CBU
#Thank you, Lauren.
Good morning, everyone, and thank you all for joining our Q1 conference call.
As you heard in Lauren's introduction, I'm being joined today by Joe <UNK>, our Senior Vice President of Finance, and not Scott Kingsley, our CFO.
Scott is having knee surgery today, so Joe will be pinch hitting for him and providing the financial commentary.
We really couldn't be more pleased with first quarter results.
EPS, excluding acquisition expenses, is up 30% over 2017 or $0.18 per share, due primarily to the strategic deployment of capital last year with the NRS and Merchants Bancshares transaction.
We also benefited from a slightly lower effective tax rate that contributed $0.03 of the $0.18 improvement.
Our fee-based businesses also had a tremendous quarter with revenues up 30% on organic linked-quarter growth and improved margin as well.
Operating expenses were in line with our expectations as was the asset quality, with the exception of additional $1 million charge-off related to the single credit we discussed last quarter.
The loan book was down for the quarter, as seasonally expected.
But it was good to see the ever so slightly positive commercial growth despite $38 million in unscheduled pay-downs, nearly half of which related to a single relationship where the underlying business was sold.
At quarter-end, both our mortgage and commercial pipelines were up 19% and 27%, respectively, over year-end.
And loan growth is positive for the month as of yesterday.
Deposit inflows were robust at the end of the quarter, with total deposit funding costs remaining at exactly 10 basis points again for the seventh consecutive quarter.
We have significant earnings momentum that we need to support the balance sheet growth, a focus for us for the remainder of the year.
We expect our operating and credit costs to be stable, our fee businesses to grow and our funding costs to increase only modestly.
In summary, we're off to an exceptional start to 2018.
Joe.
Thank you, <UNK>, and good morning, everyone.
As <UNK> noted, the first quarter of 2018 was another very solid operating quarter for us.
We set a new record for quarterly operating earnings, maintained our deposit beta at 0 and recorded a solid increase in noninterest income.
I'll start off with a few comments about our balance sheet.
We closed the first quarter of 2018 with just slightly less than $11 billion in total assets.
This is up slightly from $10.75 billion in total assets at the end of the fourth quarter of 2017.
Other than a small insurance agency tuck-in transaction, we did not consummate any significant acquisitions during the first quarter of 2018.
Average earning assets for the first quarter of 2018 were $9.4 billion, which was flat to the linked quarter of 2017 ---+ fourth quarter of 2017.
Although total earning assets did not change significantly between the linked quarters, we experienced a slight change in the composition of earning assets during the quarter, including a $56 million increase in average cash and cash equivalents, a $12 million decrease in average investment securities outstanding and a $37 million decrease in average loans outstanding.
Ending loans at March 31, 2018, were down $29.7 million from year-end 2017.
Business loans were up slightly for the quarter in spite of $38 million of unscheduled payoffs during the quarter, while the consumer portfolios were down as seasonally anticipated.
Switching to the annual quarter comparison.
Total assets, average earning assets, average loans outstanding were all up by 20% or more between the first quarter of 2017 and the first quarter of 2018, due primarily to our acquisition of Merchants Bancshares in the second quarter of 2017.
The transaction resulted in the acquisition of $2 billion of assets, $1.49 billion of loans, $370 million of investment securities as well as $1.45 billion in deposits.
As of March 31, 2018, our investment portfolio stood at $3.03 billion.
It was comprised of $589 million of U.S. agency and agency-backed mortgage obligations or 19% of the total, $510 million of municipal bonds or 17% of the total and $1.89 billion of U.S. Treasury securities or 62% of the total.
The remaining 2% was corporate and other debt securities.
The net unrealized gains/losses in the portfolio left from a net gain in December 2017 to a net loss in March 2018 due to an increase in market interest rates during the quarter.
More specifically, the portfolio contained net unrealized losses of $18 million at March 31, 2018, compared to net unrealized gains of $24 million at December 31, 2017.
The effective duration of the portfolio remains slightly less than 4 years.
Average deposit balances were up $1.3 billion between the first quarter of 2017 and the first quarter of 2018, also reflective of the Merchants transaction and continued success in core deposit gathering.
We ended the quarter with $405 million of borrowings, of which $282 million were collateralized customer repurchase agreements, which act like and are priced much more like interest-bearing checking deposits rather than wholesale borrowings.
As such, with the exception of our $123 million of highly efficient and regulatory capital added to trust preferred obligations, our March 31 balance sheet was virtually ---+ had virtually no debt ---+ external debt.
Our asset quality remained strong.
At the end of the first quarter 2018, nonperforming loans, comprised of both legacy and acquired loans, totaled $29.7 million or 0.48% of total loans.
This is 4 basis points higher than the ratio reported at the end of the linked fourth quarter 2017 and 2 basis points higher than the ratio reported at the end of the first quarter of 2017.
Our reserve for loan losses represents 0.77% of total loans outstanding and 0.97% on legacy loans outstanding.
Our reserves remain adequate and exceed the most recent trailing 4 quarters of charge-offs by multiple of 4.
We reported $3.8 million in the provision for loan losses during the first quarter of 2018.
This was $1.9 million higher than the first quarter of 2017 and $1.7 million lower than the fourth quarter of 2017.
The amount for loan losses to nonperforming loans was 162% at March 31, 2018.
This compares to 173% at the end of the fourth quarter and 206% at the end of the first quarter of 2017.
We recorded net charge-offs of $3.2 million or 21 basis points annualized on loan portfolio during the quarter.
This includes an additional $1.1 million charge-down on a single commercial credit relationship we provided commentary on during the fourth quarter earnings call.
An additional $800,000 of specifically impaired reserves remained allocated to this relationship.
By comparison, we reported net charge-offs of $2 million or 16 basis points annualized during the first quarter of 2017.
The net charge-off ratio in our consumer indirect installment loan portfolio for the first quarter of 2018 was 46 basis points.
This compares to 42 basis points during the first quarter of 2017.
We reported annualized net charge-offs on the residential mortgage and home equity loan portfolios of 3 and 5 basis points, respectively.
Our capital levels in the first quarter of 2018 continue to be very strong.
The Tier 1 leverage ratio was 10.19% at the end of the quarter, which is over 2x the well capitalized regulatory standard.
Tangible equity and the net tangible assets ended the quarter at a solid 8.42%.
This is down slightly from the end of the fourth quarter's 8.61%.
Tangible equity, which is the numerator, was unchanged at $859 million.
As flows in the company became (inaudible), it was offset by a decrease in accumulated other comprehensive income.
This was largely attributable to the decrease in the market value of the available-for-sale securities portfolio ---+ investment securities portfolio due to higher market interest rates as noted earlier.
Tangible assets, the denominator, increased $225 million between the end of the fourth quarter of 2017 and the end of the first quarter of 2018.
And the net inflow of customer deposits was invested over (inaudible) bonds.
Shifting to the income statement.
Net interest margin for the first quarter of 2018 was 3.71%.
This compares to 3.65% in the first quarter of 2017, an increase of 6 basis points between the comparable quarters.
The average yield on earning assets was up 8 basis points between the periods, while interest-bearing liabilities increased 4 basis points.
The comparative results were impacted by the inclusion of the Merchants' asset liability portfolios during the second quarter of 2017 as well as the reduction in tax equivalent yield gross up on the company's nontaxable municipal securities and loan portfolios, due to a decrease in federal corporate tax rate between the periods.
On a linked-quarter basis, net interest margin increased 3 basis points from 3.74% in the fourth quarter of 2017 to 3.71% in the first quarter of 2018.
The previously mentioned change in the tax equivalent yield on nontaxable municipal securities loans negatively impacted reported margin by approximately 4 basis points.
In addition, the fourth quarter 2017 net interest margin was favorably impacted by 3 basis points due to the receipt of the Federal Reserve Bank's semiannual dividend.
It should be noted that our proactive and disciplined management of funding costs continue to have a positive effect on margin results.
In spite of 625 basis point increases in the target debt funds rate since the fourth quarter of 2015 as well as the general increase in market interest rates, our cost of deposits has remained between 10 and 11 basis points for 9 consecutive quarters.
We reported $57.5 million in noninterest income during the first quarter of 2018.
This represents a $13.2 million or 29.7% increase over the first quarter of 2017 and $3.6 million or 6.6% increase on a linked-quarter basis.
Noninterest revenues in all 3 of the company's operating segments: banking, benefit plans administration, and All Other, which include revenues from our wealth management and insurance divisions, are up on an annual quarter and linked-quarter basis.
Noninterest income from our banking sources increased $1.1 million or 5.7% on a linked-quarter basis from $19.3 million in the fourth quarter of 2017 to $20.4 million in the first quarter of 2018.
These results are reflective of several initiatives to expand customer service offerings and increase deposit service fees, including our electronic banking rep fees.
Noninterest revenues are up $4.5 million or 28.7% in the banking segment on a comparative annual quarter basis, due to both Merchants acquisition and several fee improvement initiatives.
In addition, we reported increases in noninterest income in our benefits administration and wealth management and insurance division on a linked-quarter and annual quarter basis.
During the first quarter of 2018, we recorded $37.1 million of revenues in these businesses.
This compares to $34.6 million during the fourth quarter of 2017, an increase of $2.4 million or 7% on a linked-quarter basis.
On an annual quarter basis, revenues are up $8.6 million or 30%.
The revenue increases in these segments are due to a combination of factors, including the NRS acquisition, the Merchants transaction, 4 small insurance agency tuck-in acquisitions completed since the beginning of 2017 as well as organic growth.
Consistent with full year 2017 results, noninterest income represents about 40% of the company's total operating revenues.
We reported $86.3 million of total operating expenses during the first quarter of 2018.
This compares to total operating expenses, excluding acquisition expenses, of $86.1 million during the fourth quarter of 2017.
Although total operating expenses were relatively flat on a linked-quarter basis, there were significant variances amongst several components of operating expenses.
Similar to prior year's first quarter activities, we incurred higher levels of salaries expense for merit-based wage increases and incentives, reported increase in statutory payroll taxes and incurred higher occupancy expenses largely due to facilities (inaudible) heating and winter maintenance activities.
Adversely, we reported decreases in marketing-related expenses and certain professional services on a linked-quarter basis.
On an annual quarter comparative basis, operating expenses, excluding acquisition expenses, increased $14.5 million or 20.2%, due largely to increase in salaries and benefits expense and occupancy expense related to the NRS and Merchants transactions.
We believe the first quarter operating expenses are a fairly reasonable proxy for our core operating expense run rate for the balance of the year.
Our effective tax rate in the first quarter of 2018 was 23% versus 27.4% in the first quarter of 2017.
The net reduction in the effective tax rate between the periods is primarily due to passage of the Tax Cuts and Jobs Act signed into law in the fourth quarter of 2017, which lowered corporate tax rates from 35% to 21%.
For the next few quarters, we anticipate net interest margin to be similar to the first quarter 2018 results.
The comparatively modest organic growth opportunities in the markets for new loans as well as competitive conditions are likely to limit our ability to immediately and fully pass along recent increases in the national market interest rates to borrowers.
In addition, although we will continue to take a measured approach with respect to deposit pricing, retention (inaudible).
It is unlikely that we'll be able to maintain a 0 deposit beta during the remaining 3 quarters of 2018.
We also expect to continue to receive the Federal Reserve Bank's semiannual dividend in the second and fourth quarters of each year, but anticipate a significant reduction in the historic dividend rate due to our status as an institution with total assets of greater than $10 billion.
From an asset quality perspective, we do not see any major headwinds on the horizon.
We continue to expect a net reduction from Durbin mandated impacts on debit interchange revenues beginning in July of 2018 of approximately $12 million to $13 million annually or an estimated $6 million to $6.5 million in the second half of 2018.
However, we do expect to continue to organically grow our nonbanking segments during the balance of 2018 that may modestly offset a portion of the Durbin impact.
And finally, although winter-like weather has come around a bit longer in the Northeast than we hoped, we're beginning to experience a pickup in our residential mortgage application volume and consumer and direct loan originations, and the business loan pipeline remains solid.
In summary, we believe ---+ we remain very well positioned from both a capital and operational perspective for the remainder of 2018 and beyond.
As <UNK> mentioned, look forward to continue to execute on future organic improvement opportunities.
I'll now turn it back to Lauren to open the line for questions.
Good question.
I was referring principally to loan growth, Alex.
We've ---+ the last trailing, whatever, it's been 3 quarters or something, we haven't had growth.
I think we had net outflows.
As I commented last quarter, we've seen in the last several quarters an unusual level of pay-down activity and did not happen again in the first quarter, $38 million, including one credit that was, I think, $18 million where the business was sold.
So the underlying pipelines are strong.
The underlying market opportunities are not bad.
So we'll continue to execute on that.
I'm not worried about where the remainder of the year is going to be at all.
I think as I said, our ---+ at the end of the year, our commercial pipeline was $240 million.
Right now, it sits at $305 million at the end of the first quarter.
So it's really not for a lack of effort engagement in the markets nor a shortage of market opportunities.
It's really the impact that these significant unscheduled pay-downs.
The mortgage pipeline is picking up.
It was $80 million at the end of the year.
It's now $100 million.
Our market is usually pretty stable.
It's relatively easy to predict where the kind of mortgage production is going to be.
The increase in rates in the mortgage market hasn't seemed to have really tapped demand in any real degree that we've been able to measure.
So I think we'll be fine on the mortgage side, and it's always a tough first quarter on the mortgage side for obvious reasons for us.
So I think we'll have a pretty good year in mortgage.
Indirect, we're already up.
In indirect, kind of the car selling season has started.
As we've talked about previously, we have some level traded off volume for rate, because the spreads, the returns on that business just got below what our expected threshold needs to be.
So we may trade off a little bit of volume for rate, but we would expect to see, in any event, some growth in that net portfolio as we enter the busy season for mortgages.
The other ---+ I guess ---+ and I didn't sort of mean this in my comment when I referred to balance sheet growth.
But if you look at the yield curve right now, it's pretty flat from 5% to 10%.
And our portfolio yield is trended down.
I think this quarter, it was 2.60-something percent or 2.50%, which has trended down generally as rates have fallen over the last several years.
We're now at the point where high-quality MBS, the spreads are getting to the point they're better than the 10-year.
So I mean, I think right now, we, for the last several years, have generally let our mortgage investment portfolio run off a little bit, just not reinvesting cash flow, which is one of the reasons we have a fairly high fed funds sold position currently.
But the interest rate ---+ recent interest rate moves suggest there may be an opportunity for us to redeploy some of those cash flows that are running off from the investment portfolio back into the same portfolio at above 3% as opposed to in fed funds sold at half of that.
So I didn't really mean that.
But I was referring in my comments to loan growth, but just sort of comments relative to where the ---+ where we see the securities market right now as well.
I would say, the nonbanking business revenues are generally less seasonal than banking.
I think the deposits fee revenue is going to be somewhat seasonal.
They're typically lower in the first quarter.
And summertime, they are better than in kind of end of the year Christmas season, they're a little bit better again.
So there's same seasonality in that.
The nonbanking businesses, particularly the benefits business and the wealth management businesses really are not seasonable at all.
The insurance business is.
But that's the smaller component of our nonbanking businesses.
So it doesn't move the needle as much.
That has to be more volatile, not really seasonal.
It's just a function of when premiums are written.
And you got the contingency commissions from the carriers that can then ---+ in the second quarter.
So that tends to be a little bit more varied throughout the year, Alex.
But it's really not seasonal as much as it's just a variability and the timing of revenues there.
But again, the smaller ---+ that's a smaller component, really wouldn't move the needle at all.
So I would expect that by the end of the year, the run rate on our nonbanking businesses will be greater than they are right now.
Yes.
This is Joe.
I'll take that question.
Our basic core margin, when we sort of take away the impact of the purchase loan accretion and the FRB dividend, is in that mid-3.60s-percent range, 3.65%, 3.66%.
When you factor in the purchase loan accretion, we tend to get up a little bit over the 3.70% level.
And I think that's indicative of at least the future course.
With that said, there's some color maybe I could offer relative to some of the asset portfolio, which as <UNK> mentioned, the investment securities opportunities are a little bit better today than they were in the last few quarters with the 10-year hitting 3% and the 5-year just slightly less than that and some mortgage backed security opportunities.
So even though it's a relatively big shift, so to speak, to move, at least the new rates are better than the existing book yields.
Relative to the loan portfolios, we've begun to sort of witness some increases in the new rates of new loans going on relative to what has been running off, although marginally.
And we will continue to have some competitive challenges with the fully pass along some of the increase in the market rates to more borrowers.
But we have seen a slight uptick in the consumer and the mortgage portfolios.
But again, that's a big shift to turn around relative to the existing portfolios and adding marginal business.
And we're also, in an overnight, say our funds position have been where most of the first quarter.
And actually with an uptick in the fed funds rate, that gives us some marginal opportunity just from a cash and overnight position.
So we think the 3.70% range all-in is fair, but there are some of the opportunities we have.
Conversely, our deposit beta has remained at 0.
We expect continued challenges over the next few quarters.
It's going to be difficult to maintain that at 0.
So they potentially could offset some of the uptick that we're going to potentially see on the asset portfolios.
I think 1/2 to 1/3 is a reasonable expectation for that dividend.
That was sort of a situation where ---+ which contributed to our second and fourth quarter margin run rate.
That ---+ the effect of that dividend is going to be much reduced going forward, because it now becomes a more nominal part of the total margin equation.
So all-in, that's expected to contribute about effectively on an annualized basis about 1 basis point to the total margin.
Fair question.
My ideal preference would to be use it for growth of our business, loan growth primarily, organic growth opportunities, whatever they might be.
Like we're speaking of capital, so that means principally lending and potentially investment securities.
But clearly, an incremental dollar of excess capital, I'd rather put to work in credit.
We ---+ because of our low growth markets, we accumulate, even after a dividend, which is about half of our earnings, we still accumulate capital at a fairly rapid pace, certainly in excess of what we need to capitalize organic growth.
So historically and I think necessarily, for us strategically, we have all these looked at, high-value M&A opportunities in the banking space as well as the nonbanking space to grow those nonbanking fee-based businesses through M&A.
And I think that, that will be a strategy that will ---+ that we will continue.
I think certainly if you look at the run rate of our business in terms of GAAP earnings and the adjusted earnings that we include in the back of the press release, which we look at as a proxy for cash-based earnings, again, up over 30% in terms of the run rate over last year.
So we are accumulating capital right now at a pace that we haven't hereto foreseen.
So it will be incumbent upon us to continue to assess most effective and beneficial ways to deploy that capital for the benefit of shareholders.
Clearly, the most profitable thing you can do is reinvesting in your own business.
I would say, secondarily, investing in other people's businesses.
And then, lastly, I would say, by next year, I don't think our shareholders expect us to deploy capital in a way that creates greater earnings, a greater dividend capacity.
So buying back shares, although I understand why some companies do that, I don't think our shareholders expect us to do that.
I think that's the way to optimize returns over time either.
So I think this strategy will continue as it has for the recent past.
I would say on the banking side, it's pretty similar to how it's been for post-credit crisis in the last 8 years, 9 years.
It's best off for saying in terms of the pace for us, we're also reasonably constrained in terms of our geography.
We are not ---+ it's not our strategy to go substantially out of market.
So that, in some respects, constrains our focus on New England, Upstate New York, Pennsylvania, New Jersey, Ohio.
So I would say the opportunities are similar.
We continue to have dialogue with other institutions that we think would be high-value partners for us.
We continue to get inbound opportunities for consideration as well.
And so the pace really is similar, I would say, to where it had been on the banking side.
On the nonbanking side, that's an area where the private equity has become much more engaged.
And with the trillion dollars of liquidity uninvested by private equity ---+ participation by strategic buyers in the nonbanking space is going to get more difficult and more excessive.
I think our strategy there has been to seek out opportunities.
We have ---+ our benefits business is a national business.
We've got great leadership.
I think we've got some visibility in the ---+ in that market nationally.
And so if there are opportunities, we usually ---+ we get to look at those.
There's also those similar to the banking, where we engage someone else because of a ---+ what we perceive as a high-value partner.
So we'll continue to be active in both of those spaces.
I think on the banking side, the price expectations of sellers has gotten high.
In many instances, too high, at least for the way we approach M&A.
And I would say the same on the nonbank space.
Because of the active engagement of the private equity, we have different models and different pricing capacity than the strategic buyer.
But we'll continue to be engaged in both of those spaces.
Just want to follow up on some of the loan commentary that you've made.
I appreciate the color there.
Wondering if we could just tone down a little bit into your Merchants footprint.
We talked a little bit last quarter about the dynamics there, the intended runoff and rebuilding of that pipeline.
Just curious if we could get an update on your outlook going forward.
Sure.
We had a tough first quarter in the Merchants markets mainly because of the early pay-downs, the one single large pay-down I referred in Merchants.
There was a handful of others as well.
So the majority of those off-schedule pay-downs were in the Merchants marketplace.
Continues to be puts and takes.
We're slowly rebuilding the pipeline there.
We're getting some really high-quality looks and opportunities, but we're still facing the fact that when we got those folks onboard, there was virtually no pipeline.
But we're getting back there.
It's building.
We're getting opportunities.
We have, over the course of last, what it's been, 10 months, 9 months, a bit more front-off than what we hoped.
But I think it's moderated.
Other than the nonscheduled payoffs this quarter, which came primarily again from the Merchants marketplace, I think we're doing a better job there and we're building the pipeline.
Great.
And then my last question, just a follow-up to the M&A discussion.
Given the growth dynamics as well as your very clear funding advantage, would you characterize your appetite for depository M&A as more biased towards something that would be a bit more of a growth opportunity for you.
I think our focus, as it relates to M&A, first is high-quality franchises that we think have the opportunity to grow earnings and dividend capacity in a sustainable fashion.
That's kind of ---+ that's the first lesson.
So we are principally looking for deposit franchises, credit franchises.
Although certainly, Merchants was extremely attractive because of the high-quality commercial credit franchise that they had and the fact that their markets, particularly in Chittenden County, were more economically dynamic than the average of the remainder of our markets.
The challenge in looking at some institutions is it relates to the deposit franchise, because we have a very high-quality, long-duration, low-cost, stable funding base.
And we look at other institutions, and they have a different model.
We've always invested a great deal of management and leadership time and effort into our retail banking franchise for this exact reason.
And other banks have different models, where the focus on the credit side and they just raise rates to the point where they need to fund the loan growth.
And so that's a different model for us.
So it's ---+ it gets to be a challenge when we're looking at another institution that has 60 basis points of funding cost and the dilution to our deposit base gets to be a challenge.
But we typically ---+ because we're having very high-quality, low-cost, stable, long-duration funding base, we typically don't seek that necessarily in a partner.
Again, it's a function of the overall quality and reliability that we would have the confidence that we would have in that franchise to integrate well with us, integrate well with our business model, integrate well with our culture, and ultimately, have the ability to generate growing earnings and dividend capacity into the future.
One of the things we've done, as you know, over the years, we've acquired a fair number of branches in branch transactions from mostly larger banks.
In the last 10 years, we've probably done 6 of them.
Frankly, we would ---+ that's something we would continue to look at, despite the fact that we don't need the deposit funding.
And there would be, at this juncture, a reasonable challenge about how you invest the whole liquidity, particularly to franchise with lower growth.
But those branch transactions ---+ you're buying customer relationships, so ---+ which are really valuable.
The kind of the tax structure of those transactions is very favorable.
There's a lot of other banks.
So despite the fact that we don't need more good core funding, although we can always use as much as of them yet, we would still look at ---+ we would look at retail franchises in the event that some of the big banks would be interested in disposing.
And I know some have over the years, BMA, Key, Citizens.
I heard discussions of ---+ I think Wells Fargo has already started some dispositions.
So we would look at that as well.
Thank you, Lauren.
That's it.
Thank you all for joining the call, and we look forward to speaking to you again after the second quarter.
Thank you.
