Community Financial System - Q2 2023

Transcript

Operator (participant)

Welcome to the Community Bank System's second quarter 2023 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 risks and uncertainties that could cause actual results to differ materially from the results discussed in these statements. These risks are detailed in the company's annual report and Form 10-K filed with the Securities and Exchange Commission. Please note also that this call is being recorded today. 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 and Chief Operating Officer, for the question and answer session. Gentlemen, you may begin.

Mark Tryniski (President and CEO)

Thank you, Alan. Good morning, everyone, and thank you all for joining our second quarter conference call. I'm not going to say much about our quarterly performance other than it was very good. Joe and Dimitar will comment in more detail. I did want to acknowledge the announcement we made early last month regarding my retirement from the company, effective this December 31st. I will remain on the board through 2024 to support the transition. Most importantly, we're thrilled that Dimitar Karaivanov will be appointed President and Chief Executive Officer of Community Bank System and Community Bank, effective January 1st, 2024. Succession is something we've been working on for many years, as it's one of the most important responsibilities of a CEO and a board of directors.

I've known Dimitar for at least 15 years, starting in his prior life as a financial advisor to the company. Two years ago, he joined the company as Executive Vice President of Financial Services and Corporate Development, assuming responsibility for our benefits, insurance, and wealth businesses. He made an immediate impact on those businesses, and in 2022, was appointed Chief Operating Officer, assuming further responsibility for the banking business. Our board went through a deliberative and very thorough succession process beginning in early 2022 and culminating in last month's announcement.

Dimitar is one of the most astute financial and strategic thinkers I have ever worked with, and more importantly, fully embodies our core values of integrity, teamwork, excellence, and humility. We have right now the best leadership team across the company we have ever had. Combined with earnings and balance sheet strength, revenue diversity, tremendous funding, and growth capabilities, I fully expect the next 15 years will be even better than the last 15. Dimitar?

Dimitar Karaivanov (EVP and COO)

Thank you, Mark. It has been more than a privilege to work alongside Mark and the team. I'm grateful for the trust and confidence that the board has granted me. I've been involved with this company for 15 years, I feel very strongly that we have the best team we have ever had, our ability to service clients, win the marketplace, and provide growth opportunities for our colleagues and communities has never been better. The future of our company is bright, I'm fortunate to be part of it. All of this is evident in our results for the second quarter. The strength of our diversified business model delivered another quarter of above-average returns, regardless of the noisy environment. Operating revenues remain close to all-time highs.

We grew the number of clients and accounts across the company, and our risk metrics remain very strong, allowing us to deliver this performance with below-average risk. Looking forward, we're encouraged by the momentum across all of our businesses. The banking pipelines are healthy and our funding base is secure. The improvement in market values bodes well for our benefits and wealth businesses. In our insurance business, we're benefiting from organic growth, increased premiums, and inorganic activities. Joe will now provide you with more details on the financials. Joe?

Joseph Sutaris (EVP and CFO)

Thank you, Dimitar. Good morning, everyone. The company's earnings results were solid in the second quarter. Fully diluted GAAP earnings per share were $0.89 in the quarter, which were up $0.16 over the prior year's second quarter and $0.78 better than the linked first quarter results. Fully diluted operating earnings per share, as defined in the company's earnings press release, were $0.91 in the quarter, up $0.06 per share from the prior year's second quarter and $0.05 per share higher than the linked first quarter results. The $0.06 per share increase in operating earnings per share on a year-over-year basis was driven by an increase in operating revenues and a lower provision for credit losses, offset in part by higher operating expenses and an increase in income taxes.

The $0.05 per share increase in operating earnings per share on a linked quarter basis was driven by a decrease in the provision for credit losses and lower operating expenses, offset in part by a decrease in operating revenues. Second quarter 2023 adjusted Pre-Tax, Pre-Provision Net Revenue per share, a non-GAAP measure, as defined in the company's earnings press release, of $1.17 was up $0.04 per share as compared to the second quarter of 2022, and up $0.01 per share as compared to the linked first quarter results. The company's total revenues were up $8 million or 4.8% over the prior year's second quarter. This was driven by increases in both Net Interest Income and non-interest revenue between the periods.

Net Interest Income was up $6.1 million or 6%, driven by 29 basis points of margin expansion between the periods. Non-interest revenues were up $1.9 million or 2.9%, due largely to an increase in insurance service revenues. Comparatively, operating revenues, which excludes realized and unrealized losses on investment securities and gain on debt extinguishment, were $1.3 million or 0.7% lower than the linked first quarter results. The company recorded Net Interest Income of $109.3 million in the second quarter of 2023. This was down $1.7 million or 1.6% on a linked quarter basis, driven by increases in the company's funding costs.

The company's total Cost of Funds in the second quarter of 2023 was 67 basis points as compared to 44 basis points in the linked first quarter. The 23 basis point increase in funding costs in the quarter outpaced a 19 basis point increase in earning asset yields, resulting in a 2 basis point decrease in the company's Net Interest Margin from 3.20% in the first quarter to 3.18% in the second quarter. For context, the nationwide median Cost of Funds for banks in the second quarter was approximately 2%, and the median Net Interest Margin contraction was approximately 15 basis points.

The year-over-year increase in non-interest revenues was driven by a $2.1 million or 21.3% increase in insurance services revenues, and a slight increase in banking-related non-interest revenues, which was offset by slightly lower employee benefit services and wealth management services revenues. The increase in insurance services revenues was driven by harder insurance markets, as well as organic and acquired customer growth. Despite organic customer growth in the employee benefit services and wealth management businesses, revenues were down due to asset-based valuation factors. On a linked quarter basis, non-interest revenues, excluding realized and unrealized losses on investment securities and gain on a debt extinguishment, increased $0.5 million or 0.7%.

Reflective of an increase in loans outstanding in the stable economic forecast, the company recorded a provision for credit losses of $0.8 million during the second quarter. Comparatively, the company recorded a $3.5 million provision for credit losses in the linked first quarter of 2023, and $6 million during the second quarter of 2022, which included $3.9 million of acquisition-related provision for credit losses in connection with the Elmira Savings Bank acquisition. The company recorded $113 million in total operating expenses in the second quarter of 2023, compared to $110.4 million in total operating expenses in the prior year's second quarter.

Excluding $1 million of acquisition-related contingent earn-out expenses in the second quarter of 2023, and $4.4 million of acquisition-related expenses in the prior year's second quarter, core operating expenses increased $6 million or 5.6% year-over-year. The increase in core operating expenses was driven by higher salaries and employee benefits, data processing, communication costs, business development and marketing, and other expenses. In comparison, the company reported $114 million of core operating expenses in the linked first quarter of 2023. The effective tax rate for the second quarter of 2023 was 21.4%, down slightly from 21.6% in the second quarter of 2022.

The company's total assets were $15.1 billion at June 30, 2023, representing a $379.8 million, or 2.5% decrease from one year prior, and a $147.9 million, or 1% decrease from the end of the first quarter of 2023. The book value of average interest-earning assets decreased $264 million, or 1.9% during the second quarter, driven by a $453.5 million decrease in the average book value of investment securities, partially offset by a $188.8 million increase in average loan balances.

Ending loans increased $188.4 million, or 2.1% during the quarter, and $1.03 billion, or 12.6% over the prior year. The increase in loans outstanding in the second quarter was driven by an $85.8 million, or 2.3% increase in the business lending portfolio, and a $102.7 million, or 2% increase in the company's consumer loan portfolios. The increase in ending loans year-over-year was driven by organic loan growth in the company's business lending portfolio, totaling $501.7 million or 15.1%, and growth in all four consumer loan portfolios, totaling $524.4 million or 10.9%.

The company's ending total deposits were down $238.9 million, or 1.8% from the end of the first quarter. This was comprised of a $144.2 million, or 1.6% decrease in interest-bearing deposits, and a $94.7 million, or 2.4% decrease in non-interest-bearing deposits. On a customer segment basis, municipal deposits decreased $146.6 million during the quarter, which tend to seasonally decline in the second quarter, while business and consumer deposits decreased less than 1% or $92.3 million in the quarter. On a year-to-date basis, ending total deposits were down $140.5 million, or 1.1%.

The company's deposit base is well diversified across customer segments, comprised of approximately 63% consumer balances, 26% business balances, and 11% municipal balances, and broadly dispersed with average consumer deposit account balance of $12,000, and average business deposit relationship of approximately $60,000. The company's cycle to date Deposit Beta is 10%, reflective of a high proportion of checking and savings accounts, which represents 72% of total deposits and the composition and stability of the customer base. The weighted average age of the company's non-maturity deposit accounts is approximately 15 years, and the company does not currently carry any brokered or wholesale deposits on its balance sheet. The cycle to date Interest-Bearing Deposits Beta is 14%, and the total funding beta is 12%. The company's liquidity position remains strong.

Readily available sources of liquidity, including cash and cash equivalents, funding availability at the Federal Reserve Bank's discount window, unused borrowing capacity at the Federal Home Loan Bank, and unpledged investment securities totaled $4.27 billion at the end of the second 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 71.2%, providing future opportunity to migrate lower-yielding investment security balances into higher-yielding loans. At June 30, 2023, all the company’s in the bank regulatory capital ratios significantly exceeded well-capitalized standards. More specifically, the company's Tier 1 leverage ratio was 9.35% at the end of the second quarter, which substantially exceeded the regulatory well-capitalized standard of 5%.

The company's net tangible equity and net tangible assets ratio, a non-GAAP measure, as defined the company's first quarter or second quarter earnings press release, was 5.34% at the end of the second quarter, as compared to 5.41% at the end of the first quarter and 5.40% one year prior. During the second quarter, the company repurchased 200,000 shares of its common stock at an average price of approximately $48 per share, pursuant to its board-approved 2023 stock repurchase program. At June 30, 2023, the company's allowance for credit losses totaled $63.3 million, or 69 basis points of total loans outstanding.

This compares to $63.2 million or 70 basis points of total loans outstanding at the end of the first quarter, and $55.5 million, or 68 basis points of total loans outstanding at June 30, 2022. During the second quarter of 2023, the company reported net charge-offs of $0.7 million, or 3 basis points of averaged loans, annualized. This compares to 2 basis points of annualized net charge-offs in the same quarter last year and 7 basis points in Q1. At June 30, 2023, non-performing loans totaled $33.3 million, or 36 basis points of total loans outstanding. This was down from 38 basis points at the end of the first quarter and 46 basis points one year prior.

Loans 30-89 days delinquent were 47 basis points of total loans outstanding at June 30, 2023, up from 35 basis points at the end of the first quarter and up from 29 basis points one year prior. Overall, the company's asset quality remains strong and stable in the quarter. We believe the company's strong liquidity profile, capital reserves, stable core deposit base, historically strong asset quality, and revenue profile provide a solid foundation for future opportunities and growth.

Looking forward, we are encouraged by the momentum in our banking business and prospects for continued organic loan growth. Although we believe escalating funding costs will abate over time, we believe higher funding costs remain a challenge for the third quarter, despite the quality and strength of the company's core deposit base. In addition, new business opportunities in the company's financial services businesses remain strong. Thank you. I will now turn it back to Alan to open the line for questions.

Operator (participant)

We will now begin the question-and-answer session. To ask a question, you may press star, then one on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question comes from Nick Cucharale of the Hovde Group. Go ahead.

Nick Cucharale (Director of Equity Research)

Good morning, everyone. How are you today?

Joseph Sutaris (EVP and CFO)

Morning, Nick.

Dimitar Karaivanov (EVP and COO)

Morning, Nick.

Nick Cucharale (Director of Equity Research)

At the halfway point of the year, pretty solid loan growth. Are you starting to see others in your markets pulling back, given liquidity concerns? Can you help us think about a full year growth rate?

Dimitar Karaivanov (EVP and COO)

Sure. Nick, it's Dimitar. You're, you're spot on. We've benefited from two things. One is our own capabilities, but the 2nd is the competitive environment. The, the reality is a lot of banks, predominantly smaller ones, have run out of liquidity. They don't have enough funding that they can, they can extend to clients. A number of folks are focused on only existing clients. A number of folks are just not lending. We are seeing an opportunity to leverage our strength of the balance sheet to service our clients and to extend new relationships, for, for relationships in, in all of our markets. In terms of growth rate, I think we, we have been communicating kind of mid to high single digits range.

That still stays, probably a little bit closer to the higher end of that than the, the, the midpoint of, of, of the single digits. Just the momentum is strong and the pipeline actually increased quarter-over-quarter, as, as we sit here today in all of our businesses.

Nick Cucharale (Director of Equity Research)

That's great color. As it relates to expenses, I believe your previous guidance was for 5%-9% growth for the full year 2023. Is that consistent with your thinking at this stage?

Joseph Sutaris (EVP and CFO)

Yeah, I don't think any. This is Joe, Nick. I don't think anything has changed with it, around our expectations for operating expenses. I think we kind of acknowledged that, you know, Q1 was up a bit, but we expected that to level off throughout the remaining 3 quarters. I think we're still on path generally to have a flattish outcome, if you will, for the remaining 2 quarters. So on a full year run rate basis, still kind of that 5%-9%, I think is a reasonable expectation.

Nick Cucharale (Director of Equity Research)

Okay, great. Then lastly, for me, I, I know it's price dependent, but the repurchase has been pretty consistent the past two quarters, and you recently increased the dividend for the 31st year in a row. Can you give us your thoughts on capital return and M&A and how you balance that with your organic initiatives at this stage?

Dimitar Karaivanov (EVP and COO)

Nick, it's Dimitar again. all-- we look at all of those, all of those things. You know, the, the dividend is part of our core, value proposition and investment thesis, which is above average returns of below average risk. We try to manage volatility across our businesses and, and control, as much as we can, the outcomes as it relates to revenue and earnings, which then allows us to pay that growing dividend. It's a really important part of what we, what we aim to achieve for our shareholders. I think on share repurchases, we've communicated that our goal is to at least offset the equity dilution from our annual grants. I think right now we're kind of on, on our way-- well, well on our way, as it relates to, to that this year.

The stock, we believe continues to be attractive, you know, as we personally look at it and from a company's perspective. We probably have a little bit more to do there at these levels on the share repurchase side. On, on, on capital allocation, in terms of M&A, we, we remain very opportunistic, you know, across all of our businesses. We deploy capital in the bank every day as we grow the balance sheet, so that's part of, of, of what we do in the bank. We're actively looking at M&A across all of our businesses. You know, we, we do some small roll-ups in our insurance business, our benefits business. You know, we, we lift some practices and folks on our wealth side.

That will remain a main priority for us because we do generate a lot of capital, and we need to put it to work for our investors.

Steve Moss (Managing Director and Senior Research Analyst)

I appreciate the color. Thank you for taking my questions.

Operator (participant)

Our next question comes from Steve Moss of Raymond James. Go ahead.

Steve Moss (Managing Director and Senior Research Analyst)

Good morning.

Dimitar Karaivanov (EVP and COO)

Good morning to you.

Steve Moss (Managing Director and Senior Research Analyst)

Maybe just on the margin here. Morning. Maybe just on the margin here, just, you know, curious, Joe, you mentioned that, you know, deposit costs, it sound like deposit costs are a little bit of a headwind. Curious as to where you're thinking, deposit costs, are headed over the next 2 quarters or so?

Joseph Sutaris (EVP and CFO)

Yeah. It's, it's a very fair question, Steve. I mean, you know, our experience is that even if the Fed pauses, that there will be a continuation of, you know, higher deposit rates, just, just as, you know, we continue to see migration from low or non-interest-bearing deposits into, you know, higher rate certificates. We do, we do continue to expect, you know, increases. I'm not sure I have an exact call with respect to, you know, how much deposits are going to increase over, you know, the third quarter, but they are. You know, they were trending, you know, higher in the second quarter, and we expect some of that to continue into the first quarter. With that said, you know, if the Fed does pause over time, that pressure abates a bit.

You know, I'll call it the pace at which monies move from low interest bearing to non-interest bearing slows a bit. You know, call it the repricing of the non-maturity deposits perhaps slows a bit as well. We think those pressures will abate over time. You know, but in the third and potentially into the fourth quarter, we do see that to continue to be a headwind. You know, with respect to our margin, you know, and NII expectations, we're kind of thinking more of a, you know, kind of flat to sideways outcome for, for at least the next quarter or two. Then, you know, hopefully, we, we can see some expansion in 2024 as some of those funding pressures, you know, just abate a bit.

Steve Moss (Managing Director and Senior Research Analyst)

Okay. Then in terms of just curious on, on loan pricing here, you know, what were, origination yields for the quarter? You know, where do you guys see that shaking out here going forward?

Joseph Sutaris (EVP and CFO)

Yeah. On a, on a blended basis, we, we booked new loans at about just under 7% for the, for the quarter. You know, we're seeing pretty good, you know, rate, rate improvement, if you will, on the book over time, because the book yield is, I think, just sub, you know, sub 5. We're picking up about 200 basis points on the repricing activity, plus volume has been increasing. If, you know, if we do have kind of a, you know, mid-single digit kind of growth outcome, that's going to help over time. We also have approximately $2 billion, you know, about 25% of our loan portfolio that are repriceable, of which, you know, roughly $1 billion will reprice in the next, next 12 months or so.

you know, some of those are kind of the, you know, they might be, you know, 10-year terms with a five-year, repricing reset, and some of that occurs in, in, you know, years out. But we have about, you know, $1 billion repricing in the next 12 months or so.

Steve Moss (Managing Director and Senior Research Analyst)

Okay, that's helpful. Then maybe just on the employee benefits services business, you know, flattish year-over-year, but you guys have talked in the past on about the pipeline of new business coming in. I apologize if I missed it. Just curious as to, you know, the trends, the underlying organic trends you're seeing there.

Dimitar Karaivanov (EVP and COO)

Yeah. Morning, Steve. The underlying trends remain very strong. As Joe said, some of that's been masked by the market. I think as we're sitting here in July, you know, I wouldn't be surprised if, if we have a record month in, in that business for us. If the asset values stay where they are, which are still lower than the market peaks, you know, we're, we're already doing better than, than we were back in, in Q4 of 2021. There are some things in, in, in that business that are also, I would call them sometimes, more consulting based.

That impacted our revenues a little bit here in the first 6 months compared to last year. We're down a little bit compared to 2022. Again, right now we're in as good of a position as we've been. My expectation is we're going to more than make it up by the end of 2023, should the market value stay where they are.

Steve Moss (Managing Director and Senior Research Analyst)

Great. Appreciate all the color. Nice quarter, guys.

Joseph Sutaris (EVP and CFO)

Thank you.

Dimitar Karaivanov (EVP and COO)

Thank you.

Operator (participant)

The next question comes from Alex Twerdahl of Piper Sandler. Go ahead.

Steve Moss (Managing Director and Senior Research Analyst)

Hey, good morning, guys.

Dimitar Karaivanov (EVP and COO)

Morning, Alex.

Alex Twerdahl (Managing Director and Senior Research Analyst)

First off, just in terms of sort of balance sheet management, can you just remind us what you have coming due in terms of securities and, you know, whether that will be sufficient or if that's the mechanism that you plan to use to fund the loan growth? I think you kind of alluded to another $300 million-$400 million of loan growth later this year based on your growth targets. I'm just wondering if the securities cash flows will be sufficient and, and sort of the outlook for, you know, for funding.

Joseph Sutaris (EVP and CFO)

Yeah. In the third quarter, Alex, this quarter, we have about another $100 million of maturity. That's going to certainly help for, for the funding, at least for the balance of 2023. As we get into 2024, you know, we do have a little bit of a slower cash flow coming off the securities portfolio, you know, less than about $100 million in 2024. We do have some, some plans basically to, to, to continue to grow. With, with the higher loan yields, we can continue to, you know, bridge to, to cash flows a little further out, just through probably some wholesale borrowings. You know, given where rates are, it's still fairly attractive to do that.

Alex Twerdahl (Managing Director and Senior Research Analyst)

Can you say the number from the third quarter? It just broke up a little bit, and I'm not sure if that was just my line or everyone's line.

Joseph Sutaris (EVP and CFO)

Sorry. Yeah. The third quarter is about $150 million, Alex-

Alex Twerdahl (Managing Director and Senior Research Analyst)

Okay.

Joseph Sutaris (EVP and CFO)

maturities.

Alex Twerdahl (Managing Director and Senior Research Analyst)

Anything in the fourth quarter?

Joseph Sutaris (EVP and CFO)

It's fairly nominal in the fourth quarter. I don't have a precise number, but it's, it's fairly nominal. Most of it's in the third.

Alex Twerdahl (Managing Director and Senior Research Analyst)

Would the expectation in terms of other deposit flows, that the $146 million-$147 million of municipal deposits that went out in the second quarter, can you just remind us, that usually builds into the end of October? Is that correct?

Joseph Sutaris (EVP and CFO)

That's correct, Alex. Yeah, for us, it's somewhat seasonal, the second quarter being the low point for municipal deposits. Then in New York State, in particular, tax collection occurs in the third quarter and in the first quarter. We tend to see a little bit of a, a rebound, if you will, in municipal deposits. For that matter, also, on the municipal repurchase agreements, particularly in our Vermont market, our New England market, they bounce back a little bit in the third quarter as well. We do have some, you know, some expectations that municipal funding is going to roll back in the door, if you will, in the third quarter.

Alex Twerdahl (Managing Director and Senior Research Analyst)

Okay. Do you, do you happen to have the, just the, the sort of exit Net Interest Margin from the quarter and/or exit Cost of Funds?

Joseph Sutaris (EVP and CFO)

Yeah. It was, it was relatively flat, you know, I'll say May to June, from an NII perspective. Cost of funds, we kind of exited the quarter at about 90, about 90 basis points, if memory serves here. I'm sorry, I'm off. About 80 basis points, total cost of funds exiting at the end of the quarter.

Alex Twerdahl (Managing Director and Senior Research Analyst)

Okay.

Dimitar Karaivanov (EVP and COO)

Alex, the, the margin in June was consistent with the second quarter number.

Alex Twerdahl (Managing Director and Senior Research Analyst)

Okay. Yeah, it's pretty flat across the quarter. I wasn't sure if there was anything funky in there from the deleveraging transaction you guys did back in the first quarter that would make the numbers not seem as, as straightforward as they look. Then just the final question I had is on fees. I know last quarter you guys mentioned some adjustments to NSF fees, I think you guided to, like, a $6 million-$8 million hit across the year on NSF. Then it just doesn't look like we saw that show up in the deposit service charges fees this quarter. It looks like that, I mean, that second quarter looked stronger than the second quarter a year ago, and much stronger than the first quarter.

I'm just curious if there's something else in there that we should be thinking about, or if there's any change to that, that full year guidance for, for the hit to deposit service charges from that.

Joseph Sutaris (EVP and CFO)

We also had a little higher, debit interchange outcome for the second quarter. That sort of, you know, offsets some of the reduction for, for the, for the NSF changes.

Alex Twerdahl (Managing Director and Senior Research Analyst)

Okay. the full-year guide of the $6 million-$8 million hit is still intact?

Joseph Sutaris (EVP and CFO)

Yeah, I think that's, that's, that's still fair, Alex.

Alex Twerdahl (Managing Director and Senior Research Analyst)

Perfect. Thank you for taking my questions.

Joseph Sutaris (EVP and CFO)

You're welcome.

Operator (participant)

Our next question comes from Manuel Navas of D.A. Davidson. Go ahead.

Manuel Navas (SVP and Equity Research Analyst)

Hey, good morning. A lot of my questions have been answered. I just was wondering about the loan outlook with thinking about the mix. Consumer was pretty strong and just trying to see what are the trends there.

Dimitar Karaivanov (EVP and COO)

Yeah. Morning, Manuel. You're right, the consumer, we did reasonably well this quarter. The pipelines remain very robust. On the mortgage side, we hinted at it last quarter as well, we've gained even more momentum on, on the mortgage side. I, I think we're going to have a pretty robust quarter here and in Q3 and going into Q4. That's usually when we book the most on the mortgage side anyways, the pipelines are actually stronger than they were a year ago. As you can imagine, it's 85% purchase money, so all of that is additive to the balance sheet. It's going to result in a bit of a higher number than usual in terms of net growth.

As it relates to the auto business or car business, that also is in, is in pretty good shape. You know, we've benefited from some of the same things that we talked a little bit earlier on the call, which is competitors exiting certain markets on a wholesale basis, when you do that, you know, you kind of create an opening in the segments that we play in, because as you know, we don't play everywhere, but in the segments that we play in are part of the market. That's created some opportunities for us. That business remains in, in good shape. It is hard to predict, as we've said before.

We're trying to manage risk and return there on an active basis, you know, for rate, and, you know, the, the segments we focus on. We expect that to be in line with the second quarter, frankly, as we sit here today.

Manuel Navas (SVP and Equity Research Analyst)

Mostly, what, what, new yields are you getting on, on auto loans, on new paper?

Dimitar Karaivanov (EVP and COO)

On a net basis, we're in the high 6s and kind of 7% range on a net basis to us.

Manuel Navas (SVP and Equity Research Analyst)

That's great. I, I appreciate the update. Thank you.

Operator (participant)

As a reminder, if you have a question, please press Star, then One. Our next question comes from Matthew Breese of Stephens. Go ahead.

Matthew Breese (Managing Director and Senior Equity Research Analyst)

Good morning.

Dimitar Karaivanov (EVP and COO)

Good morning, Matt.

Matthew Breese (Managing Director and Senior Equity Research Analyst)

I think the credit metrics largely speak for themselves. With that in mind, I'd be curious your thoughts around the provisioning outlook, and on the overall reserve level, it's fairly flat year-over-year. Just curious if the bias is to remain flat or even down, just considering the credit performance.

Joseph Sutaris (EVP and CFO)

Yeah, Matt, this is Joe. The expectations right now are flat. I mean, we, we have not seen, fortunately, any sort of turns in credit. In fact, when you look at kind of our risk ratings on a year-over-year basis, we've seen some, some improvement, which, which is good. You know, net charge-offs are still fairly low. I think things are normalizing a little bit in the indirect business, but, you know, our, our indirect, net charge-offs of, you know, tend to average about 30 basis points over a long period of time. You know, so we're really not seeing any, any sort of headwinds, knock on wood, you know, on the credit front right now. So, you know, given that, our expectations are, you know, kind of, about the same until, until we see some, some changes.

Matthew Breese (Managing Director and Senior Equity Research Analyst)

Okay. Look, I, I think your, your stance on tangible common equity as a capital ratio and impacts from AOCI are pretty well known at this point. I would be curious, one, as it stands today, what the duration of the securities portfolio is? Two, just given continued impacts, should we expect you to remain patient in terms of ultimate recapture, or are you considering additional kind of balance sheet restructuring opportunities out there to maybe to, to lessen things here, the impact?

Dimitar Karaivanov (EVP and COO)

Yeah. Hey, Matt, it's Dimitar. I mean, we're not going to surprise you here. There, there's no change in how we look at our business. You know, we also have to desegregate the bank from the aggregate business. You know, keep in mind, the balance sheet only shows one of our four businesses. We've got a tremendous amount of value if you want to talk about value and economic value to our shareholders, that is not captured on the balance sheet. If you were to think about that, you know, frankly, and apply back to the, to the balance sheet, the, the numbers are, are very strong, and, and those businesses provide tremendous amount of capital every year to, to the rest of the company. We're focused on regulatory ratios.

We don't believe because one-third of our revenue, more than one-third of our revenue is coming from non-balance sheet activities, we don't believe that the balance sheet itself fully reflects, you know, the, the, the economic value of, of the company. Our regulatory ratios remain very strong. They continue to increase. We're, you know, the, the transaction we did earlier this year was really focused on allowing us to monitor economically net value positive for our shareholders because we got our money back one year sooner than we would have gotten it otherwise.

Secondly, allowed us the flexibility to now service more clients when other people are pulling back. We don't, we don't feel like we need to do anything similar here for the next 2 quarters at the very least. Capital is, is accruing at a very robust pace. We have not been able to, to deploy it through, through M&A, so it just keeps accruing to our company.

Matthew Breese (Managing Director and Senior Equity Research Analyst)

Great. I appreciate that. One last one before I sign off. You know, first, Dimitar, congrats on the promotion. Mark, congratulations on retirement. I think the stock and the bank balance sheet speaks for itself in terms of legacy. Dimitar, as you kind of commence your CEO role here in the not too distant future, where do you think you and Mark differ in terms of strategy or bank management, fee income, business management? I'd be curious if there's any sort of notable differences in terms of philosophy, both around the day-to-day organic businesses and how you run them, and then inorganic in terms of how you think about M&A and acquisitions.

Dimitar Karaivanov (EVP and COO)

Yeah, Matt, that's a fair question. I there is a reason why I feel like I've been part of this company for a long time, because we all of us here tend to think very similarly, and evaluate things in a, in a similar light. You're not going to see much in the way of change for us shareholder thesis remains what it's always been, which is we need to provide that consistency of results and cash flows back to our shareholders.

What that means is having a diversified business model, which includes all of our businesses. We need to invest as much as we can in all of them. We need to stay vigilant for other opportunities to add to those verticals, you know, be tangential to them or, you know, a new vertical potentially. Again, in the spirit of having a diversified company that functions regardless of the rate environment or the market environment or, you know, the insurance market. I think we're going to have an increased focus on that diversification, an increased focus on managing, you know, the low volatility and risk across our businesses.

Joseph Sutaris (EVP and CFO)

It's really an evolution. I think, one of the differences that we have today than we did historically, and that's kudos to, to Mark and, and, and the team. We're much better at organic growth, we're going to continue to leaning into that. We're going to continue to look at new markets and new opportunities to expand organically. We allocate capital in multiple ways. One of it is through the P&L, investments in people and, new businesses through the P&L, which we're, we're doing daily. As we have opportunities to deploy that excess capital that we, we generate into, transactions, we're going to continue looking at that. As we've communicated, it's really more strategically focused and tactically focused, because of the lesser need to generate earnings growth through M&A.

Matthew Breese (Managing Director and Senior Equity Research Analyst)

Appreciate all that very much. Thank you for taking my questions.

Joseph Sutaris (EVP and CFO)

Thank you.

Operator (participant)

Our next question comes from Chris O'Connell of KBW. Go ahead.

Chris O'Connell (Director of Equity Research)

Morning. Yeah, congratulations to you, Mark, on your retirement, and Dimitar, on the promotion. I was hoping to circle back to some of the margin discussion. I mean, it sounds like, you know, you guys have been doing a really good job of, of keeping the margin kind of held up where it is here, you know, this past quarter, in year to date, as well as it seems like the spot margin into June. I mean, given, you know, that there's still some funding pressure, you know, coming in the back half of the year, I- I mean, do you expect the margin to, you know, remain under pressure, into the back half of the year? Or do you think you can, you know, keep it held up, you know, more or less, you know, around the current levels?

Joseph Sutaris (EVP and CFO)

Yeah, I think, Chris, our best, you know, expectation at this point is, is kind of, you know, I'll say flat to, you know, call it sideways for 2 quarters, which, which I think is potentially going to outperform the rest of the market just because of the strength and resilience of our, of our funding base. You know, if those pressures do abate, which, you know, if the Fed pauses and they do abate, you know, the expectation would be that the rate at which funding costs increase in 2024 will slow significantly. In the meantime, we are still, you know, turning over the loan portfolio, you know, at a pretty, pretty healthy clip with, you know, with basically a 200 basis point pickup on the turnover.

You know, the hope and expectation is that NII, Net Interest Income, will, you know, hopefully improve as we look into 2024 and beyond. You know, obviously, you know, rates don't go one direction, and it's, you know, sometimes there's fluctuations. You know, based on where we are today, the expectation is that we would go effectively, you know, sideways, maybe down a few basis points on the NIM, maybe, you know, a couple of basis points in the next couple of quarters, generally sideways.

Chris O'Connell (Director of Equity Research)

Got it. Do you think that there's, you know, more risk of compression in the fourth quarter versus the third quarter, given the lack of securities roll-off?

Joseph Sutaris (EVP and CFO)

We typically have some funding roll in, as I mentioned, in the third and fourth quarters from a municipal side, and that should, you know, hopefully, allow for, you know, a reduction in some of the, the more expensive overnight borrowings. Potentially, you know, again, we're still kind of signaling flat, but, but, you know, I don't see further erosion in Q4 versus Q3.

Chris O'Connell (Director of Equity Research)

Got it. What's the average or blended cost of like the municipal deposit book versus the rest of the portfolio?

Joseph Sutaris (EVP and CFO)

It's a fair question, Chris, but to be perfectly frank, I need to look it up, but it's. Let's see. I'm not sure I've got that. I'm not sure I have the breakout in front of me, Chris, but it certainly is much more-- it's slightly more than that of the IPC Deposits and, and, you know, certainly less than overnight borrowings.

Chris O'Connell (Director of Equity Research)

Got it. Just on the M&A outlook, I mean, I, I know you guys are, you know, actively looking, you know, at the fee businesses and, you know, for, you know, potential ads there. On the traditional bank M&A side, are you seeing opportunities? Are you, you know, actively or, or, you know, seriously pursuing opportunities at this time, just given kind of the overall slowdown in the traditional bank M&A environment? You know, have you seen any pickup in those type of opportunities from, you know, the, they call it, like, early March, and kind of the disruption that happened in March and April?

Dimitar Karaivanov (EVP and COO)

Chris, I, I, I think on the bank side, there is a little bit of a, of a slight uptick, I would call it, in the sense of sellers being more willing to engage in discussions. I, I think the challenges there remain similar to what they've been for the past couple of quarters, which is, you've got a lot of unknowns as to what the balance sheet looks like, what the margin looks like. You know, I, I think this cycle is showcasing that some balance sheets can, can change quite drastically in the matter of a couple of quarters.

When earnings are going down for some folks, you know, 25%-30%, in a short period of time, that's pretty hard to price in terms of what is the value of that earnings stream to us, given that we're focused on consistency first and foremost in our results. I think that's one challenge. I think the second challenge is, you know, for a lot of folks, there's not a lot of capital left once you mark the balance sheet. You know, we have to essentially pay for the deal twice. Some of those challenges are pretty hard to stomach, especially depending on the size of the opportunity.

As Joe pointed out to a number of us, very wisely, you know, it's also hard to figure out in today's environment, when you announce a transaction on bank, a bank deal, what does that do to the deposit base, given that it's like sounding the starting signal for all the competitors and high rates customers to start looking around yet again. I think that's kind of hard to put your arms around. Then the last piece is the uncertainty as to the timing of closure of transactions these days. Clearly, there's a higher hurdle in terms of unknowns that come with a transaction from all the regulatory bodies.

That creates another challenge in terms of you don't know when you're going to close a transaction, and that puts pressure on retaining clients, retaining people, having to pay a lot more for, for, for customers. That's another unknown that's really kind of creating that unfavorable risk and reward right now. With that said, you know, we continue to look, you know, on the flip side, we, we know now some franchises that their balance sheets are holding up better than, than expected and better than others. That's something that we're going to remember for a long time. When the opportunity comes, we will be active and hopefully in a better environment.

Steve Moss (Managing Director and Senior Research Analyst)

Great. Thanks for your time. Appreciate you taking my questions.

Operator (participant)

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

Mark Tryniski (President and CEO)

Thank you all for joining again, our conference call, and I guess I will see you 1 last time here in October, and hope you all have a great rest of the summer. Thank you.

Operator (participant)

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