Community Financial System, Inc.

Welcome to the Community Bank System Fourth Quarter 2020 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 predictions 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 Trenisky, President and Chief Executive Officer, and Joseph Sitaris, Executive Vice President and Chief Financial Officer. They will also be joined by Joseph Serbin, Executive Vice President and Chief Banking Officer for the question and answer session. Gentlemen, you may begin.

Thank you, Tom. Good morning, everyone, and thank you all for joining our fourth quarter conference call. Joe will do a deeper dive on Q4, so I'll start with a couple of brief observations and then comment on 2020 as a whole. Fourth quarter earnings and operating performance were just fine. No surprises. It was about as we expected. operating earnings were up a few pennies over last year's fourth quarter and a penny better than Q3, so modest forward progress. Loan growth was slightly negative in the quarter, not atypical, but deposits just continued to grow, similar to others, and were up $100 million for the quarter. Asset quality continues to be very good. We did report a spike in NPAs because of a policy judgment around deferrals that Joe will explain further. 2020 as a whole was certainly a challenging year. However, operating earnings were only off 5 cents or 1.5% from 2019. In hindsight, that's much better than we were expecting earlier in the year. There are a lot of moving parts in the reconciliation between the years due to the pandemic, but there was a significant negative impact from the decline in our core margin and our retail banking revenues, which we were able to offset in a number of other ways, principally operating expense reductions and performance of our non-banking businesses, all of which had a tremendous year. The pre-tax operating earnings of our benefits business was up 11%. Wealth was up 13%, and insurance was up 16%. The value of a diversified revenue model was readily apparent in 2020. From an operational perspective, it was an extremely productive year, despite the challenges of the pandemic. We developed and implemented several new digital products and platforms. We consolidated 13 branches, and we closed on the acquisition of Steuben Trust in the second quarter. So I'm relatively pleased with 2020 overall and our forward progress, pandemic notwithstanding. Looking ahead to 2021, our focus will be on effectively countering ongoing margin pressure, improving organic performance, continued growth and investment in our non-banking businesses, and a continuation of our investment in digital and rationalization of analog. I also expect the strength of our earnings, balance sheet, and capital generation will serve us well going forward as we continue to evaluate high-value strategic opportunities across our businesses for the benefit of our shareholders.

Joe? Thank you, Mark, and good morning, everyone. As Mark noted, the earnings results for the fourth quarter of the 2020 were very solid, especially in light of the economic challenges and industry headwinds we faced throughout the year. The company recorded 86 cents in fully diluted gap earnings per share for the fourth quarter, excluding acquisition expenses, acquisition-related provision for credit losses, unrealized gain on equity securities, and gain on debt extinguishment net of tax effect. Fully diluted operating earnings per share were 85 cents for the quarter. These results match third quarter 2020 results and were two cents per share higher than the fourth quarter of 2019, fully diluted operating earnings per share of 83 cents. The company recorded total revenues of $150.6 million in the fourth quarter of 2020, an increase of $0.8 million or 0.5% from the prior year's fourth quarter. The increase in total revenues between the periods was driven by an increase in net interest income, higher non-interest revenues in the company's financial services businesses, and a gain on debt extinguishment offset in part by a decrease in banking-related non-interest revenues. Total revenues were down $2 million, or 1.3%, from the linked third quarter, driven largely by a $4.8 million decrease in mortgage banking revenues as the company pivoted from selling its secondary market-held residential mortgage loans during the third quarter to holding them for its own portfolio in the fourth quarter. The company recorded net interest income of $93.4 million in the fourth quarter, up $0.7 million, or 0.7%, over the fourth quarter of 2019. The increase was driven by a $2.28 billion, or 22.7% increase in average earning assets between the periods, offset in part by a 66 basis point decrease in net interest margin. The company's fully tax equivalent net interest margin was 3.05% in the fourth quarter of 2020, as compared to 3.71% in the fourth quarter of 2019. Net interest income increased $0.5 million, or 0.5%, over the length third quarter, while net interest margin was down seven basis points. During the fourth quarter, the company recorded $3.5 million of PPP-related interest income as compared to $3 million of PPP-related interest income in the third quarter of 2020. At December 31, 2020, remaining net deferred fees associated with the 2020 PPP originations were $9 million, the majority of which the company expects to realize through interest income in 2021. Non-interest revenues were up $0.1 million, or 0.1% between the fourth quarter of 2019 and the fourth quarter of 2020. Employee benefit services revenues were up $1.7 million, or 7%. from $25 million in the fourth quarter of 2019 to $26.7 million in the fourth quarter of 2020, driven by increases in plan administration record-keeping revenues and employee benefit trust revenues. Wealth management insurance services revenues were also up $1 million or 7.3% over the same periods. These increases were partially offset by a $2 million or 11.2% decrease in deposit service and other banking fees due to lower deposit-related activity fees, including overdraft occurrences. We recorded $0.9 million loss on mortgage banking activities in the fourth quarter of 2020 as compared to a $0.2 million gain during the fourth quarter of 2019, resulting in a $1.1 million decrease between the periods due to the change in the company's mortgage banking strategy as known previously. Finally, during the fourth quarter of 2020, We redeemed $10 million of support data notes acquired in connection with the 2019 acquisition of Kendrick of Bancorp and recorded a $0.4 million gain on debt extinguishment. The company recorded a $3.1 million net benefit in the provision for credit losses during the fourth quarter of 2020. This compares to a $2.9 million provision for credit losses during the fourth quarter of 2019. The net benefit recorded in the... provision for credit losses was driven by several factors, including a $2 million reversal of a previously recorded allowance for credit losses and a purchase credit maturated loan, a significant improvement in the economic outlook, and a substantial decrease in loans under COVID-19-related forbearance agreements, offset in part by anticipated increases in non-performing assets and the related specific impairment results on those non-performing assets. For comparative purposes, the company recorded $1.9 million in the provision for credit losses during the third quarter of 2020, $9.8 million in the second quarter of 2020, including $3.2 million of acquisition-related provision for the credit losses due to the acquisitions we've been, and $5.6 million of provision for credit losses during the first quarter of 2020. During the first two quarters of 2020, financial conditions deteriorated rapidly as state and local governments shut down a substantial portion of business activities in the company's markets and an unemployment-level spike. These conditions drove the company to build its allowance for credit losses during the first two quarters of 2020 to account for the expected lack of loan losses and loan portfolio. During the third quarter, the economic outlook remained unclear as markets were uncertain as to the efficacy, approval, and rollout of the COVID-19 vaccines. With a greater than anticipated decline in actual unemployment levels, as well as the federal government's approval of the COVID-19 vaccine and Congress's recent approval of the additional federal stimulus funding, The near-term economic forecast improved driving and net release in the allowance for credit losses during the fourth quarter. The company reported loan net charge-offs of $1.3 million, or seven basis points annualized during the fourth quarter of 2020. Comparatively, loan net charge-offs in the fourth quarter of 2019 were $2.4 million, or 14 basis points annualized. On a full year basis, the company reported net charge-offs of $5 million, or seven basis points of average loan outstanding. This compares to $7.8 million, or 12 basis points in net charge-offs for 2019. The company recorded $94.6 million of total operating expenses in the fourth quarter of 2020, exclusive of $0.4 million of acquisition-related expenses. This compares to total operating expenses of $94.4 million in the fourth quarter of 2019, exclusive of $0.8 million of acquisition-related expenses. $0.2 million or 0.2% increase in operating expenses exclusive of acquisition-related expenses, attributable to a $1.7 million or 2.9% increase in salaries and employee benefits, and a $1.5 million or 13.5% increase in data processing communications expenses offset in part by a $2.5 million or 19.4% decrease in other expenses, and a $0.4 million or 11% decrease in the amortization of intangible assets. The increase in salaries and employee benefits was driven by merit-related increases in employee wages and a net increase in full-time employment employees between the periods due to both the student acquisition in the second quarter of 2020 and other factors, but were partially offset by lower employee benefit expenses primarily associated with the decrease in employee medical expenses due to reduced provider utilization. The increase in data processing and communication expenses was due to the student acquisition and the implementation of new customer-facing digital technologies and back office workflow systems. Other expenses were down through the general decrease in the level of business activities as a result of the COVID-19 pandemic, including travel and entertainment, marketing, and business development expenses. Comparatively, the company recorded $93.2 million of total operating expenses in the third quarter of 2020, exclusive of $3 million of litigation accrual expenses and $0.8 million of acquisition related expenses. The company closed the fourth quarter of 2020 with total assets of $13.93 billion. This was up $85.8 million or 0.6% from the end of the third quarter and up $2.52 billion or 22.1% from a year earlier. Similarly, average interest earning assets for the fourth quarter of 2020 of $12.31 billion were up $356.8 million or 3% from the third quarter of 2021. up $2.28 billion to 22.7% from one year prior. A very large increase in total assets and average interest earning assets over the prior 12 months, including by the second quarter 2020 acquisition of Steuben Trust Corporation, and large inflows of government stimulus-related funding and PPP originations. Ending loans at December 31, 2020, were $7.42 billion, up $525.4 million, or 7.6% from one year prior, due to the student acquisition and the origination of PPP loans. Ending loans, however, were down $42.7 million, or 0.6%, from the end of the linked third quarter to a decline in business equity in the company's markets due to seasonal factors, the COVID-19 pandemic, and PPP forgiveness. During the quarter, the company's PPP loan balances decreased $36.5 million, or 7.2%, for $507.2 million at September 30, 2020, to $473.2 million. $27.7 million at December 31st, 2020. During the fourth quarter, the company's average investment securities book balances increased $636.9 million, or 20.2%, from $3.15 billion in the third quarter to $3.78 billion during the fourth quarter due to the purchase of treasury and mortgage-backed securities during the quarter. Average cash equivalents decreased $221.7 million, or 17%, from $1.3 billion during the third quarter to $1.08 billion during the fourth quarter. During the fourth quarter, the company purchased $1.02 billion of treasury and mortgage-backed securities at a weighted average market yield of 1.38%. The purchases were made to stabilize near-term net interest income and hedge interest rate risk against a sustained low interest rate environment. Companies average total deposits were up $275.9 million or 2.5% on a quarter basis and up $2.1 billion or 23.2% over the fourth quarter of 2019. Total average deposits for the fourth quarter were $11.21 billion as compared to $9.1 billion in the fourth quarter of 2019. The company's capital reserves remain strong in the fourth quarter. The company's net tangible equity and net tangible assets ratio was 9.92% at December 31st, 2020. This was down from 10.01% at the end of 2019, but consistent with the end of the length of the third quarter. The company's tier one leverage ratio was 10.16% at December 31st, 2020, which remained over two times the well-capitalized regulatory standard of 5%. The company has an abundance of liquidity resources and is extremely well positioned to fund future loan growth. A combination of the company's cash and cash equivalents, borrowing availability at the Federal Reserve Bank, borrowing capacity at the Federal Home Loan Bank, and unplensed available for sale investment securities portfolio provided the company with over $5.25 billion of immediately available sources of liquidity. From a credit risk and lending perspective, the company continues to closely monitor the activities of its COVID-19-infected borrowers and develop loss mitigation strategies on a case-by-case basis, including but not limited to the extension of forbearance arrangements. At December 31, 2020, 74 borrowers, representing $66.5 million and less than 1% of total loans outstanding, remained in COVID-related forbearance. This compares to 216 borrowers representing $192.7 million, or 2.6% of loans outstanding were active under COVID-related forbearance in September 30, 2020, and 3,699 borrowers representing $704.1 million, or 9.4% of loans outstanding at 2.30 of 2020. Although these trends are favorable, non-performing loans increased in the fourth quarter. the $76.9 million, or 1.04% of loans outstanding, up $44.6 million from the length of the third quarter, and up $52.69 from the fourth quarter of 2019. During the fourth quarter, the company determined that borrowers that were granted loan payment deferrals under forbearance beyond 180 days would be classified as non-accrual loans unless they could demonstrate current repayment capacity or sufficient cash reserves to service their pre-forbearance payment obligations. The substantial majority of these bars operate in the hotel sector, including several that operate near the Canadian border, which have been additionally impacted by restrictions on cross-border travel. The specifically identified reserves held against the company's non-performing loans totaled $3.9 million at December 31, 2020, $3 million of which was attributed to a single non-performing hotel loan. As mentioned in prior earnings calls, the weighted average estimated loan to value in the company's hospitality loan portfolio prior to the onset of COVID was approximately 55%. We continue to believe that the ultimate losses recognized in the current flow of non-performing hotel homes will be well-contained given the pre-COVID cash flow of these properties, the financial strength of the operators we have historically financed, and the low loan to values on these assets. At December 31st, 2020, the level of loans 30 to 89 days delinquent remained fairly consistent with pre-COVID levels. Loans 30 to 89 days delinquent totaled $34.8 million, or 0.47% of loans outstanding at December 1st, 2020. This compares to loans 30 to 89 days delinquent of $40.9 million, or 0.59% one year prior, and $26.6 million, or 0.36% at the end of the length third quarter. Net charge-offs on loans were low at $1.3 million for seven basis points annualized in the fourth quarter and $5 million for seven base points for the full year of 2020. The company's allowance for credit losses decreased from $65 million, or 0.87% of total loans outstanding at September 30, 2020, to $60.9 million, or 0.82% of total loans outstanding at December 31, 2020. The net $4.1 million release of allowance for credit losses was driven by an improving economic outlook, a substantial decrease in loans and forbearance, a $2 million reversal of a previously recorded allowance for credit losses and a purchase credit deteriorated loan, which was paid off during the fourth quarter. At December 31st, 2020, the allowance for credit losses of $60.9 million represented over 12 times the company's trailing 12 months net charge-offs. Operationally, we will continue to adapt to changing market conditions and remain very focused on asset quality and credit loss mitigation. We anticipate assisting the substantial majority of the company's 2020 first draw of PPP borrowers with forgiveness requests throughout 2021 and granting new second draw of PPP loans and advances. Although we began to redeploy portions of our cash equivalent balances into investment securities during the fourth quarter to increase interest income on a going forward basis and provide a hedge against sustained the sustained low interest rate environment. We also expect net interest margin pressures to persist or remain well below our historical levels. Furthermore, we anticipate the deposit levels to remain elevated for most of 2020, especially for 2021, especially with potentially more federal stimulus on the horizon. Accordingly, we will look to deploy additional overnight cash flow to higher yielding earning assets. Fortunately, the company's diversified non-interest revenue streams, which represent approximately 38% of the company's total revenues in 2020, remain strong and are anticipated to mitigate the continued pressure on net interest margin. In addition, the company's management team is actively implementing various earnings improvement initiatives, including revenue enhancements and cost-cutting measures intended to favorably impact future earnings. Thank you.