Community Financial System, Inc. Q3 FY2022 Earnings Call

Welcome to the Community Bank System Third Quarter 2022 Earnings Conference Call. Please note that this presentation contains 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. Such statements involve risk 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 Tryniski, President and Chief Executive Officer; and Joseph Sutaris, Executive Vice President and Chief Financial Officer. They will be joined by Dimitar Karaivanov, Executive Vice President of Financial Services and Corporate Development for the question-and-answer session. Gentlemen, you may begin. Please go ahead.

Thank you. Good morning, everyone. Hope all is well, and thank you all for joining our third quarter conference call. You can see from the release, this was one of the best operating quarters we've ever reported. In fact, I believe it is the best quarter we've ever reported, absent last year's post COVID reserve releases and PPE revenues in Q1. Earnings for the quarter were driven by improvement across the board, including solid loan growth, a growing margin, higher noninterest revenues in our Banking and Insurance segments, an improved efficiency ratio, and solid credit quality. Loan growth was across all of our portfolios, and that momentum continues. 5% growth in the quarter follows 4% growth in Q2, so continues to be a performance highlight delivered by our credit generation teams. The larger loan loss provision was driven almost entirely by loan growth, and deteriorating qualitative factors in the CECL model. Deposit costs remain contained and average balances were flat for the quarter with public fund outflows of about $300 million, offset by growth in consumer and business balances of $300 million. Overall, GAAP EPS is up 8% over last year and PPNR is up 20%. Both numbers would be even greater excluding PPP revenues in last year's quarter. So we could not be more pleased with this quarter's results and believe we are well-positioned heading into Q4 as well in terms of our pipelines and margin expectations. Looking forward, we expect our current operating momentum to continue. Obviously, this is an unpredictable and volatile environment. But given our stable core funding base, a higher rate environment will continue to be additive to our results. Joe?

Thank you, Mark, and good morning, everyone. As Mark noted, the third quarter earnings results were solid with fully diluted GAAP and operating earnings per share of $0.90. These results were up $0.07 or 8.4% over the third quarter 2021 results of $0.83 per share. The improvement in operating results was largely driven by a significant improvement in the company's net interest income, an increase in noninterest revenues and a decrease in weighted-average shares outstanding between the periods, offset in part by increases in operating expenses, the provision for credit losses and income taxes. Adjusted pre-tax, pre-provision net revenue or adjusted PPNR per share, which excludes the provision for credit losses, acquisition-related expenses, other non-operating revenues and expenses and income taxes was $1.25 in the third quarter, up $0.21 or 20.2% over the prior year's third quarter. Adjusted PPNR per share was also up $0.12 or 10.6% over the linked second quarter result of $1.13. The company recorded total revenues of $175.6 million in the third quarter of 2022, this was up $18.7 million or 11.9% over the prior year's third quarter and established a new quarterly record for the company. Net interest income, the primary driver of the company's revenue growth was up 17.8% or 19.2% over the prior year's third quarter due to market interest rate-related tailwinds, strong loan growth, and investment securities purchases between the periods. The company's average interest-earning assets increased $1.08 billion or 8%, while the tax equivalent net interest margin increased 29 basis points from 2.74% in the third quarter of 2021 to 3.03% in the third quarter of 2022. Net interest income was also up $7.2 million or 7% over linked second quarter results, while the tax equivalent net interest margin expanded 14 basis points. Although interest expense was up $2.4 million over the prior year's third quarter, the company's average cost of funds was up just 6 basis points from 10 basis points in the third quarter of 2021 to 16 basis points in the third quarter of 2022. The company’s average cost of deposits remained low at 11 basis points for the quarter. Noninterest revenues increased $0.9 million over the prior year's third quarter, led by a $1.6 million or 9.7% increase in banking-related revenues and a $1.3 million or 7.6% increase in wealth management and insurance services revenues. Banking noninterest revenues increased from $16.9 million in the third quarter 2021 to $18.5 million in the third quarter of 2022, driven by an increase in deposit service and other banking fees. The increase in wealth management and insurance services revenues was driven primarily by organic and acquired growth in the insurance services business, offset in part by a decrease in wealth management services revenues due to challenging investment market conditions. Employee benefit services revenues were down $2 million or 6.8% as compared to the prior year's third quarter due to a decrease in asset-based employee benefit trust and custodial fees. Although asset quality remains very strong, the company recorded $5.1 million in the provision for credit losses in the third quarter reflective of strong loan growth and a weaker economic forecast. This compares to a $0.9 million net benefit recorded in the provision for credit losses in the third quarter of 2021. Comparatively, during the second quarter of 2022, the company recorded a provision for credit losses of $6 million, with $3.9 million of which was due to the acquisition of Elmira Savings Bank during the quarter. The company recorded $108.2 million in total operating expenses in the third quarter of 2022 compared to $100.4 million of total operating expenses in the prior year's third quarter. The $7.7 million or 7.7% increase in operating expenses was driven by a $3.3 million or 5.3% increase in salaries and employee benefits, a $2.2 million or 19.8% increase in other expenses and a $1.2 million or 9.4% increase in data processing and communication expenses. On a combined basis, all other expenses increased $1 million between the comparable periods. In comparison, the company recorded $110.4 million of total operating expenses in the second quarter of 2022. The $2.2 million or 2% sequential decrease in quarterly operating expenses was largely attributable to a $4 million decrease in acquisition-related expenses, partially offset by increases in salaries and employee benefits, data processing and communication expenses, and other expenses. The effective tax rate for the third quarter of 2022 was 22%. The company’s average earning assets increased $1.08 billion or 8% over the prior year from $13.53 billion in the third quarter of 2021 to $14.61 billion in the third quarter of 2022. This included a $2.07 billion or 49.4% increase in the average book value of investment securities and a $1.06 billion or 14.6% increase in average loans outstanding, partially offset by a $2.05 billion decrease in average cash equivalents. Average deposit balances, which includes $522.3 million of deposits acquired in the Elmira acquisition, increased $830.9 million or 6.6% over the same period. On a linked-quarter basis, average earning assets increased $140.5 million or 1%. Ending loans increased $398.9 million or 4.9% during the third quarter and $1.26 billion or 17.3% over the prior 12-month period. Exclusive of $437 million of loans acquired in connection with the second quarter acquisition of Elmira, ending loans outstanding have increased $824 million or 11.3% over the prior 12-month period despite a $156.2 million decrease in PPP loans. During the third quarter, the company originated over $750 million of new loans at a weighted average rate of just under 5%. Comparatively, the book yield on the company's loan portfolio was 4.22% during the third quarter. Asset quality remained strong in the third quarter. At September 30, 2022, nonperforming loans were $32.5 million, or 0.38% of total loans outstanding. This compares to $37.1 million or 0.46% of total loans outstanding at the end of the linked second quarter of 2022 and $67.8 million or 0.93% of total loans outstanding one year earlier. The decrease in nonperforming loans as compared to the prior year's third quarter was primarily due to the reclassification of certain pandemic-impacted hotel loans from nonaccrual status back to accruing status. Loans 30 days to 89 days delinquent were 0.33% of total loans outstanding at September 30, 2022, up slightly from 0.29% at the end of the second quarter of 2022, but down slightly from 0.35% one year earlier. The company’s regulatory capital ratios remained strong in the third quarter. The company’s Tier 1 leverage ratio of 8.78% was up 13 basis points in the quarter. This significantly exceeds the well-capitalized regulatory standard of 5%. The company has an abundance of liquidity, the combination of the company's cash and cash equivalents, borrowing capacity at the Federal Reserve Bank, borrowing availability at the Federal Home Loan Bank, and unpledged available-for-sale investment securities portfolio provided the company with over $5.2 billion of immediately available sources of liquidity at the end of the third quarter. The company’s loan to deposit ratio at the end of the third quarter was 63.4%, providing future opportunity to migrate lower yield investment security balances into higher yield loans. Looking forward, we are encouraged by the momentum in our business, as the company generates strong organic loan growth over the prior five quarters, the net interest margin expanded meaningfully in the quarter, asset quality remained strong, and the loan pipeline is robust. In addition, the pipeline of new business opportunities in the financial services business remained strong. In Q4 and 2023 we’ll remain focused on new loan generation, managing the company’s funding strategies in a rapidly changing interest rate environment, while continuing to pursue accretive low risk and strategically valuable merger and acquisition opportunities.

We will now begin the question-and-answer session. Our first question is from Alex Twerdahl from Piper Sandler. Alex, please go ahead.

Hey, good morning, guys.

Good morning, Alex.

Good morning.

First off, I appreciate your comments on a robust loan pipeline going into the fourth quarter, obviously strong together a couple of quarters, a very nice loan growth. I'm just curious if you can spend a little bit more time just elaborating on what we should expect to see in terms of the funding of that loan growth or potential loan growth in the fourth quarter, just given sort of the ebbs and flows of the municipal deposits as well as any other cash flows that we should expect to see from the securities portfolio over the next several quarters?

Hey Alex, this is Joe, I'll take that question. Yeah, it is quite possible that we wind up in a borrowing position at the end of the year, an overnight borrowing position given the robust loan growth in the pipeline. With that said, we do have about $600 million of securities maturities and payments next year in 2023, which, if you kind of do the math on that, that can support about 7% growth rate on our existing loan portfolio. So although we'll have moments throughout the year, we'll be in a borrowing position. We also think that those securities cash flows will support a lot of that growth next year. With regard to loan demand, it is still robust. I think the market is expecting that the higher-rate environment will squeeze out some of that demand next year, which, given our securities portfolio cash flows we think we could support a lot of that growth just by transferring effectively from an investment security earning asset into a loan earning asset.

Got it. So over the next quarter and early next year, we don't expect much in terms of securities cash flows. If I remember correctly, the next significant one matures in May of next year. In the meantime, could you remind us about the changes in the municipal deposits? I know you anticipate some inflows until the end of October and then outflows after that. Am I correct in that thinking? And could you help us quantify how to think about that?

Yeah, Alex, we do have at least with New York State, which is the primary driver of our municipal flows, there is a tax collection season that occurs effectively at the end of the third quarter and we tend to be somewhat level, if you will, in terms of municipal deposits in the fourth quarter, although that can vary a bit from year to year. And then there's another large tax collection cycle on property taxes in New York State in the month of January, so typically will see a little bit of an increase in tax collection and municipal deposit flows in the first quarter.

Okay. And then can you give us some color on what you're seeing in terms of deposit pricing pressures in your market? I know historically you've done an extremely good job keeping those betas about as low as possible. I'm just wondering if you're thinking through this cycle any differently about the complexion of the deposit mix?

Good morning, Alex. It's Dimitar. We're not seeing much in the way of deposits pressures in our markets at this point in time. With that in mind, I would say that it's more likely that those will accelerate from where they are today as everybody is experiencing pretty robust loan demand. But right now no one has really moved in any meaningful way in our markets.

Got it. Thanks for taking my questions.

You're welcome, Alex.

Thanks, Alex.

And our next question comes from Eric Zwick from Hovde Group. Please, Eric, go ahead.

Thank you. Good morning, everyone.

Good morning, Erik.

Good morning.

Wondering if I could just start on the net interest margin and what your thoughts are. You've talked a little bit about deposit beta and deposit pricing pressure maybe starting to creep in or some expectation that you might start to see that towards the end of the year into next, just given the fact that we likely have some more Fed funds rate increases coming here at the end of the year and maybe into next year as well. Just curious like your thoughts for the direction and if you could quantify any expectations for where you think the margin goes in 4Q and maybe the early part of next year?

Sure, Erik. This is Joe, and I’ll address that question. We have experienced two consecutive quarters of significant margin expansion, with an increase of 16 basis points in Q2 and 14 basis points in Q3. However, we do not expect that rate of margin expansion to continue. This expectation is partially connected to the question about borrowings; we will likely borrow a bit in the fourth quarter, and that will be at a significantly higher rate than our deposit base. Therefore, we do not anticipate the same level of margin expansion as in the previous quarters. Nevertheless, the loan pipeline and our current momentum should help support the existing margin, which could lead to a slight increase of a couple of basis points in the quarter. We do expect some expansion of net interest income due to deposit growth and ongoing momentum, though probably not at the same rate we have seen recently. Over the long term, we maintain our expectations for mid-single-digit loan growth, which should support margin expansion over time. However, in the short term, we do not expect continued levels of expansion.

That's helpful. I have a follow-up question on this topic. If loans can grow in the mid-single digits and you have opportunities to use some cash flows from the investment securities portfolio in 2023 to support that growth, how should we consider average earning asset growth in the upcoming quarters?

Yeah, I think that's a fair question. I wouldn't expect it to certainly increase at the levels that we saw during the pandemic. We just don't have those types of flows from the deposit side to continue to support growth in the overall base. But the long side of the equation is, we get a higher run rate. So I would expect that overall earning assets could probably grow in the low-to mid-single digits, just based on the loan pipeline and expectations around growth as we move ahead, but certainly not the double-digit levels we saw during the pandemic.

Thanks for the extra clarity there. And just moving on to credit, obviously, the metrics that you have in your portfolio continue to get better in terms of nonperforming loans, OREO, early delinquencies. The provision this quarter reflected, as you mentioned, both organic loan growth and then just a deterioration in that, I think national outlook is what it said in the press release. Curious what you're seeing with your own eyes and hear with your own ears, there in your own markets in terms of communities and businesses are you seeing any signs of pressure or weakness there or more just kind of caution and businesses and consumers preparing for what might be a recession coming in the next few quarters?

Hey Erik, it's Dimitar. We're not seeing really anything that gives us concern on the credit side. We're watching it a little bit more, obviously, with rates going up. I think that's all secured some of the demand and maybe some of the more marginal, more worse as well. So right now if you look at our metrics across every single portfolio, they're below or at historical averages and delinquencies are very, very low. We would expect them to creep up a little bit and you saw some of that into provisioning this quarter kind of looking ahead, but certainly does not feel like any sort of credit event in our markets.

I appreciate the color. That's all my questions right now. Thank you.

Thank you, Erik.

And our next question is coming from Chris O'Connell from KBW. Chris, please go ahead.

Good morning. Just wanted to start off on the fee businesses. It’s shot up well this quarter, especially wealth and insurance, and you mentioned you had a good pipeline there. So maybe if you could walk us through kind of what you're thinking for organic growth rates going forward, assuming the broader financial markets remain more or less flat?

Good morning, Chris. It's Dimitar. If you take a moment to consider our fee businesses, the resilience they have shown this year is remarkable. We have seen growth year-to-date across our fee income platforms, and we experienced quarter-over-quarter increases as well. When we combine our benefits, wealth, and insurance sectors, about 50% of that is dependent on the market. With the market down 20% in fixed income and equities, this highlights the organic opportunities we have discussed in our calls. We have achieved double-digit growth in units within those sectors, indicating more activity and more clients, demonstrating strong organic performance. While some of this growth has been affected by market conditions, we are still on track to be close to flat year-over-year in those businesses. We view this as a positive outcome, particularly since many of our competitors are likely to see declines in fee income. It’s worth noting that not all fee income behaves the same. We are encouraged by the momentum in each of these businesses, with double-digit organic growth, which we are very happy about. However, it's important to recognize that half of this growth is connected to the market performance.

Got it. That's helpful. Thank you. And just circling back to some of the margin discussions, a little bit surprising, I guess, not more bullish on the near-term margin outlook. Maybe if you could provide what the spot rates are on the deposits today that would be helpful. And is all of the near-term 4Q less expansion due to the borrowings coming on the books in the fourth quarter? Or do you expect deposit betas to accelerate from here?

Yes. Hi, Chris. This is Joe. I'll take that. So far in the current cycle, our cost of funding and cost of deposits has not increased significantly. In fact, our funding beta is around two, though this level may not persist as we progress deeper into the cycle. We will likely need to adjust our funding costs as we move forward, which is typical. Additionally, we are experiencing strong loan demand that requires funding. We will evaluate our deposit base and seek opportunities to grow it at a rate higher than our current deposit cost of 11 basis points. Therefore, we expect to see higher funding betas as we approach the fourth quarter. Regarding your question about the fourth quarter, some of the shorter-term borrowing costs will limit our ability to enhance the net interest margin during that time, but as we move into next year, we will start to see some of those securities cash flow transition effectively into the loan portfolio. In the short term, the funding aspect will pose challenges. We booked new loan volume this past quarter at a blended rate close to 5%. It's important to note that some of those originations had rates set with borrowers before the recent rate increases. We anticipate that the rate for new loans will increase slightly in Q4. However, the immediate challenge will be the higher borrowing costs for the fourth quarter, possibly extending into the first quarter.

Great. That's helpful. And you mentioned –

I’m sorry, Chris. But NII will continue. We expect to expand in Q4.

Yes. You mentioned the uptick in origination yields post the end of the quarter. Maybe you could just provide an update on where the origination yields for the various buckets are coming on at?

They're varied, but actually they're fairly tight relative to last quarter. So I'll take that back. I don't have those right in front of me, Chris, on each of the individual portfolios. I missed it –

That's it.

In the third quarter, the originated yield on mortgages was approximately 38 basis points higher than the portfolio yield. Business lending exceeded 100 basis points, primarily driven by the auto lending business, which was around 80 basis points higher. Home equity performed exceptionally well, increasing by a couple of hundred basis points. Direct consumer lending, though limited, rose by about 65 basis points. Overall, we are seeing substantial increases across the board and anticipate this trend to persist into the fourth quarter, maintaining the divergence between portfolio yield and yields on newly originated assets.

Great. And then lastly, just with the AOCI impact on DC. I know you guys primarily focused on the regulatory capital ratios, but maybe just an update on how you guys are thinking about that? And any updated conversations in general with how the regulators feel about that? And you mentioned still pursuing accretive M&A transactions. Maybe just kind of outlining what you guys are seeing in the market there and what type of transactions you'd be interested in pursuing now?

Regarding the question on AOCI and tangible capital, we don't focus much on that metric here. The changes in AOCI over the last few quarters have mainly been related to treasury securities. We don’t feel the need for additional capital to address fluctuations in the market value of these securities since we have certainty about the incoming cash flows. Therefore, our attention is primarily on regulatory capital, which is also what regulators prioritize. Additionally, we have a stable core deposit funding base with a long duration, which, despite not being able to write it to its true value, helps support our overall portfolio valuation. This stability has allowed us to extend some of our asset durations since a significant portion of our deposits is in checking and savings accounts that are not particularly sensitive to interest rate changes.

I think regarding the M&A question, as we mentioned last quarter, we are still interested in pursuing high-value acquisition opportunities. The market environment seems to be conducive for having those conversations. We're pleased that these opportunities continue. However, one change for us is that our ability to grow organically on the bank side has influenced our M&A strategy. Our growth opportunities can be viewed as a three-legged stool: bank organic growth, non-bank organic growth, and M&A. Traditionally, the M&A leg and the non-bank organic leg have performed well, while the bank organic growth has lagged, which we addressed with tactical M&A opportunities. Now that we can strengthen the bank side and grow organically, we can focus more on strategic M&A opportunities. This is the conversation we are having internally. There may be a slight adjustment to the strategy, but our interest and ability for M&A discussions remain unchanged and productive.

Great. Appreciate the color and thanks for taking my questions.

Thank you.

Thank you, Chris.

Our next question comes from Matthew Breese from Stephens Inc. Please go ahead, Matthew.

Good morning, everybody.

Good morning.

I first just wanted to confirm on the loan growth outlook, it feels like mid-single digits is a pretty good bogey, low single digit earning asset growth with the difference there being expected securities runoff. Is that an accurate statement?

Yes. We think that's accurate, Matt.

Okay. And then within the loan pipeline, where are the greatest strengths and where do you expect to grow or should we expect loan growth to be pretty diverse like we saw this quarter?

Good morning, Matt. The pipeline is strong across all of our businesses, so we anticipate growth in commercial, which has been a significant area of expansion for us. The pipeline in that sector remains very robust. Similarly, in mortgage, despite what you're hearing about the national situation, our markets continue to be resilient. While refinance volume is down, we've accounted for that on our balance sheet, making it a net zero impact for us. Purchase applications are actually on the rise this year. We've also been reorganizing our go-to-market model, so we expect mortgage to keep growing on the balance sheet side. Indirect has performed very well this year; it's a more cyclical business and can be unpredictable, but currently, application volume is strong despite rate increases. On the direct side, we've seen growth this year and expect to continue into the fourth quarter, which is a promising sign. Moreover, this is the first year in a while that we’ve seen growth in home equities, in addition to other areas. Overall, we feel optimistic, although it might not be as strong as the third quarter. Still, a mid-single digit growth rate seems attainable for us next year.

Can you discuss the health of the underlying borrowers from an underwriting perspective, considering the challenging environment? Is what we're observing indicative of the typical bus markets, along with increased lending capacity and exposure to some urban areas? Have you needed to adjust your underwriting practices or become more selective in this climate?

So, Matt, our underwriting has not changed at all. What's changed is just our ability to be on the street and getting opportunities in the door across our business lines. So if you just kind of also look at our markets, they remain housing constrained. Inventory is low, it's actually down on a year over year basis versus a lot of markets in the country where it's up very meaningfully. So there's just not a lot of housing to go around. So the borrowers, again, before we are writing mortgages in the 7s today, just like everybody else and the purchase applications are strong. The commercial borrowers as well, we're looking at their financials on a constant basis where we've gone into the larger markets, we've gone with the best-in-class developers and clients. As we like to say around here, your biggest clients need to be your best clients. So we're very focused on that. So now our credit metrics, if you look at our indirect business, our FICOs are actually up year over year. As you know, we write kind of prime and super prime type paper in the used market. So nothing has changed in terms of our underwriting. It's just our ability to actually be more present in the markets.

Great. And then two other ones. The first quick one is just on tax rate and expected tax rate going forward. I have 23% model, but it's been a bit below that year to date?

Yes. I mean, I think the last couple of quarters is indicative of our expectations, which is in around 20% plus or minus, call it, 0.5% depending on activity in a particular quarter. Barring, of course, any changes in state tax rates or anything along those lines, I would expect that the last couple of quarters is indicative of the future tax rate of above 22%.

Okay. Thank you. And then last one is just, Mark, when you discussed more strategic M&A, could you give us some idea of the key differences in your view for strategic M&A versus some of the past deals that you've done? What do you look for in the strategic deal?

Sure. We look for new markets, generally adjacent contiguous extensions that we think are strategic because we don't have a presence there. We have a lot of opportunities in those markets, they might represent some of those kind of slightly larger markets that we've gone into in the last handful of years. Albany, Buffalo markets like that are a little bit bigger, they're still not what you would consider metropolitan. But bigger than our kind of historical legacy market. So I think that's number one. Talent is always something that's important to us that we assess as a component of our evaluation of transactional opportunities, maybe particular businesses that are of great interest to us for some reason. Some banks have outsized really high-quality trust businesses, which is very additive and other wealth-managed resources, some have insurance. Sometimes it's talent, sometimes it's the market. So it can be a variety of things. I would suggest that the tactical type transactions have historically been kind of the smaller in-market, plug and play kinds of transactions where they're smaller so the accretion percentage, let's call it, the economic value is greater. There's lower execution risk because they're in-market. Those I would consider to be historically more tactical and with the ability to have that kind of third leg of the growth stool, those will become less, let’s call it, necessary or important in terms of our M&A strategy. We'll focus more on those kind of market extensions, talent acquisition, business line, product acquisition, those kinds of things, which we consider to be more strategic and less tactical.

Great. I appreciate all the color. That's all I had. Thank you.

Thank you.

Thank you, Matt.

We have Alex Twerdahl from Piper Sandler with a follow-up question. Alex, go ahead.

Thank you. Regarding the previous point about strategic mergers and acquisitions, your historical asset size targets have ranged from $0.5 billion to around $2 billion. Does your strategic focus include the possibility of considering larger assets?

Probably not at this juncture, it would have to be something significant and special for us to think about something beyond $2 billion at this point. We think there's a lot of really good strategic opportunities that are less than $2 billion. And so I would say at this juncture, Alex, no. I would say $2 billion is probably the top side of where we'd be thinking currently.

Got it. And then just on expenses, I don't think we touched on it yet, but just in terms of cost savings and sort of expected expense run rate. Is this sort of $108 million the right starting point? And as you look into next year, how do you see expense trajectory?

Yes. Hi, Alex. It's Joe again. I'll take that question. So, our history was growing at, call it, low single digits, maybe, call it, 3% as kind of a run rate around OpEx. We've invested a few additional resources in new loan generation and new business development. So that in itself has the cost structure associated with that. But as I think we're all keenly aware, there's inflationary pressures on wages and other pressures, even vendors and the like from the standpoint of higher costs. So our expectations is that, our run rate from this point forward will be kind of mid-single digits, potentially a tad higher if the inflation persists, but right now kind of mid-single digits is our expectation.

Great. And the $108 million is the right starting point for that mid-single digits?

That seems reasonable. We typically have some seasonal patterns around expenses, the snow will fly here at some point, there's just higher costs associated with Q4 and then Q1 into next year. We typically have our merit increases in the beginning of the year and then things level out. But I think the long-term trajectory of mid-single digits is a fair expectation. Of course barring any additional M&A at this point.

Got it. And then just to clarify on your NII growth comments. I think you said the fourth quarter you expect NII growth expansion. I'm just wondering as we head into 2023, as you kind of outlook and sort of see, obviously, you have the exchange of low-yielding securities for higher-yielding loans. But given that weighed against higher funding costs, do you feel confident that NII can expand across 2023 as well?

Yes. We still expect that to continue to expand in 2023. Just the rate of change and rate of increase is unlikely to be replicated in 2023.

Right. Thank you for taking my follow-ups.

You're welcome.

And now we have a question from Manuel Navas from D.A. Davidson. Manuel, please go ahead.

Hey, good morning fellows.

Good morning.

The noninterest bearing deposit growth, is that all tied to public funds? Or is that also seeing some nice growth from new commercial customers?

Sorry, Manuel. Can you –

I think we had outflows from public funds during the quarter. So the growth

Can you provide additional details about the end of period noninterest bearing deposit growth?

Yes, it's consumer and business.

Okay, great. That's about 32% right now. Any thoughts on how that can be maintained in a rapidly increasing deposit beta environment?

Not sure what the 32% you are referring to, Manuel.

You have roughly 32% noninterest bearing deposits?

No. Actually, yes. If you look at our deposit account balances, checking and savings accounts represent about 70% of the total, while money market accounts and CDs make up about 30%. Historically, we have navigated various interest rate cycles successfully, demonstrating strong beta performance throughout. Our core deposits have shown significant duration; the last study we did indicated an average duration of around 14 years, highlighting the stickiness of these deposits. Although we anticipate a different environment moving forward, and some other banks are experiencing challenges with their deposit bases and funding costs, we believe we will manage these influences over time. Currently, our situation is stable, and as Dimitar mentioned, we are not facing significant risks at this moment. While that may change, I am confident in our deposit mix and our historical performance in maintaining deposits and interest rates with much lower beta. We won't face the same pressure we might have otherwise, as we’re planning to adjust our investment portfolio down by a couple of billion dollars over the next few years while still maintaining plenty of liquidity and optimizing our balance sheet. We expect some fluctuations in funding needs each quarter based on deposits and overnight borrowing. However, we have a solid long-term strategy for repositioning our balance sheet that will maximize our earnings potential. For instance, managing a couple of billion dollars in securities at 4% could result in an earnings increase of $1 per share. Therefore, we see this opportunity for improved earnings over the next few years without compromising liquidity or taking excessive risks, and without over-leveraging our balance sheet. The remix of our balance sheet is advantageous. Funding costs have always been crucial for us, and we have built a stable, low-cost core deposit funding base that withstands economic fluctuations, including varying interest rates and market downturns. Overall, I am pleased with our current position. However, in the short term, we may need to raise deposit rates eventually, and we could face a more challenging environment for deposit retention ahead, although we haven't encountered that just yet.

Manuel, to clarify, it's Dimitar. When we refer to a savings rate of 75%, we view it that way because our savings accounts are nominally interest-bearing. They don't appear in the 30% figure you consider from a noninterest-bearing standpoint, but the rate on those accounts is only a few basis points. Additionally, that rate doesn't scale up with betas like our products do.

I mean, you historically have a very strong deposit base and you have more noninterest bearing deposits as a percent of deposits that you've ever had. That's what I'm trying to highlight. That seems pretty good.

We like it.

All right. That's it for questions for me. Thank you.

Thanks, Manuel.

And this concludes our question-and-answer session. I would like to turn the conference back over to Mr. Tryniski for any closing remarks. Thank you.

Thank you, Marlese. Thank you to everyone for joining today on our third quarter call, and we will talk to you again in January. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.