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

Good day, and welcome to the Community Financial Systems, Inc. Second 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 and 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 reference 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, Betsy. Good morning, everyone. Thank you for joining us today. This was another consecutive record quarter, which I would classify as solid with continued expansion in net interest income, strong fee performance in banking, employee benefits and wealth management and managed recurring run rate expenses. Both credit and liquidity remain top tier. Insurance revenues were short of expectations, and we also had a few expense items which we do not consider recurring. I'm particularly encouraged by the continued client and talent acquisition momentum across all of our markets in banking, the new product launches and growing capabilities in our Employee Benefits business, the above-market results in our Wealth Management business and the addition of ClearPoint. Clearly, insurance will be challenged this year and fall short of our expectations. That is driven by meaningfully lower contingencies, self premium markets and also some organic challenges. However, you will notice that we had a nice gain of over $3 million on investment during the quarter, and that's related to an insurance investment, a great example of the optionality associated with our presence in the broader insurance space. We made more than 5x our money in this particular situation. We're also looking at a very strong pipeline of M&A opportunities in insurance, which may put us on a nice strike for 2027 revenue expansion. A couple of items of note. First, an update on our de novo efforts. We finished the second quarter right around $140 million in deposits across our de novos. Between the de novos and our acquisition of the Santander branches in the Lehigh Valley, we expect to end the year at approximately $700 million of the new additive funding in our growth expansion markets and are quickly putting that to work in quality loans. That is right in line with our strategic plan. You will notice that even with this sizable aggregate addition of deposits that were priced higher than our legacy ones, our overall cost of deposits continue to come down, hopefully, directly addressing some prior concerns. Second, we spent a fair amount of time talking about our commercial banking business and the success there, but here's a data point on the terrific things that our mortgage team is doing as well. Right now, our mortgage pipeline is at its highest point it has been for the past 7 years. And as we know, this is not a booming mortgage market. As of the latest HMDA data, we're the #2 bank originator in our footprint. Four years ago, we were #1. Speaking of housing in our markets, based on the May 2026 data from IMS, Fransen PA is the market with the highest increase in housing price in the United States. Worcester, New York at the second, [indiscernible] New York is the fifth, [indiscernible] is the sixth, Allentown is the 14. This is driven by inventory being down 50% compared to historical averages. Needless to say, this all bodes well for us. Third, as it relates to activity across our markets, a few data points. 4 years ago, Central Europe was delivering less than 400 new units of housing per year. Last year, the permits filed were over 2,400. By most estimates, we need over 3,000 to meet the housing demand. On the banking side, I have seen more discussions around multifamily and even hospitality deals in Central work in the past 6 months than I have seen in the past 5 years cumulative. With that said, it is still early days, and it is not what is driving our growth yet. Our differentiated growth comes from market share gains across all of our footprint. There isn't much of a difference in the growth rates of our regions. This past quarter was particularly strong in New England and Pennsylvania looking at the pipeline, I expect virtually all regions to have second strong second half of the year. We also have insurance and benefits customers seeing nice lifts in their operations from activity across all of our footprint. Lastly, our banking assets now sit at $17.4 billion, our wealth assets under management and administration sit at $17.1 billion and our retirement assets under administration are $16.5 billion. In other words, both our Employee Benefits and Wealth Management businesses now have a similar amount of assets in care as our banking business, which further underscores the diversification strategy of our company. You can expect continued focus and investments across all of our businesses and driving the growth of all the in line with our previously communicated strategies. Without that said, this was a record quarter for our company with overall operating pretax preprovision earnings up 14.9% year-over-year. Banking pretax earnings were up 13.2%. Employee Benefits pretax earnings were up 16.2%. Wealth Management pretax earnings were up 46.5% and insurance was down 10.8% year-over-year. More importantly, our trajectory remains very attractive, and we expect acceleration in results across all of our businesses in the second half of the year. As a reminder, in the fourth quarter, we began unshackling ourselves from the weight of our securities portfolio as we start getting back meaningful cash flows, which should provide a line tailwind in the future quarters. I will now pass to Marya for more color on the numbers and our updated guidance. Marya?

Thank you, Dimitar. Good morning all. As Dimitar noted, the company's second quarter performance was solid. GAAP earnings per share of $1.16 increased $0.19 or 19.6% from the second quarter of the prior year and increased $0.08 or 7.4% from linked first quarter results. Operating earnings per share and operating pretax, pre-provision net revenue per share or record quarterly results for the company. Operating earnings per share were $1.16 in the second quarter as compared to $1.04 one year prior and $1.15 in the linked first quarter. Second quarter operating PPNR per share of $1.62 increased $0.21 from 1 year prior and increased $0.01 on a linked quarter basis. These record operating results were driven by a new quarterly high for net interest income. The company's net interest income was $139.1 million in the second quarter. This represents a $4.4 million or a 3.3% increase over the linked first quarter and $14.4 million or 11.5% improvement over the second quarter of 2025 and marked the ninth consecutive quarter of net interest income expansion. The company's fully tax equivalent net interest margin increased 4 basis points from 3.45% in the linked first quarter to 3.49% in the second quarter, reflective of lower funding costs. During the quarter, the company's cost of funds was 1.18%, a decrease of 2 basis points from the prior quarter primarily driven by lower deposit costs. Operating noninterest revenues increased $4.8 million or 6.4% and compared to the prior year second quarter and increased $0.3 million or 0.4% in the late first quarter. The increase in operating noninterest revenues compared to the second quarter of 2025 and was reflective of increases in employee benefit services, wealth management services and banking noninterest revenues, partially offset by a decrease in insurance services noninterest revenues due to a softer insurance market and lower organic growth. Operating noninterest revenues represented 36% of total operating revenues during the second quarter a metric that continuously emphasizes the diversification of our businesses. The company recorded a $4.6 million provision for credit losses during the second quarter. This compares to $4.1 million in the prior year second quarter and $5.6 million in the linked first quarter. During the second quarter, the company recorded $137.7 million in total noninterest expenses, an increase of $4.7 million or 3.5% from the linked first quarter and an increase of $8.6 million or 6.7% from the prior year second quarter. The increase from the linked first quarter was due in part to a $2.1 million increase in salaries and employee benefits, reflective of one additional payroll day and true-up of performance-based annual management incentive plan expense, $0.7 million of expenses associated with ClearPoint as well as a onetime $0.6 million early termination charge related to a debit card processing platform conversion. $3.4 million of the increase in total noninterest expenses from the second quarter of 2025 was attributed to salaries and employee benefits primarily due to incremental costs associated with acquisitions and de novo bank branches opened between the periods, along with the impact of annual merit pace increases. Occupancy and equipment expenses increased $2.4 million from the prior year second quarter, driven by incremental costs associated with the opening of 60 de novo branches and 3 regional headquarters along with the 7 branches acquired from Santander in the prior year's fourth quarter. Year-to-date, operating noninterest expenses were $261.2 million, an increase of $15.2 million or 6.2% from the first 6 months of 2025. Excluding operating expenses related to acquisitions completed in the last 12 months, operating noninterest expenses increased $10.4 million or 4.2% from the same prior year period. Ending loans increased $151.6 million or 1.4% during the second quarter and increased $763.7 million or 7.3% from 1 year prior. The increase from 1 year prior reflected organic growth in the overall business in consumer lending portfolios, while the increase during the second quarter primarily reflected organic growth in the business lending portfolio. The company's ending total deposits increased $1.01 billion or 7.4% from 1 year prior and decreased $159.7 million or 1.1% from March 31, 2026. The decrease in total deposits during the second quarter was primarily reflective of seasonal outflows of municipal deposits. The increase in total deposits over the last 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 net charge-off ratio increased 1 basis point from the linked first quarter while the loans 30 to 89 days delinquent ratio decreased 9 basis points from last quarter, aligned with typical seasonal trends. The company's allowance for credit losses was $91.7 million or 81 basis points of total loans outstanding at the end of the second quarter, an increase of $1.5 million during the quarter. The increase was primarily attributed to reserve building in the business lending portfolio. The allowance for credit losses at the end of the second quarter represented 8x the company's trailing 12 months net charge-offs. We are pleased with the second quarter results, which reinforces our commitment to expand operating leverage and scale as a diversified financial services company. 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 a more detailed update to our expectations for full year 2026 as we enter into the second half of the year, inclusive of the estimated impact of the completed ClearPoint acquisition. We are currently expecting 5% to 6% growth in loan balances, 3% to 4% growth in deposit balances, 10% to 11% growth in net interest income, 6% to 7% growth in noninterest revenues and a provision for credit losses in the range of $20 million to $25 million. In addition, our expectation is for continued net interest margin expansion over the next 6 months, exiting 2026 in the low to mid-3.5 range. We expect modest temporary pressure in the third quarter within a range of up 1 basis point to down 2 basis points due in part to seasonally higher overnight borrowing levels. Core noninterest expenses are expected to be in the range of $550 million to $555 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 associated with ClearPoint, including nonoperating intangible asset amortization. These estimates do not include the impact of pending or future acquisitions. Additionally, we continue to anticipate an effective tax rate between 23% and 24%. That concludes my prepared earnings comments, and Dimitar and I will now take questions. Betsy, I will 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 just starting off on the competitive environment in Upstate New York. Good to good to kind of -- it sounds like there's going to be a bit of an acceleration here in overall businesses, including loan growth. Just kind of curious what you guys are seeing these days, maybe where is competition more intense and where there's opportunity?

Thank you, Steve. As I mentioned, it's really across the footprint. I couldn't tell you that Upstate is any better or different than, frankly, New England or Pennsylvania. It is competitive. I think our expectations are, as Marya said, 5% to 6% on the loan growth side for the year. I think we're tracking just about in that range right now, towards the higher end, but we also have some -- second half of last year was stronger than the first half, so we have different comps. It is active across the board. I would say that we've seen a little bit more competition as it relates to pricing, including some structures as well. People are kind of really focused on putting assets on the books. And certainly, our growth would have been even higher this quarter if we have taken a similar approach. To me, it was a little bit interesting because rates went up during the quarter while actual rates over to customers went down in our markets, just compressing spread pretty meaningfully. We did not partake in a lot of those, but we still feel that our pipeline is pretty solid, and we'll be able to hit those growth rates.

And do you think -- I mean going forward for the second half of the year, is it just going to be more commercially driven? And are you just going to be trying to hold indirect auto flat? I realize there's some competition in that market this quarter here.

Yes. I think one in the kind of the third and the fourth quarter, we kind of really bear the benefits of our activities on the mortgage side. So I expect that the mortgage portfolio is going to move. As I mentioned, our pipeline today in that book is the highest it's been in 7 years. and those have a pretty good time line to closing. So you can estimate if we see the pipeline today, most of it will clear out this quarter, and then we'll be repeating again. So I think the third and the fourth quarter will be good in mortgage. On the auto side, I think that the pricing has improved a little bit. So we're more active on that side as well. So I think we'll see kind of where it takes us. So I do think that the consumer is going to be stronger in the second half of the year than certainly it was in the first half of the year. Commercial, I think, remains in a very good spot. We have very good pipelines. I think we may even have opportunities to do a little bit better on pricing if our competitors feel similarly that rates should be moving up rather than down.

Okay. Got you. And then in terms of -- on the fee income side, insurance here, -- just kind of curious like how to think about contingent fees going forward? Is it kind of -- I hear you it's softer and I'm not exactly sure how much you had in continued fee this quarter. Just kind of curious, as we go into '27, it's probably going to be a bit more muted on the contingency side and obviously probably on growth, too?

Yes, I think that's right. I mean out of the shortfall in insurance kind of year-to-date compared to where we thought we were going to be about $1 million just dealt in contingencies. The team has done a very nice job in terms of controlling costs, but it's hard to overcome that. And then the rest of it has been kind of organic softness, premiums. So it's a little bit hard to tell where it's going to settle. We think the second half of the year will be better. We expect some acceleration, we expect to make up some ground that's not going to take us to our normal growth rate. So we're down 6.5% year-to-date. We hope to make that up, not finish necessarily the year down, but we'll see how it shakes out. It could go either way. I will say that kind of this environment, it's made things a little bit more active on the M&A side, as I mentioned. And we have multiple ways to grow revenues there. And the pipeline right now on the M&A side is the best it's been, including some things that could be much more kind of needle movers than historically for us. So I think if we're able to execute well on that side, kind of, again, looking forward into will move in much better shape.

The next question comes from Manuel Navas with Piper Sandler.

This is Grant [indiscernible] on for Manuel. I had a question on how do deposit pipelines look going forward, noting the muni seasonality this quarter? And then how are de novo branches doing gathering deposits.

Sure. So as you pointed out correctly, in the second quarter, we have a meaningful amount of seasonality as the teachers and other employees basically take the summer and there's payments made at the end of June to all those employees. So you see an outflow as property taxes start coming in here, the end of the third quarter and the fourth quarter that we'll rebuild back into liquidity. So these are just kind of normal temporary fluctuations across our footprint. As it relates to de novos, as I mentioned, we ended the quarter with $140 million in deposits, right on track in terms of what we were planning and hoping for, for the year. Continuity levels are pretty good. So we're very pleased with the outcomes there. Overall, deposits are not easy to come by. That's not just for us. I think it's the same for everybody in the industry. The [indiscernible] are always the part of the equation. That is the life blood of the bank. So we continue to remain very focused on that. Pricing has become a little bit less constructive on that side, and we've decided not to participate in some of those opportunities. We're certainly seeing things that are going off at rates above wholesale funding rates, which doesn't make a lot of sense to me. So we're not going to participate in that. We have a much stronger balance sheet than most and a lot more flexibility than most. Our loan-to-deposit ratio is 76%. We have a lot of runway there as opposed to our folks. And then the other thing I would note is, again, we have a tremendous amount of cash flows coming from our portfolio starting here in the fourth quarter and to next year. the next 18 months, we're looking at over $1 billion of cash flows coming our way. So that's a great way for us to also optimize how we fund the growth on the loan side.

And then just switching over to repurchases. I noticed like decreased this quarter. Is there a right pace for repurchases going forward?