Community Financial System, Inc.

Welcome to the Community Bank System Second Quarter 2020 Earnings Conference Call. Please note that this presentation contains forward-looking statements within the provisions of the Private Security Litigations 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. detailed in the company's annual report in Form 10-K, followed with the Securities and Exchange Commission. Today's call presenters are Mark Cherninsky, President and Chief Executive Officer, and Joseph Cesaris, Executive Vice President and Chief Financial Officer. They will be joined by Joseph Cesaris, Executive Vice President and Chief Banking Officer for the question and answer session. Gentlemen, you may begin.

Thank you, Cole. Good morning, everyone, and thank you all for joining our Q2 conference call. We hope all of you and your families are well. Like most banks, we had a busy quarter that revolved around PPP, loan deferrals, and for us, an acquisition as well. We provided nearly $500 million of PPP loans for our customers and granted $700 million of deferrals. One of the most significant impacts of the quarter was the change in our balance sheet. which grew by over $1.6 billion from a combination of PPP, the Stubent acquisition, and significant stimulus-induced deposit growth. Not surprisingly, organic loan growth was negative for the quarter. Despite granting $700 million of loan deferrals over the past two quarters, total active deferrals as of Friday were down to $150 million, and requests for a second deferral had been very limited, which we hope is good news for the future. We're certainly starting from a very good point given current credit metrics, but don't expect to necessarily sustain these levels as we move into the second half of the year. Operating earnings were actually pretty good for the quarter, as Joe will discuss in further detail, with operating PPNR up from both this last quarter and last year's Q2. Encouragingly, our benefits, wealth, and insurance businesses are all up year-to-date over last year on both a revenue and an earnings basis. The Stubent acquisition closed on June 15th with the conversion and integration going nearly flawlessly. We were excited about this in-market transaction and the further strengthening of our Western New York footprint. Loan and deposit retention has both been almost 100%, and we got three consolidations done there already, so we're off to a very good start. Looking forward to the remainder of the year and into 2021, it's all about three things in my view. credit, the economic environment, and interest rates. It's too early to forecast this credit cycle, but we should get more visibility in the second half of the year. We're starting from a position of strength not just with respect to credit, but also as it relates to earnings, capital, and liquidity. The economic environment is equally subject to uncertainty, but we did see significant improvement in consumer activity in the last half of the quarter. The question for me is not just the near-term challenges and severity, but more the longer-term impact on consumer and business behavior and the ultimate demand for financial products and services. And we all know the current interest rate environment has the potential to create continued margin challenges going forward. It's hard to predict whether stimulus or inflation will ultimately prevail, but the current rate environment will make it increasingly more difficult for banks to deliver earnings growth. Despite these forward uncertainties and challenges, I think CBSI is in extremely good stead. As I said last quarter, there is no substitute for earnings, liquidity, capital, asset quality, core deposits, and revenue diversification. When I look at the fundamental financial strength of this company, I remain highly confident that we are well prepared to manage the challenges that lie ahead and to capitalize on the opportunities that are created as a result.

Joe? Thank you, Mark, and good morning, everyone. As Mark noted, the earnings results for the second quarter of 2020 were solid in spite of the challenges related to the COVID-19 pandemic. The company recorded 66 cents in fully diluted gap earnings per share for the second quarter, excluding 5 cents per share for acquisition-related expenses net of tax effect and 5 cents per share for acquisition-related provision for credit losses net of tax effect due to the Steuben acquisition. Fully diluted operating earnings per share were 76 cents for the quarter. These results are $0.04 per share lower than the second quarter of 2019 operating earnings per share of $0.80 due largely to the COVID-19 pandemic and its related impacts on the company's operations. The company recorded $6.6 million in its provision for credit losses, exclusive of acquisition-related provision in the second quarter of 2020, reflective of expected credit losses due to weak economic conditions. The company's adjusted pre-tax, pre-provision net revenue increased 5 cents per share, or 4.9%, between comparable annual quarters, and 3 cents, or 2.9%, on a linked quarter basis. I will next touch on the Steuben acquisition and the company's balance sheet before providing additional details on the company's earning performance for the quarter. On June 12, 2020, the company acquired Steuben Trust Corporation and its banking subsidiary, Steuben Trust Company, for a combination of stock and cash representing total consideration valued at approximately $98.6 million. The acquisition extended the company's footprint into two new counties in western New York State and enhanced the company's presence in four western New York State counties in which it currently operates. In connection with the acquisition, the company consolidated three former Steuven branch offices into existing community bank branch offices and added 11 additional full-service offices to its current network. The company acquired total deposits of $516.3 million and total loans of $339.7 million in connection with the transaction. The company closed the second quarter of 2020 with total assets of $13.44 billion. This is up $1.64 billion or 13.8% from the end of the linked first quarter and up $2.7 billion or 25.1% from a year earlier. The very large increase in total assets over the last 12 months was driven by the third quarter 2019 acquisition of Kinderhook Bancorp, the second quarter 2020 acquisition of Steuben, large inflows of government stimulus-related funding, PPP originations, and other organic balance sheet growth. Similarly, average interest earning assets for the second quarter of 2020 of $11.11 billion was up $1.07 billion or 10.6% from the link quarter of 2020, and up $1.68 billion or 17.8% from one year prior. Ending loans at June 30th, 2020 were $7.53 billion. This was up $661.9 million or 9.6% from the end of the first quarter and up $1.24 billion or 19.8% when compared to June 30th, 2019. The company acquired $339.7 million of loans in the student acquisition and originated $492.4 million of PPP loans. Exclusive of these activities, the company's outstanding loan balances decreased $170.2 million or 2.5% during the quarter, due largely to a significant slowdown in business activities and the pandemic-related shutdown of non-essential businesses in the company's northeast markets. At June 30, 2020, the carrying value of the company's available for sale investment securities portfolio was $3.29 billion. This includes net unrealized gains of $163.1 million, up from $155.3 million in net unrealized gains at March 31, 2020, and $36.3 million in net unrealized gains a year earlier. The effective duration of the company's investment securities portfolio was 3.3 years at June 30, 2020. The company maintained average cash equivalents during the second quarter of 2020 of $823 million. This is up $708.3 million, or 618% over the linked first quarter, and $488.7 million, or 146% over the second quarter of 2019. The very large increase in cash equivalent balances was due to large inflows of government stimulus funding driving up the company's deposit liabilities, which in turn were invested in overnight Fed funds at an average yield of 10 basis points during the quarter. The very large increase in cash equivalents during the quarter placed a significant drag on the company's net interest margin and return on asset metrics in the second quarter. Average sold deposits were up $1.05 billion, or 11.6%, on a linked quarter basis due to Stuban and Stimulus and $1.61 billion, or 19%, over the same quarter last year due to Stuban, Stimulus, and Kinderhook. As Mark noted, we believe the company's capital reserves and liquidity, along with diversified revenue streams, a strong credit record and experienced management team, leaves us well prepared to endure the impacts of the COVID-19 pandemic. The company's net tangible equity to net tangible assets ratio is 10.08% at June 30, 2020. This was down from 10.78% at the end of the first quarter and 10.56% from one year earlier due primarily to a significant increase in assets. The company's Tier 1 leverage ratio is 10.79% at the end of the second quarter, which remains over two times the well-capitalized regulatory standard of 5%, while the company's Tier 1 risk-based capital ratio, total risk-based capital, and common equity Tier 1 capital ratios were 17.1%, 18%, and 16.1%, respectively, reflective of the company's lower risk asset base and high levels of regulatory capital. The company has an abundance of liquidity resources and is extremely well positioned to fund future loan growth. The company's funding base is largely comprised of low-cost core deposits. At June 30, 2020, checking and savings accounts represented 71.7% of the company's total deposit base. The company's cash and cash equivalents net afloat in the reserves totaled $1.25 billion at June 30. Total borrowing availability at the Federal Reserve Bank was $259.8 million, and total borrowing capacity at the Federal Home Loan Bank was $1.8 billion. Available for sale investments, securities portfolio was valued at $3.29 billion, $1.62 billion of which was available for pledging if needed. In total, these sources of immediate liquidity exceeded $4.9 billion. The company recorded total operating revenues of $144.9 million in the second quarter of 2020, This represents a $0.8 million or 0.5% increase over the second quarter of 2019, excluding net gains on securities of $4.9 million. A $3.7 million or 4.1% increase in net interest income between comparable quarters were partially offset by a $2.8 million or 16.5% decrease in banking non-interest revenues and a slight decrease in financial service business revenues. The increase in net interest income was due to a $1.7 billion or 17.8% increase in average earning assets between the periods offset in part by a 43 basis point decrease in net interest margin, a decrease in market interest rates, and a significant increase in change in the composition of earning assets, including a $488.7 million increase in average cash equivalents between the periods negatively impacted the company's net interest margin. Total revenues were down $3.8 million or 2.5% on a link quarter basis, The company recorded a $4.3 million or 24.7% decrease in deposit service revenues and a $1.9 million or 4.8% decrease in financial services business revenues between the linked quarters, offset in part by a $1.9 million or 2.1% increase in net interest income and a $0.5 million or 50% increase in mortgage banking revenues. Interest income and fees on loans was up $4.7 million or 6.3% over the comparable prior year quarter due to a $924.7 million or 14.7% increase in average total loans outstanding and $2.9 million of PPP-related interest and fee income partially offset by a 33 basis point net decrease in the average loan yield. The increase in average outstanding loan balances was due to the Kinderhooker acquisition in the third quarter of 2019, pre-COVID organic loan growth, the Steuben acquisition in the second quarter of 2020, as well as a significant increase in business lending due to $492.4 million of PPP loan originations during the quarter. Interest income on investments, including cash equivalents, decreased $1.8 million, or 8.9%, between the second quarter of 2019 and the second quarter of 2020. The decrease is reflective of lower market interest rates, a significant increase in the proportion of low-yield cash equivalent balances, and a $0.8 million decrease in the company's Federal Reserve Bank semi-annual dividend payment, offset in part by a $265.2 million, or 9.5% increase in the average book value of investment securities. Interest expense was $0.8 million, or 13.4% lower than the previous year's second quarter, driven by a nine basis point decrease in the cost on interest-bearing liabilities, partially offset by a $971.9 million, or 15% increase in average interest-bearing liabilities. The average cost of deposits was 17 basis points in the second quarter of 2020, as compared to 22 basis points in the second quarter of 2019, reflective of market-driven rate decreases for deposits between the periods and significant increases in non-interest-bearing deposits. By comparison, the average cost of deposits during the first quarter of 2020 was 25 basis points. The company recorded $9.8 million in the provision for credit losses during the second quarter of 2020. This was comprised of $3.2 million of acquisition-related provision due to the Steuben transaction and $6.6 million of provision related to expected credit losses largely due to the COVID-19 pandemic. Net charge-offs for the quarter were $0.9 million. This compares to $1.4 million in the provision for credit losses and $1.2 million in net charge-offs recorded during the second quarter of 2019. On a linked quarter basis, the provision for credit losses exclusive of the acquisition-related provision increased $1 million due to weaker economic forecasts and the continued financial hardship experienced by certain segments of the company's loan customers. The company recorded $52.9 million in non-initiative revenues in the second quarter of 2020, as compared to $55.8 million in the second quarter of 2019, excluding $4.9 million of investment security gains. This represents a $2.8 million or 5.2% decrease in non-interest revenues between the periods, $2.7 million of which is attributable to a decrease in banking-related non-interest revenues. The significant decrease in banking non-interest revenues was due to a $4 million decrease in deposit service and other banking revenues offset in part by a $1.2 million increase in mortgage banking revenue. The decrease in deposit service and other banking revenues was driven by a precipitous drop in deposit transaction activity due to the mandated shutdown of non-essential businesses in the company's northeast markets during the quarter. Employee benefit service revenues for the second quarter of 2020 were $0.3 million or 1.2% higher than the prior year's second quarter due to increases in plan administration, record keeping, and actuarial service fees. Insurance service and wealth management revenues were down $0.4 million or 2.4% from the same quarter last year. Total non-interest revenues decreased $5.7 million or 9.7% on a one-quarter basis. This was driven by a $4.3 million or 24.7% decrease in deposit service and other banking revenues. a $1.3 million or 5.1% decrease in employee benefit service revenues, and a $0.7 million or 10.8% decrease in wealth management revenues, partially offset by a $0.5 million or 50% increase in mortgage banking revenue and a slight increase in insurance service revenues. Excluding acquisition expenses, operating expenses decreased $2.5 million or 2.7%, from 90 million in the second quarter of 2019 to 87.5 million in the second quarter of 2020. The decrease in operating expenses between the periods was largely attributable to the decreased levels of business activities due to the COVID-19 pandemic. Business development and marketing expenses decreased $1.6 million, or 52.1%, between the periods. Other expenses decreased $2.1 million, or 33.6%, driven largely by decreases in employee business expenses. Salaries and employee benefits expenses increased $0.7 million or 1.3%, but benefited from a $0.8 million or 21% decrease in employee medical expenses due to the reduced provider utilization. On a combined basis, data processing and communications expenses, legal and professional expenses, and occupancy and equipment expense increased $0.9 million or 4.2% between the comparable quarterly periods. Intangible asset amortization, Expense decreased $0.4 million or 9.7% between the periods. On the late quarter basis, total operating expenses excluding acquisition expenses decreased $5.8 million or 6.2%, primarily due to a $3.6 million or 6.1% decrease in salaries and employee benefits, a million dollars or 9.2% decrease in occupancy and equipment expense, and a $1 million or 40.2% decrease in business development and marketing expenses. The effective tax rate for the second quarter of 2020 was 20.3%, up from 20.2% in the second quarter of 2019 and 18.8% in the first quarter of 2020. From a credit risk and lending perspective, the company has taken actions to identify and assess its COVID-19-related credit exposures based on asset class and borrower type. With respect to the company's lending activities, the company implemented a customer forbearance program to assist with both consumer and business borrowers that may be experiencing financial hardship due to COVID-19-related challenges. At June 30, 2020, approximately $700 million, or 9.3% of the company's outstanding loan balances, were under active COVID-related forbearance. As of last week, the outstanding loan balances under active forbearance dropped below $150 million. The company anticipates at the end of the third quarter the number of active forbearance agreements will decrease further, but the number and amount of delinquent loans will likely rise. At June 30, 2020, non-performing loans decreased to 0.36% of total loans outstanding. This compares to 0.39% of total loans outstanding at the end of the second quarter of 2019 and 0.46% at the end of the first quarter of 2020. Total delinquent loans, which includes non-performing loans and loans 30 or more days delinquent to total loans outstanding, were 0.72% at the end of the second quarter of 2020, This compares to 0.87% at the end of the second quarter of 2019 and 1.11% at the end of the late first quarter of 2020. The delinquency status for loans on payment deferment due to the COVID-19 financial hardship were reported at June 30, 2020, based on their delinquency status at the end of the first quarter and less subsequent to March 31, 2020. The borrower made all required past due payments to bring the loan to current status. The company's allowance for credit losses increased from $55.7 million or 0.81% of total loans outstanding at March 31st, 2020 to $64.4 million or 0.86% of total loans outstanding at June 3rd, 2020. The $8.7 million increase in allowance for credit losses included $3.6 million in additional reserves due to the Steuben acquisition and $5.1 million due primarily to expected COVID-19 pandemic related losses. The allowance for credit losses at June 30, 2020 represented approximately 10 times the company's trailing 12-month net charge-offs. Looking forward, operationally, we will continue to adapt to the changing market conditions and remain very focused on asset quality and credit loss mitigation. We anticipate assisting the substantial majority of the company's PPP borrowers with forgiveness requests during the third and the fourth quarters of 2020. The eligibility of the borrower's forgiveness request and the SBA's ability to provide loan forgiveness in a timely manner is uncertain at this time. For these reasons, it is uncertain as to the timing for which the company's remaining $13.1 million in net deferred PPP fees will be recognized through the income statement. It seems likely that the pandemic will continue to negatively impact the level of business activity and employment. These factors will continue to adversely affect certain borrowers' ability to service debt and may increase loan delinquency and credit losses levels for the remaining two quarters of 2020 and potentially beyond. Loan demand may be impaired by weak economic conditions. We're also uncertain as to whether or not the high level of deposit liabilities will be maintained, spent down, or increased further by additional stimulus. We do expect the company's deposit service revenues to increase slightly in the third quarter, barring another shutdown of non-essential businesses in the company's market footprint. Although we will remain focused on containing operating expenses, it is likely that they will increase in the third quarter as the company has resumed certain marketing and business development endeavors. The company's dividend capacity remains strong. Accordingly, the company expects to continue to pay a quarterly dividend consistent with past practice. Undoubtedly, the COVID-19 crisis has changed the near-term outlook for society in general as well as the expectations around economic conditions. With this said, we will continue to support our stakeholders in a thoughtful, disciplined, and compassionate manner and believe the company is well prepared to endure its impacts. Thank you. I will now turn it back to our host, Cole, to open the line for questions.