Good day, and welcome to the Community Bank System First Quarter 2024 Earnings Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Dimitar Karaivanov, President and Chief Executive Officer of Community Bank Systems. Please go ahead.

Thank you, Nick, and good morning, everyone, and thank you for joining the Community Bank Systems Q1 2024 earnings call. This quarter was a good illustration of the benefit of our diversified financial model. Our market-sensitive recurring fee income businesses showcased their strength and fully offset margin pressure in our banking business, leading to another quarter of record revenue for the Company. We normalized the expense growth rate while continuing to invest in all of our businesses. Our below-average risk profile remains firmly rooted in the low credit risk intensity and exceptional liquidity of our balance sheet. During the quarter, we also modestly increased our qualitative assessment of future uncertainty and proactively added to our reserves. In our banking business, growth continued in our commercial, mortgage, and consumer installment portfolios. Strong loan growth of $179 million was more than fully funded through deposit growth of $424 million. Market share gain opportunities remain attractive across our footprint as many competitors are limited by their liquidity profiles. Pipelines remain excellent with particular strength in C&I compared to prior quarters. We also formally announced our branch expansion plans with 14 locations expected to open in the next five quarters. Two in Buffalo, three in Rochester, Syracuse, two in the Capital Region, two in the Lehigh Valley, one in Springfield, Massachusetts, and our first location in New Hampshire. In our Employee Benefit Services business, we are now benefiting from both new client counts and market appreciation. Revenue growth was 7.9%, and we also closed on the acquisition of creative plan designs during the quarter. Looking forward, organic momentum remains strong, and market values remain supportive. Our insurance services business was relatively flat in terms of revenue performance due to the timing of certain commercial premiums and lower contingency revenue. However, both the organic and inorganic growth opportunities remain attractive for 2024. Our wealth business had a record revenue quarter with double-digit gains in revenue and increased inflows. Our wealth team is energized and focused on increasing penetration levels while also launching a number of new service offerings on a nationwide basis. Overall, I'm encouraged by our operational execution this quarter, as evidenced by the improvement in pretax pre-provision net revenues over the prior two quarters. In terms of capital deployment, we closed on a number of smaller acquisitions in our fee income businesses and also repurchased 750,000 shares at what we deem to be very attractive levels, given the intrinsic earnings power of our company. I will now pass it on to Joe for more details.

Thank you, Dimitar, and good morning, everyone. The Company recorded $0.76 of GAAP diluted earnings per share in the first quarter. This compares to $0.11 in the first quarter of 2023 and $0.63 in the linked fourth quarter of 2023. As a reminder, during the first quarter of 2023, the Company recorded a $52.3 million pretax realized loss on the sale of certain available-for-sale investment securities in connection with the Company's balance sheet repositioning strategy, which negatively impacted GAAP diluted earnings per share by $0.75 in that quarter. Operating diluted earnings per share, which excludes certain non-operating revenues and expenses as delineated in this morning's press release, were $0.82 in the first quarter and linked fourth quarter, compared to $0.92 in the first quarter of the prior year. The $0.10 decrease in operating diluted earnings per share from the prior year's first quarter was driven by a decrease in net interest income and increases in the provision for credit losses, operating expenses, and income taxes, offset in part by an increase in operating non-interest revenues. On a linked quarter basis, a decrease in operating expenses and an increase in non-interest revenues were offset by a decrease in net interest income, a higher provision for credit losses, and an increase in income taxes. Operating pretax, pre-provision net revenue per share, as defined in the press release, was $1.18 for the first quarter. This was up $0.05 per share over the linked fourth quarter but $0.04 per share below the prior year's first quarter. During the first quarter, the Company recorded total revenues of $177.3 million. This established a new quarterly record for the Company and highlights our diversified business model. Higher levels of operating non-interest revenues in our banking, employee benefit services, and wealth management services businesses overcame declines in net interest income and insurance services revenues in both the linked quarter and the prior quarter. The Company recorded net interest income of $107 million in the first quarter compared to $109.2 million in the linked fourth quarter. Despite solid loan growth in the quarter and an improvement in yield on interest-earning assets, pressure on funding costs did not abate. During the quarter, the Company continued to experience a migration of customer deposit balances from lower-rate checking and saving accounts to higher-rate money market and time deposits, increasing the cost of deposits by 16 basis points in the quarter from 98 basis points in the linked fourth quarter to 1.14% in the first quarter. When combined with higher borrowing costs, the Company's total cost of funds increased 23 basis points from 1.08% in the linked fourth quarter to 1.31% in the first quarter. This outpaced a 13 basis point increase in interest-earning asset yields, resulting in a 9 basis point decrease in the Company's fully tax-equivalent net interest margin from 3.07% in the fourth quarter of 2023 to 2.9% in the first quarter of 2024. Comparatively, the Company reported net interest income of $111 million in the first quarter of 2023. We believe the first quarter net interest income result of $107 million represents a bottom for the Company in 2024, and the outlook remains positive for net interest income expansion on a full-year basis. As mentioned previously, operating non-interest revenues were up in three of our four businesses on both an annual quarter and linked-quarter basis. Banking-related non-interest revenues were up $1.8 million or 11.1% over the same quarter of the prior year, driven by increases in debit interchange and ATM fees and loan placement and advisory revenues, while Employee Benefit Services and Wealth Management services revenues were up $2.3 million or 7.9% and $1 million or 11.7%, respectively, over the same period, driven by favorable investment market conditions and employee benefit plan participant growth. Insurance Services revenues were down approximately $400,000 or 3.6% due to timing differences on certain commercial policy renewals and insurance carrier related contingency revenues. On a linked-quarter basis, banking-related non-interest revenues were up slightly, while employee benefit services revenues and wealth management services revenues increased $1.7 million or 5.6% and $1.3 million or 16.5%, respectively. Insurance Services revenues were down approximately $500,000 or 4.2%. During the first quarter, the Company recorded $118.1 million in non-interest expenses. This represents a $4 million or a 3.5% increase from the prior year's first quarter and an $11 million or 8.5% decrease from the linked fourth quarter results. Total operating non-interest expenses, which exclude certain non-operating expenses as detailed in the Company's press release, were $114.4 million in the quarter, compared to $110.3 million in the prior year's first quarter and $116.4 million in the linked fourth quarter. As mentioned on last quarter's earnings call, although the Company will continue to make front-foot investments in its leadership team, talent across all lines of business, data systems, and risk management, operating expense growth is expected to moderate in 2024. The first quarter results were consistent with expectations. The Company recorded a $6.1 million provision for credit losses during the first quarter of 2024. This compares to $3.5 million in the prior year's first quarter and $4.1 million in the linked fourth quarter. Although the Company's credit metrics remained strong during the first quarter, the Company built loss reserves reflective of an increase in our qualitative assessment of future uncertainty. The Company's allowance for credit losses stood at $70.1 million or 71 basis points of total loans outstanding at the end of the first quarter, up $3.4 million or 2 basis points in the quarter and up $6.9 million or 1 basis point over the prior year's first quarter. The effective tax rate for the first quarter of 2024 was 22.9%, up from 16.9% in the first quarter of 2023. Excluding the impact of tax expense and benefits related to stock-based compensation activity and income tax credit amortization, the effective tax rate for the first quarter of 2024 was 22%, up from 21.4% in the first quarter of 2023. Ending loans increased $178.9 million or 1.8% during the first quarter. This marks the 11th consecutive quarter of loan growth and reflects the Company's continued investment in its organic loan growth capabilities. Although outstanding balances in the consumer mortgage and consumer direct segments increased in the first quarter despite seasonal headwinds, the primary driver of loan growth in the quarter was the $135.8 million or 3.3% increase in the Company's business lending portfolio. The Company's ending total deposits increased $423.9 million or 3.3% during the first quarter of 2024, driven by seasonal inflows of municipal deposits. Ending deposits also increased $241.4 million or 1.8% from one year prior. Although funding costs continued to increase in the first quarter, as previously noted, non-interest-bearing and low-rate checking and savings accounts continue to represent almost two-thirds of total deposits, and the Company's cycle-to-date deposit beta of 20% continues to be one of the best in the banking industry and reflects the strength of the Company's core deposit base. The Company's liquidity position remains strong, with readily available sources of liquidity, including cash and cash equivalents, funding availability at the Federal Reserve Bank discount window, unused borrowing capacity at the Federal Home Loan Bank of New York, and unpledged investment securities totaling $4.6 billion at the end of the first quarter. These sources of immediately available liquidity represent over 200% of the Company's estimated uninsured deposits, net of collateralized and intercompany deposits. The Company's loan-to-deposit ratio at the end of the first quarter was 74%, providing future opportunity to migrate lower-yielding investment security balances into higher-yielding loans. At the end of the first quarter, all the companies and the bank's regulatory capital ratios significantly exceeded well-capitalized standards. Specifically, the Company's Tier 1 leverage ratio was 9.01%, which substantially exceeded the regulatory well-capitalized standard of 5%. During the first quarter, the Company repurchased 750,000 shares of its common stock at an average price of approximately $46 per share. The Company recorded net charge-offs of $2.8 million or 12 basis points of average loans annualized during the first quarter. This is up slightly from 10 basis points in the linked fourth quarter and 7 basis points in the same quarter of the prior year, with increases primarily attributed to the consumer indirect loan portfolio. At March 31, 2024, non-performing loans totaled $49.4 million or 50 basis points of total loans outstanding. This represents a decline from $54.6 million or 56 basis points of total loans at the end of the linked fourth quarter. Non-performing loans were $33.8 million or 38 basis points of total loans one year prior. Loans 30 to 89 days delinquent were also down on a linked quarter basis from $48.4 million or 50 basis points of total loans at the end of 2023 to $42.1 million or 43 basis points of total loans at the end of the first quarter. Overall, the Company's asset quality remained strong in the quarter. We believe the Company's diversified revenue profile, strong liquidity, regulatory capital reserves, stable core deposit base, and historically strong asset quality provide a fundamentally solid foundation for future opportunities and growth. Looking forward, we are very encouraged by the revenue outlook in all four of our businesses. We will continue to lean into growth and prudently deploy capital, aligning with the interests of our shareholders. That concludes my prepared comments. Thank you. I'll now turn it over to Nick to open the line for questions.

Our first question comes from Manuel Navas with DA Davidson. Please go ahead.

This is Sharanjit on for Manuel. So, OpEx this quarter was much better than expected. What are some of your expectations for the OpEx run rate going forward?

Yes. We believe our run rate for OpEx will kind of be contained, I'll call it historic levels of about mid-single digits, call it, 3% to 6%. We invested pretty heavily in a lot of our infrastructure, talent, and technology last year, which kind of increased the OpEx run rate, but they were mostly front-footed investments. I mean, obviously, there were some wage pressures as well. But we expected that to sort of come down, if you will, in 2024. I think the first quarter is a pretty good data point for us from the standpoint of what the expectations are going forward.

Great. And do you have any updated thoughts on the pace of the buybacks, given strong loan growth?

Yes. We expect that the pace will slow a bit. I wouldn't expect just an additional 750,000 shares going forward. We just had an opportunity at these levels, so we took advantage of that, if you will. Generally, our philosophy over the years has been to buy back the equity plan issuance during the year and potentially a little more in this case with the current price points.

Our next question comes from Steve Moss with B. Riley FBR. Please go ahead.

I'm sorry for joining late, but I'd like to start by discussing the loan pipeline. You demonstrated strong commercial loan growth this quarter. I'm curious about what you're observing regarding economic activity and the opportunities available.

Our pipeline is robust and indeed stronger than it was at the end of last year and likely stronger than it has been in the last few quarters. Notably, the commercial pipeline has undergone a significant shift, which we've been aiming for over the past few quarters, moving from commercial real estate to commercial and industrial lending. Over half of our current pipeline is in this area. While this sector typically requires a longer time frame to close, we may not experience the same growth pace even with an increased pipeline. However, the activity remains strong, and the mortgage sector also shows that our pipeline is higher compared to last year. In our consumer installment business, we are focusing more on pricing versus growth. Many of our competitors are still facing constraints in liquidity, capital, or optimizing risk-weighted assets, resulting in substantial market share opportunities for us. Our markets are holding steady with above-average historical economic activity. For instance, data from local organizations indicate that Central New York currently has ten times the economic development activity in its pipeline compared to five years ago, not including investments in the semiconductor corridor. There are many positive developments in our markets, and we are well-positioned to capture more market share.

Okay. That's really helpful. Appreciate the color there, Dimitar. Just curious as to what's the add-on rate for new loans these days for you guys?

Yes, we're right back in the mid-7s, which is where we've been in the past couple of quarters. So really, pricing has remained pretty firm here in terms of our new originations.

Okay, appreciate that. Regarding the margin, I understand that your deposit beta is low and your funding costs are notably lower compared to Fed funds. I'm interested in how you're approaching the margin in a prolonged high-interest environment. Do you anticipate any increase in funding costs? Also, since securities take longer to reprice, should we expect to see further margin pressure in the upcoming quarters?

Yes, this is Joe. I will address that. Our expectation is that the net interest income for the first quarter will likely be the lowest point for us. We believe that even under prolonged higher rates, net interest income will increase in the remaining quarters of 2024 and hopefully surpass the overall result from 2023. There are many variables that could change before the year ends. Over the past year, we had approximately $1.3 billion in principal payments and prepayments on our loan portfolio and originated around $2.2 billion, resulting in a net growth of about $900 million. As older loans with lower yields roll off, they are being replaced with new loans yielding 7.5%, which should provide a significant boost to our earning assets. On the funding side, we anticipate some relief from the pressures we're experiencing. However, if long-term rates rise, those pressures may continue. Currently, we expect the cost of deposits to stabilize and not increase as rapidly in the coming quarters. This will shape our net interest income growth. For the recent quarter, we recorded $298 million in net interest margin on a tax-equivalent basis, and we expect that margin may increase slightly while we continue to grow net interest income. It is important to monitor deposit balances, as they play a crucial role in supporting ongoing loan growth. If we shift from a deposit base just over 1% to 5% borrowing, it could become costly. We also need to account for the migration to higher-cost deposits that will affect overall costs, along with changes in the yield curve. While there are factors that may influence the outcome, we expect net interest income to grow moving forward.

Thank you. Regarding the insurance business, I understand there were timing issues affecting the insurance revenues this quarter. I assume it's still a challenging market, and I would appreciate any updates on revenue growth in that area. Additionally, while the market for stocks and bonds has been strong, there has also been noticeable growth in employee benefits. I'd like to hear your thoughts on that as well.

Sure. Mr. Steve. I'll start with the insurance business. We continue to believe that both organic expansion in terms of new clients and higher rates is going to be positive this year. Additionally, we do have a very good pipeline in terms of inorganic add-ons as well. So, as you think about the revenue growth in that business, we've grown at double digits over the past three years. We still think that kind of high single digits is probably achievable for this year. As the business gets bigger, that double-digit number is continuing to increase as well. But the opportunities are strong. We did have some what we consider timing cutoffs and mismatches this quarter, which kind of muted a little bit of the revenue performance. But the full-year expectation for the business is still very positive. On the employee benefit side, we've been talking for years about adding a lot of new customers and a lot of new lives on the platform. That's been the case. It's just been muted for a couple of years because the asset values were too low. Now you're seeing both those new units, if you will, and the asset values come together, and we had a great quarter, and our expectation is that that's going to continue. We did acquire credit plan designs and did not have much revenue in this quarter from that acquisition as well. So, there is some back-end, second-half-of-the-year loaded revenue from the acquisition activities as well.

The next question comes from Christopher O'Connell with KBW. Please go ahead.

Just wanted to follow up on the fee discussion. I realize that markets are strong, but wealth management, the uptick was pretty strong there as well as the BPaaS group. Is that a good sustainable run rate on a go-forward basis?

Yes. I think, Chris, I mean, our wealth business is very much the same story as our employee benefits business. Folks have been very busy adding more clients over the past couple of years. And again, that growth has been a little bit muted. So, if market value stays where they are, yes, that will be a very close run rate for us for the rest of the year in that business. So, look, we've got four businesses. We always talk about our four businesses; that's how we run the Company. If you think about our company as having four engines, which is a couple of engines more than most. Right now, our wealth business and our employee benefit services business are ramping up, our insurance business, as we mentioned, is a little bit lower, but we expect it to ramp up over the rest of the year. Our banking engine is a little bit sputtering on the interest income side, but the gas tank is full. If we do get some slowdown in the mixing of the deposit base, that's going to start contributing quite meaningfully. So, we feel pretty good about the organic and market value-driven and inorganic growth across all of those four businesses for the year.

Great. And I apologize if I missed it, but did you guys say how much the creative plan designs acquisition adds in terms of revenues?

It's going to be somewhere between $3 million and $4 million per year.

Great. And you mentioned a couple of times, I think, in the prepared remarks, the inorganic acquisition opportunities. Can you just talk about where you're seeing the greatest opportunities on the fees side? And then a little bit about what you're seeing and how the market progressed in terms of the traditional bank M&A side?

Sure. So, we're pretty active in terms of what we would consider kind of roll-up acquisitions, and those have been predominantly in our insurance business over the past couple of years. I think we're down about 11% in the past three years. As you can imagine, there are three to four to five kind of books of businesses that we're tucking in, and that's across various geographies for us where we're present. So that pipeline remains just as strong as it was last year, and I fully expect that we'll be doing another three or four or five tuck-ins in the insurance business. Our employee benefits business, we've completed three tuck-ins so far this year. They vary in size with creative plan designs being the larger one. The others are kind of $0.5 million to $1 million here and there. So, they add up over time, and that's part of our business model is to continue to deploy capital in those very attractive segments. In our Wealth business, we thought we would acquire practices every once in a while. So, every year, we'll probably have an opportunity to do one or two of those. They are more like equity hires, if you will, with somebody just moving on to our platform, and we pay them for a book of business. That's kind of what we do in those three businesses. On the bank side, as we mentioned in the prior call, we remain very interested in pursuing acquisitions. We have a bit of a different lens today than we did four or five years ago. That doesn't mean that we're not interested in bank transactions. There has been a little bit more of a pickup in the way of discussions, but we all know the hurdles, right, in terms of rates and marks and values. A lot of things need to come together for those to happen, but we remain engaged on that side of the business as well.

Great, that's helpful. Can you share what you are observing regarding credit? All trends this quarter appear solid regarding NPAs and delinquencies. However, you mentioned a bit about business lending and the consumer and direct portfolios. Is there anything different there, or do you foresee credit costs increasing in those segments over time?

Yes. Good question, Chris. So, on credit, our outlook has not really changed much. We believe that with an unemployment rate of under 4% and a tremendous amount of government spending and nominal GDP growth of 5%, the outlook for credit is positive across the board. Having said that, if you just think about the distribution of probabilities, this quarter's end versus last quarter's, if we were to remain in a bit of a higher for longer scenario, eventually, the higher cost of credit has to feed through and find its way into the real economy. So, we looked at our model, which actually suggested a little bit of a lower quantitative outcome compared to prior quarters. I don't think that's a big surprise. You've seen a lot of banks release reserves this quarter. We just didn't think it was appropriate for us, given the outlook, and our loss coverage remains very, very strong. Our 12 basis points of losses this quarter means we have six years' worth of losses in the ACL. That remains very strong. We just felt that given the qualitative outlook for maybe higher for longer, there may be a little bit more pressure over time in some point in the portfolios.

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

Joe, you had mentioned a little bit that you're starting to see the increase in deposit costs starting to slow over time. I was curious, if you look at the composition of deposits, if that is matching up with stability, particularly in the lower cost categories as well. And along those lines, if you had any sort of projections as to where we might see DDAs kind of settle out later this year?

I'm not certain where the time deposit mix will be at the end of the year. I believe the migration we saw in the first quarter will slow a bit throughout the year. Most of the rate-sensitive deposits have likely moved to higher-cost funds. I would have noted the same last quarter. The expectation is for the migration to continue, but probably not at the same fast pace. Additionally, while there could be more increases in the overall cost throughout the year, we anticipate that the rate of increase on the deposit side will also slow down. It's important to mention that we experience seasonal inflows of municipal deposits, which occurred in the first quarter. There was some shift from consumer checking accounts into municipal accounts for tax collection at higher rates. Consequently, part of our cost increase on deposits came from this rotation into those higher-cost municipal accounts, and some of that will also slow down. This is why we expect a different rate of increase in deposit costs compared to the last couple of quarters.

Got it. Okay. And then the other part, I think this is from a prior call, but there's not much in the way of securities kind of maturing or cash flow coming back to you this year. The yield is well below market rates. I was curious if you in a degree of way have considered securities restructuring to kind of get that book up to market rates.

I think you're right, Matt. Most of our securities portfolio is below market value, but there are parts of it that are closer to market. In the first quarter, we identified a significant amount of those securities, but the rates moved against us in the latter half of the quarter. If there’s a rate decrease, we have a considerable amount of potential liquidity in the portfolio that we could unlock at values close to par. That's our perspective on it. Regarding something akin to what we did last year, it really comes down to the net present value of those cash flows. When we restructured last year, the 10-year rate was below 4%. We advanced three years' worth of cash flows, which we are now receiving with a higher-for-longer scenario likely lasting around 18 months instead of the two years we initially expected. It turned out to be a very positive NPV transaction. If another opportunity arises, we will explore it. My assumption is that we need to gain a better understanding, and just to note, our portfolio comprises 85% treasury, which provides certainty in terms of outcome but is dependent on the treasury curve.

Got it. Okay. And then last one for me is just inventory on whole bank M&A. It feels like deals are more under the microscope from a regulatory perspective than ever. Certain deals that you're expecting a fairly routine are taking longer or haven't gotten done. I was curious if that's played into your thinking or how that might be a competitive advantage given all the deals over the years.

Yes. I think, Matt, it does. We feel like we've got a very good track record of execution. To your point, it does enable us to make a case and differentiate ourselves in discussions. I think what this does, though, if you're just sitting there and thinking about capital deployment is you've got now uncertainty on timing. In our experience, deals and acquisitions don't get better over time as they sit in uncertainty. So, the question is how do you price that uncertainty in the transaction? That's also a hard discussion to have with a seller, right, because it's no one's fault. But clearly, that asset is going to be worth less to us in 18 months than it is in nine months and than it is in six months. That’s something that's percolating in the back of some of those discussions. Hopefully, as we get more transactions kind of through the pipeline as an industry, there will be a little bit more of a playbook. Right now, the playbook is also a little bit uncertain because every agency came out with kind of new proposed rules, and they're proposed, but sometimes that means a little more than just proposed. We have to evaluate all of that as we think about capital deployment.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Karaivanov for any closing remarks.

Thank you, Nick, and thank you, everybody, who participated and listened to our call. We really appreciate your support and interest in our company, and we look forward to speaking to you after the second quarter. Thank you.

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