and we've tried to be responsive and responsible in terms of the tce ratio and driving the increased number that we we currently sit with today. I think the highest and best use of our capital is to reinvest.
In the business, too.
Port our growth initiatives as you, you know, we'll monitor it closely with our board relative to the priorities of how we allocate capital in light of as you're pointing out our our growth projections, but the highest and best use clearly from my perspective is a continue to invest in the company.
supporting our growth
Okay, and then you all done a nice job transforming the balance sheet the last few years and appreciate the continuation of that with some of the targets that Justin outline. I guess this morning in terms of the loan portfolio mix wage that you're targeting if you look at longer-term, I guess similar question on Capitol optimal mix a balance sheet mix or Revenue mix or however you want to look at and what is your profitability look like at that opt out of balance sheet next. So I guess it's just a simple way of asking it is, you know longer-term targets for for makes and profitability.
So we we haven't really provided longer-term targets for Knicks and profitability. But I mean, you know, we're going to continue certainly for 2020 as described in a Guidance with a focus and I anticipate this Focus will continue beyond 20 20 on relationship business, you know, so the indirect auto business is not a relationship business. We're going to continue to right-size that with a focus on those relationships. So the only other piece of information I could I can give you and feel comfortable giving you is back from a security perspective. We're going to Target eighteen to nineteen percent of total assets for Securities. So we're not necessarily looking to make any changes their life. So from a mix perspective that will obviously, you know, if our assets continue to grow we will need to continue to grow slightly our Securities portfolio.
But from a mix perspective.
I think it's more of the same answer your question Joe. Well, we feel really good about you know, our business model. We've made some Investments strategically. We've got a really strong and high-performing Community Bank where we can deliver education advice and solutions to all of our consumer and Commercial clients and supplement that with the wealth management and you know risk management that our insurance brokerage provide so long, you know that translates is just as talking about into the relationship based activities at the bank level of loans and deposits with core customers as well growing in our non-interest revenues and reducing Reliance on on the name business as we continue to push forward.
Okay. Now I appreciate all that and I guess just the follow up with Cecil and the associated I guess projected impact on provisioning and and and whatever else did that change at all any thoughts on how you want to manage the business longer-term. So for instance the Cecil didn't exist. It kind of felt like after last quarter that the balance sheet transition was, you know, that phase was was done wrong, but maybe you just kind of waiting for the fourth quarter. They're kind of put you know to officially provide projections for for this upcoming year was Cecil coincidental to this next phase of the balance sheet transition, or does it impact your thinking
I don't I think I'm going to address it the way you started with. The question was is Cecil going to change the way we run the business and I think the short answer to that at this time is no God, but I think the entire industry is going to be really interested to see how Cecil impacts banks on a quarter-to-quarter basis particularly is economic forecast change. And then I think there's no I think the banking industry as a whole is going to have to react to that however, they see fit.
Okay, and then last one for me, I guess you know, there's been some guys some pick up and m&a activity in your markets just remind us especially with a little bit more Capital Management flexibility of the m&a strategy and and kind of how you think about m&a for the company.
So we're obviously open to those possibilities and we're well aware of the transactions that have occurred Joe. I think from our perspective. We want to be very disciplined in terms of the pursuit of those transactions those opportunities and making sure that they are incrementally positive in the ways that you would expect them to be relative to appreciate solution and earned back and from our perspective. We feel good about the, you know, execution of our strategic plan for swimming organic growth and wage be relative to the transaction. Just got it. Thank you guys.
Thanks, Joe.
This concludes our question-and-answer session. I would like to turn the conference back over to Marty Birmingham president and chief executive officer for any closing remarks. Thanks operator. I just want to thank everybody for their participation this morning. We'll look forward to continuing to build our dialogue with you and future quarters.
It's a conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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