Community Financial System - Earnings Call - Q2 2025

Executive Summary

• Record quarter on company-reported operating metrics: operating diluted EPS $1.04 (+6.1% q/q; +9.5% y/y) and net interest income $124.7M (+3.8% q/q; +14.0% y/y) on expanding NIM and loan growth.
• Against S&P Global consensus, Q2 EPS was slightly below and revenue missed: Primary EPS 0.99 vs 1.01 estimate; revenue $195.1M vs $201.3M estimate; company-reported total revenues were $199.3M, a new record, reflecting presentation differences with S&P actuals (EPS miss, revenue miss) [Values retrieved from S&P Global]*.
• Credit quality mixed: elevated net charge-offs (0.20% annualized) from a single CRE resolution, but nonperforming loans fell to 0.51% of loans and delinquency improved sequentially.
• Strategic catalysts: announced acquisition of seven Santander branches (~$600M deposits, blended cost just below 2%, expected close Q4’25) and a dividend increase to $0.47 (33rd consecutive year), supporting liquidity deployment and shareholder returns.

What Went Well and What Went Wrong

What Went Well

• Record operating performance driven by banking margin expansion: “record quarterly operating diluted EPS of $1.04… driven by margin expansion in the banking business” (CEO).
• NIM rose 6 bps q/q to 3.27% (FTE 3.30%), with asset yields higher and stable funding costs; cost of funds 1.32% and deposit costs a low 1.19% (CFO).
• Liquidity and capital strong: readily available sources of liquidity $5.94B (246% of estimated uninsured deposits); tier 1 leverage 9.42%, well above well‑capitalized.

What Went Wrong

• Seasonal softness in fee businesses: non-banking noninterest revenues down 3.9% q/q; employee benefits, insurance, and wealth pressured by timing/seasonality (CFO).
• Elevated NCOs from a single previously reserved CRE relationship ($4.3M charge-off), lifting net charge-offs to $5.1M (0.20% annualized).
• OpEx rose 8.5% y/y to $129.1M on wages, tech investments, and $1.5M restructuring tied to branch consolidation, while de novo builds also added expenses (CFO).

Transcript

Speaker 1

Today, and welcome to the Community Financial System, Inc.'s second quarter 2025 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star, then one on your telephone keypad. To withdraw your question, please press star, then two. Please note that this event is being recorded, and discussion may contain forward-looking statements within the provisions of the Private Securities Litigation Reform Act of 1995 that are based on current expectations, estimates, and projections about the industry, markets, and economic environment in which the company operates. These statements involve risks and uncertainties that could cause actual results to differ materially from the results discussed.

Refer to our SEC filings, including the Risk Factors section, for more details. Discussion may also include references to certain non-GAAP financial measures. Reconciliations of these non-GAAP measures to the most directly comparable GAAP measures can be found in our earnings release. I would now like to turn the conference over to Dimitar Karaivanov, President and CEO. Please go ahead.

Speaker 3

Thank you, Michael. Good morning, everyone, and thank you for joining our Q2 2025 earnings call. My general summary of the quarter is one of continued solid progress across our diversified business and record operating results per share. In our banking business, net interest income continues to expand on the heels of both increasing asset yields and growth in balances. Core funding is growing, and consumer lending had a very strong quarter, with momentum continuing into the third quarter. Commercial banking balances were impacted by some constructive repayments of criticized credits and the resolution of a couple of non-performing assets. However, the pipeline is very good, and I expect a very strong third quarter that will put us back on track to our previously communicated growth targets. Banking fee income also remains strong.

Credit results were impacted by the resolution of our two largest non-performing assets, with one being paid off with a very small charge and the other being written down and taken into OREO. Outside of those previously reserved-for situations, net charge-offs were minimal, at less than two basis points. Our employee benefit services business was basically flat year over year and quarter over quarter. With that said, there are two parts to that story. Our record-keeping business is growing at high single digits, while our fiduciary trust business has been experiencing some headwinds as we work to reposition the business and reinvest in the next stage of growth. With that said, I'm very encouraged by the early results of those initiatives, the pipeline that is already built, and expect that we will be well-positioned in 2026 and beyond.

In insurance services, it is important to note that we had a pull forward of the timing of contingency payments in Q1 of this year versus typically Q2. Year to date, the business is up 13% in revenue, and operating margin is up to 23%, driving operating pre-tax earnings expansion of 70%. Wealth management services came off a very strong Q1, and also, as we talked about back in January, we exited certain non-productive revenue arrangements. As a result, revenue growth was muted year over year, while both operating pre-tax earnings and margin expanded compared to the same quarter last year. Pre-tax operating earnings were up 16%. In summary, we're well on our way towards our goals for the year. We also had a very exciting branch acquisition announcement last month, and I expect to close that transaction in the fourth quarter of this year.

The transaction provides our banking business with a very strong presence in a market that is of high strategic importance to us, high-quality liquidity, no asset issues or concentrations, limited execution risk, and comes with no share issuance. In other words, our shareholders get to keep all the upside as we deploy the cash proceeds into earning assets over the next few years. It is unusual for a banking transaction to check multiple of these boxes for us, and very unusual to check all of them, so we're very excited. In addition, other productive discussions are occurring across our fee income businesses, and I'm hopeful that we will continue to productively deploy capital in the second half of this year. I will now pass it on to Marya for more details on the financials.

Speaker 0

Thank you, Dimitar, and good morning. As Dimitar noted, the company's second quarter performance was solid. GAAP earnings per share of $0.97 were up $0.06, or 6.6%, over the second quarter of the prior year and were up $0.04, or 4.3%, over linked first quarter results. GAAP earnings per share included the impact of $0.02 in restructuring expenses associated with the workforce optimization plan, and in addition, $0.01 tied to performance-based incentive accrual. Operating earnings per share and operating pre-tax pre-provision net revenue per share were record quarterly results for the company. Operating earnings per share were $1.04 in the second quarter as compared to $0.95 one year prior and $0.98 in the linked first quarter. Second quarter operating PP&R per share of $1.41 was up $0.12 from one year prior and was up $0.01 on a linked quarter basis.

These record operating results were driven by a new quarterly high for total operating revenues of $199.3 million in the second quarter. Operating revenues were up $16.1 million, or 8.8%, from one year prior and were up $3.3 million, or 1.7%, from the linked first quarter, driven by record net interest income results in our banking business. The company's net interest income was $124.7 million in the second quarter. This represents a $4.5 million or 3.8% increase over the linked first quarter result and a $15.3 million or 14% improvement over the second quarter of 2024 and marks the fifth consecutive quarter of net interest income expansion. The company's fully tax-equivalent net interest margin increased 6 basis points from 3.24% in the linked first quarter to 3.3% in the second quarter.

Higher interest-earning asset yields and stable funding costs drove increases in both net interest income and net interest margin in the quarter. During the quarter, the company's cost of funds was 1.32%, a decrease of 1 basis point from the prior quarter, while the company's cost of deposits remained low relative to the industry at 1.19%. Operating non-interest revenues were up $0.7 million or 1% compared to the prior year's second quarter and represented 37.4% of total operating revenues, a metric that continuously underscores the diversification of our businesses. Banking-related operating non-interest revenues were up $0.9 million or 5% from the linked first quarter, driven by higher customer interest rate swap fee revenues and CRE financing and advisory revenues.

This was offset by a $2.2 million or 3.9% decrease in non-banking financial services non-interest revenues over the same period due to seasonal factors in the employee benefits, insurance, and wealth businesses. The company recorded a $4.1 million provision for credit losses during the second quarter. This compares to $2.7 million in the prior year's second quarter and $6.7 million in the linked first quarter. During the second quarter, the company recorded $129.1 million in total non-interest expenses. This compares to $119 million of total non-interest expenses in the prior year's second quarter. Expense control remains a focus. The $10.1 million or 8.5% increase between the time periods was primarily driven by an increase of $5.6 million or 7.6% in salaries and employee benefits, $1.4 million or 9.3% in data processing and communication expenses, and the impact of a $1.5 million non-operating restructuring charge.

The increase also included approximately $1.5 million in expenses associated with the bank's De Novo branch expansions. Ending loans increased $98 million or 0.9% during the second quarter, primarily driven by net organic growth in the consumer indirect lending portfolio. The company continues to invest in its organic loan growth capabilities and expects continued expansion into undertapped markets within our Northeast footprint. Ending loans were up $495.3 million or 4.9% from one year prior, primarily due to growth in the business lending and consumer mortgage portfolios. The company's ending total deposits increased $563.9 million or 4.3% from one year prior and decreased $190.3 million or 1.4% from the end of the linked first quarter. The decrease in total deposits during the quarter was driven by seasonal outflow of municipal deposits.

Non-interest-bearing and lower-rate checking and savings accounts continue to represent almost two-thirds of the total deposits, reflective of the core characteristics of the company's deposit base. The company did not hold any brokered or wholesale deposits on its balance sheet during the quarter. The company's liquidity position remains strong as readily available sources of liquidity totaled $5.9 billion or 246% of the company's estimated uninsured deposits that have collateralized in intercompany deposits at the end of the second quarter. The company's loan-to-deposit ratio at the end of the second quarter was 76.8%, providing future opportunity to migrate lower-yielding investment securities into higher-yielding loans. All the company's and the bank's regulatory capital ratios continue to substantially exceed well-capitalized standards. The company's tier-one leverage ratio increased 13 basis points during the second quarter to 9.42%, which is significantly higher than the regulatory well-capitalized standard of 5%.

During the quarter, the company charged off one non-owner-occupied CRE loan relationship and received substantial repayment of one multifamily CRE loan relationship, both of which were previously allocated specific reserves. As a result, net charge-offs in the quarter were elevated relative to recent results, but non-performing and delinquent loan metrics were favorably impacted. Non-performing loans totaled $53.3 million or 51 basis points of total loans outstanding at the end of the second quarter. This represents a $21.7 million or 21 basis point decrease from the end of the linked first quarter. Comparatively, non-performing loans were $50.5 million or 50 basis points of total loans outstanding one year prior.

Loans 30 to 89 days delinquent were also down on a linked quarter basis from $59.2 million or 57 basis points of total loans at the end of the first quarter to $53.3 million or 51 basis points of total loans at the end of the second quarter. The company recorded net charge-offs of $5.1 million or 20 basis points of average loans annualized during the second quarter. This was up $3.8 million over the prior year's second quarter and up $1.9 million from the linked first quarter, driven by the charge-off associated with the previously mentioned CRE loan relationship during the quarter totaling $4.3 million.

The company's allowance for credit losses was $81.9 million or 78 basis points of total loans outstanding at the end of the second quarter, down $1 million during the quarter, due in part to the decrease in specific reserves previously mentioned and up $10.4 million from one year prior. The allowance for credit losses at the end of the second quarter represented over five times the company's trailing 12-month net charge-offs. We are pleased with the second quarter results. It is an exciting time, especially given our announcement of the acquisition of the seven Santander branches in Pennsylvania, which accelerates our retail growth strategy. To echo Dimitar's comments, this transaction ensures that our shareholders keep all the upside as we deploy the cash proceeds into earning assets.

Looking forward, we believe the company's diversified revenue profile, strong liquidity, regulatory capital reserves, stable core deposit base, and historically good asset quality provide a solid foundation for continued earnings growth. That concludes my prepared earnings comments, and Dimitar and I will now take questions. Michael, I will turn it back to you to open the line. Thank you.

Speaker 1

Thank you. We will now begin the question and answer session. To ask a question, you may press star, then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. If at any time your question has been addressed and you would like to withdraw your question, please press star, then two. At this time, we will pause momentarily to assemble our roster. Your first question today comes from Steve Moss with Raymond James. Please go ahead.

Good morning. This is Thomas on for Steve. Thanks for taking my question. Just wanted to start off maybe on loans here. Can you speak to the competitive landscape you're seeing in terms of lending? I know you said that competition was getting tougher in prior quarters. Is that still the case? Maybe just where is loan pricing these days?

Speaker 3

Morning, Thomas. Yes, it is certainly a lot more competitive today than it was the last couple of years. I think, as we discussed in the last quarter, there's a lot of competitors that didn't participate much in the markets because of liquidity and all kinds of other constraints, and now they're trying to make it up. I would say they're trying to make it up on both rates and credits. As I talked about in my remarks, we were able to offload a number of criticized credits during the quarter. I think there will be some more the rest of the year as well, which we're happy to part ways with, and we're happy for other people to take them. That is fine.

As it relates to us, we're going to continue to outperform because for us, it's mostly about market share gains and things that we've been at it for a number of years in terms of reputation and people and activity in the market. As I said, I expect that we're going to start seeing some of that kind of accruing here in the third quarter and into the fourth quarter, and I expect that on a full-year basis, we will do better than our peers. In terms of yields, we're seeing pressure on that as well. I think if you step back and you look at the second quarter, you know the three-year and the five-year Treasury, which is the majority of where we price off of in our lending portfolio, those rates were down close to 30 basis points on an average basis versus the first quarter.

Effectively, there's already been a cut and more into those rates. That is reflected into the yields at which things are coming in. You add the competition, which has accounted for probably another 15 to 20 basis points on top of that. In the second quarter, our originations were kind of in the 6.75% range in aggregate, varied by portfolio. I expect that that number is probably trending lower as opposed to higher over time. Competition is high on both rate and credit, as I mentioned.

Okay, all that's very helpful. Thank you. How are you feeling about the 2 to 7 basis points of quarterly NIM expansion from here? Is that still a good range?

Speaker 0

I can take that. I would say we're in the range closer to three to five at this point. Dimitar just outlined some of the metrics that are contributing to that number for us, but you know can't underscore enough the progress that we're seeing in the markets and the pipeline's strength. We're very bullish on that overall.

Okay. The last one from me. It sounds like you guys, with the $600 million of acquired deposits, is it likely that that'll sort of just boost your liquidity and that'll be invested over time? Are you considering securities purchases? Maybe your updated thoughts around that?

Speaker 3

I think we look at that as loan growth for us over the next number of years. Between our organic growth on the deposit side and this transaction, we've got a number of years of loan growth here ahead of us. Initially, some of those proceeds are likely to stay in short-term instruments, and then we're going to deploy them over time. Obviously, as we deploy them over time, the impact of that transaction also improves for our shareholders.

Okay, great. That's all the questions for me. Thanks and congrats on a good quarter, guys.

Thank you, Thomas.

Speaker 1

Your next question comes from Manuel Navas with DA Davidson. Please go ahead.

Hello. Good morning. This is Sharanjit Cheema from Manuel. Thank you for taking my question. I was wondering, could you talk a little bit about OpEx trends from here? Does some of the restructuring of the personnel this quarter lower costs in third quarter? Is there any shift to the overall expense trajectory?

Speaker 0

Yes, there was a lot in that question. That was a long one. The restructuring charge that you saw come through is due to consolidating some branches. We're looking to evolve our platform in up-service. We look at it as a very positive thing. As we continue to open the De Novo branches and expand in Eastern Pennsylvania, this was an important point for us. In terms of OpEx, you're going to see it sort of be flat as we move forward. As we mentioned in our opening remarks, we're focused on it and looking to ensure that everything that we're investing in has a trajectory to push the business forward. Dimitar also mentioned that in his opening remarks when it comes to our fee income businesses.

When you're growing a business, there are going to be times as things move up that you are looking at increasing some expenses, but we don't see that as a go-forward. We're just looking at some of these as one-time.

Great. Thank you. Shifting over a little bit to the branch acquisition, how is that going so far? Is it as expected? Could you discuss a little bit more on how this transaction builds into or ties into your previously planned De Novo expansions?

Speaker 3

Sure. We're right on track with our expectations. It is very early days, so we expect that we're going to work through the regulatory side of this here in the summer, and closing is slated for the fourth quarter, probably sometime in November is our goal. I will say it's exactly what we've been looking for. It is a perfect complement to our organic strategy in that market. We have three De Novo branches opening up in the Lehigh Valley. Actually, one of them is already open. By the end of the year, between the acquisition and those three branches, we're going to have 10 branches right into the heart of the valley and then 12 more broadly in the greater area, which brings us to a top five market share in terms of presence. That is when good things start happening. We're very excited about that.

If we could replicate that in every one of our markets, we would love to, but those are hard to come by.

Great. Thank you so much. That's all for me.

Speaker 1

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

Hey, good morning.

Morning, Matt.

I was hoping we could learn a little bit more about the pipeline. You mentioned a couple of times that it's robust and you're bullish on it. I also just wanted to hear a little bit more about, or a reminder of, financial targets. I think you were referring back to the investor day in September when you said through cycle loan growth of 5 to 7%. Do you think the pipeline supports that?

Speaker 3

Sure. Matt, I'll take that. If you look at our business on the lending side, basically, there are three things we do, right? We do mortgages or home equities. We do auto loans. That's our consumer lending in aggregate. Then we do commercial, of which there are virtually two products for the most part, CRE and CNI. Across all of those, we generally target mid-single-digit growth in all of those portfolios. Some years, some of them will be stronger. Some years, they'll be a little bit weaker. The aggregate number is somewhere in the mid-single digits. Earlier this year, we talked about probably that being a little bit closer to the lower end of that.

If mid-single digits are four to six to seven, and the past few years, we were growing kind of seven plus, we expected this year would be closer to kind of the four to five handle, given we expected competition. We expected more pressure in that sense. When I say we're thinking that we'll be back on track for all of those metrics, I mean that range. Four plus or minus a little bit is probably a reasonable number for us this year. We certainly started a little bit slower on the consumer lending, on the indirect portion of that. We've made up a lot of that ground in the second quarter, and we're now positive. Momentum there continues. Mortgage is holding up pretty well in a very tough market with where rates are.

All the yields I talked about, the pressure, that's actually not occurred on the mortgage side because that's the long end of the curve. That's really putting an impact on demand. We're holding our own and outperforming the industry. In the commercial business, it's been a little bit of a story of two tales because you have the CNI business has grown very, very well this year. In fact, probably on track for high single digits to double-digit growth even. At the same time, we've again cleaned up some of the exposures on the CRE side. I would say some of those were higher risk and some of them were unproductive because of the non-performing assets. You might see the balance come off, but it's not accruing interest anyways. Now we've got capacity to get back and refill some of those buckets a little bit more.

The activity is very good. We have had just in the context of payoffs, we've had over $100 million of payoffs year to date in the commercial business. Probably 40% of those were in assets that we were happy to see go. We probably have another $100 million to go in terms of prepayments in the second half of the year. Given the pipeline, we think we're going to absorb that and actually grow meaningfully.

Great. I appreciate all that. Two or three others from me. The first one is just going back to the branch acquisition. Could you give us some sense for the composition of the deposits being acquired, the all-in cost? Particularly in this day and age with mobile banking, I'd love to hear your thoughts on retention.

Sure. If you kind of look at the aggregate population there, these are deposits that look very much like ours in terms of their granularity. The average account size is less than $20,000. If you look at kind of the split between transaction and DDAs versus CDs, it's somewhere up in the 65-35% split range. With that said, basically, the CDs are the same customers. They're not single product customers. Very, very few, very small % are single product customers. It's the same customer that just parked money out of a transaction account into a CD for the rate environment. As we look at kind of the opportunity to deploy that capital, that liquidity, we feel that the next couple of years, we'll be able to make a decent dent into it. Over five and six, we'll probably bring that to our normal kind of target of loan-to-deposit ratio.

As you think about the long term, probably 75 to 85% loan-to-deposit ratio by year five or six. The blended cost of funds there is just below 2%, and that's a little bit dated. It's probably a little bit lower today. Very high-quality deposits in a really great market for us.

Great. I appreciate that. The next one is just on the, could you remind us where you are in terms of the De Novo branch build-out? I think the total was maybe like 15 or 16 branches that you wanted to open. How many of those are in fact open today? How many do you expect will be open by the end of this year? On the other side of that, I think I saw in the applications, there's something like maybe 17 branch closings submitted. Could you help me out on potential branch closures near term? Thank you.

Speaker 0

Sure. On the De Novo, it's 19. What has opened so far? Seven. We've opened seven total across the footprint. We just opened three in Q2, and there will be two in July. That's going extremely well. We're really happy with the progress there. They're beautiful branches. They're very well staffed. The sentiment around, as we definitely talk to the field and get out to talk to customers and our employees that are opening these branches, is extremely positive. We're really happy with that strategy, and we'll continue to do our best to get those stood up, all 19, by the end of the year. Possibly a couple will fall into Q1 of 2026, but that's all on track. We're really, really happy with that progress. In terms of closures, 17 is correct.

Speaker 3

Matt, you may recall, we've committed consistently that our branch expansion will be net neutral to our shareholders. We're closing as many as we're opening and basically reallocating resources. Some of that you saw this quarter with a restructuring charge.

Great. I appreciate that. The other one I wanted to ask was just on loan yields. They were up five basis points this quarter. It's just a bit more than what I was expecting. Was there anything atypical or unusual there? You had mentioned some payoffs. I'm curious if there is repayment of interest income that was on new accrual, or is this a decent pace of loan yield expansion in the absence of rate cuts?

Speaker 0

It's the latter. You're exactly correct. There's nothing atypical that we're seeing. We obviously are looking at this on a daily, weekly basis, and all is in line there.

Thank you. Just the last one is any updates. The CHIPS Act was kind of in focus of the new administration earlier this year. Is there anything upsetting the apple cart there? I was curious if Micron is still on track to break ground later this year. That's all I had. Thank you for taking all these.

Speaker 3

It is still on track. I believe the fourth quarter is when they're going to break ground. There's a public process as it relates to some of the environmental concerns that's ongoing right now. I think actually the number, the investment number actually went up, the expected investment. That's all good. As we've said before, that's really not what we're growing because of today and not what we're going to grow because of the next probably couple of years. As the impact of that 16-year investment comes into play, certainly over time, there will be a positive lift for everybody involved.

Thank you.

Speaker 1

Again, if you have a question, please press star, then one. Your next question comes from David Konrad with KBW. Please go ahead.

Good morning. Just one from me, just on fee income. You mentioned some seasonality, some pull forward insurance this quarter. I think you're up like 1% year over year this quarter. Just kind of thinking about the run rate over the next two quarters as stuff picks up a little bit and kind of your year-over-year expectations for 2025.

Speaker 3

Yeah, morning, David.

Morning.

On the insurance, we usually get the contingent payments in the second quarter. This year, we got them in the first quarter. The first quarter was quite robust for us in insurance. We did communicate that that's probably not sustainable. 27% revenue growth was not the run rate of the business. We traditionally target high single-digit to low double-digit growth rate in that business between organic and inorganic. Year to date, we're at 13%. We certainly expect that this year will not be an exception from our targets. Whether we end up a little bit in the high single digits or maybe just a hair in the double digits, who knows? That's kind of the ultimate target. Business is doing well. Pipeline is pretty good. The seasonality there, again, is typically the second quarter. This year was more in the first quarter. We're going to have a nice third quarter.

That's usually another big renewal quarter for us. The fourth quarter is usually a little bit slower. In the aggregate basis, I think we're very much on track to get to our historical growth rate, which over the past 10-plus years has been 11%, actually, in that business.

Great. Thank you.

Speaker 1

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

Speaker 3

Thank you to you, Michael, for hosting the call. Thank you for everybody who joined. We look forward to speaking with you in a couple of months.

Speaker 1

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