Community Financial System - Earnings Call - Q3 2025

Executive Summary

• Record operating diluted EPS of $1.09, up 23.9% YoY and 4.8% QoQ, driven by broad-based revenue growth and margin expansion; GAAP diluted EPS was $1.04.
• Total GAAP revenues rose to $207.1M (+9.6% YoY, +3.9% QoQ) with net interest income reaching a new high of $128.2M and NIM at 3.30% (+27 bps YoY, +3 bps QoQ).
• Consensus comparison: Operating EPS beat Wall Street ($1.09 vs $1.048, bold beat), while revenue was modestly below consensus on an FTE basis ($207.7M vs $208.8M, bold miss)*.
• Management guided continued NIM expansion (+3–5 bps expected in Q4), strong loan pipelines, and incremental ~$1M Q4 expense from charitable prepayments and incentive adjustments; branch acquisition slated to accelerate retail growth in Lehigh Valley.
• Catalysts: closing of seven Santander branches (Nov 7, ~$553M deposits), record operating metrics, and capital deployment into Leap Insurance MGA to scale fee income.

What Went Well and What Went Wrong

What Went Well

• Strong diversified growth: record operating revenues ($206.8M), record net interest income ($128.2M), and NIM expansion to 3.30% (+27 bps YoY) on higher asset yields and lower funding costs.
• CEO emphasis on high-return capital deployment: “pre-tax tangible returns for the quarter were 63% for insurance services, 62% for employee benefit services, 48% for wealth management services, and 25% for banking and corporate”.
• Noninterest revenues rose to $78.9M (+3.5% YoY, +5.9% QoQ) with contributions across banking fees, employee benefits, insurance renewals, and wealth management.

What Went Wrong

• Provision for credit losses increased QoQ to $5.6M (from $4.1M), reflecting loan growth and macro caution; allowance rose to 0.79% of loans.
• Competitive loan pricing pressure noted, particularly in CRE and mortgage originations as market rates declined, with some peers offering mid-5% promotional CRE rates.
• Elevated data processing and communications expense (+$3.2M YoY) including a $1.4M one-time consulting fee for core renegotiation; Q4 expected to include ~$1M of incremental expenses (charitable prepayment and incentives).

Transcript

Operator (participant)

Today, and welcome to the Community Financial System, Inc's third 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 a touch-tone phone. 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 the company's 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 the company's earnings release. I would now like to turn the conference over to Dimitar Karaivanov, President and CEO. Please go ahead.

Dimitar Karaivanov (President and CEO)

Thank you, Bailey. Good morning. Thank you all for joining our Q3 2025 earnings call. We had an excellent quarter. Strong and diversified revenue growth remains a core differentiator for our company. Market share gains across all of our businesses continue. We remain focused on expenses, even as we are making a $100 million investment in facilities, talent, and technology across all of our businesses. Risk metrics remain excellent. The strength of our capital, liquidity, and credit continues to provide the base for our growth. All in all, record operating earnings per share of 23.9% year-over-year. I'd like to highlight a few recognitions to give you a better sense of where our businesses stand in terms of capabilities and reputation. Our employee benefit services business, BPAS, was recognized again as one of the top five record keepers nationwide by the National Association of Plan Advisors.

Our insurance services business, OneGroup, was ranked as the 68th largest property and casualty broker in the country by the Insurance Journal. OneGroup is now the third-largest bank-owned broker. In our wealth management services business, Nottingham Advisors was recognized as a five-star wealth management team by InvestmentNews. Our banking business, Community Bank, was recognized by S&P Global as one of the top 20 banks in the country in their inaugural deposit rankings. Also importantly, the culture and values of our company and people led to our recognition by the United Way of Central New York with their Community Champion Award. All of these things matter. They make a difference. They make us who we are and lead to the results you see. We have deep national-level talent and capabilities and are now becoming nationally recognized.

We have also been fortunate to have excellent capital deployment opportunities year to date. We're on track to deploy approximately $100 million in cash capital in transactions that push forward our strategic priorities: diversified, higher growth, subscription-like revenue streams in insurance, benefits, or wealth, and for the banking business, strong funding and liquidity in attractive high-priority markets. You will note that this quarter we also provided in the press release the tangible returns for each one of our businesses. I believe those speak for themselves and are largely self-explanatory for our capital allocation strategy. The pre-tax tangible returns for the quarter were 63% for insurance services, 62% for employee benefit services, 48% for wealth management services, and 25% for banking and corporate. We will continue to aggressively pursue similar opportunities to deploy capital at high tangible returns.

I am optimistic that we will continue to do so, in particular in our insurance and wealth businesses. In addition, we also had the opportunity after our prior earnings release to buy back approximately 206,000 shares at what we believe was meaningfully below intrinsic value for our company. This largely eliminated any share dilution to our shareholders for the year. I will now pass it on to Marya for details on the financials.

Marya Wlos (CFO)

Thank you, Dimitar. Good morning. As Dimitar noted, the company's third quarter performance was robust in all four of our businesses. GAAP earnings per share of $1.04 increased $0.21 or 25.3% from the third quarter of the prior year and increased $0.07 or 7.2% from linked second quarter results. 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 $1.09 in the third quarter as compared to $0.88 one year prior and $1.04 in the linked second quarter. Third quarter operating PPNR per share of $1.56 increased $0.27 from one year prior and increased $0.15 on a linked quarter basis. These record operating results were driven by a new quarterly high for total operating revenues of $206.8 million in the third quarter.

Operating revenues increased $7.6 million or 3.8% from the linked second quarter and increased $17.7 million or 9.4% from one year prior, driven by a record net interest income in our banking business. The company's net interest income was $128.2 million in the third quarter. This represents a $3.4 million or 2.7% increase over the linked second quarter and a $15.4 million or 13.7% improvement over the third quarter of 2024 and marks the sixth consecutive quarter of net interest income expansion. The company's fully tax-equivalent net interest margin increased 3 basis points from 3.3% in the linked second quarter to 3.33% in the third quarter. Higher loan 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 1.33%, an increase of 1 basis point from the prior quarter, driven by a higher average of overnight borrowing balance, while the company's cost of deposits decreased 2 basis points and remained low relative to industry at 1.17%. Operating non-interest revenues increased $2.3 million or 3% compared to the prior year's third quarter and increased $4.1 million or 5.6% from the linked second quarter, reflective of revenue growth in all four of our businesses. Operating non-interest revenues represented 38% of total operating revenues during the third quarter, a metric that continuously emphasizes the diversification of our businesses. The company reported a $5.6 million provision for credit losses during the third quarter. This compares to $7.7 million in the prior year's third quarter and $4.1 million in the linked second quarter.

During the third quarter, the company recorded $128.3 million in total non-interest expenses. This represents an increase of $4.1 million or 3.3% from the prior year's third quarter. The increase included approximately $2.3 million of expenses associated with the Bank's de novo branch expansions and an increase of data processing and communication expenses that included a $1.4 million consulting expense in connection with a contract renegotiation with our core system provider. The impact of the consulting item on total managers' expenses was offset by medical rebates and an incentive true-up, which drove a $1.5 million or 1.9% decrease in salaries and employee benefits. In the fourth quarter, we anticipate approximately $1 million of incremental expense driven by the prepayment of charitable contribution commitments in response to tech bought changes and incentive compensation adjustments contingent on final scorecard items.

The effective tax rate during the third quarter of 24.7% increased from 23% in the prior year's third quarter, driven by increases in certain state income taxes. The effective tax rate for the first nine months of 2025 was 23.3%, only slightly higher than the 22.9% for the first nine months of 2024. Ending loans increased $231.1 million or 2.2% during the third quarter and increased $498.6 million or 4.9% from one year prior, reflective of organic growth in the overall business and consumer lending portfolio. The company continues to invest in its organic loan growth opportunities and expects continued expansion into undertapped markets within our Northeast footprint. The company's ending total deposits increased $580.7 million or 4.3% from one year prior and increased $355.1 million or 2.6% from the end of the linked second quarter.

The increase in total deposits between both periods was driven by growth in non-time deposits across governmental and non-governmental customers. Non-interest-bearing and relatively low-rate checking and savings accounts continue to represent almost 2/3 of the total deposits, reflective of the core characteristics of a 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 total $6.6 billion or 240% of the company's estimated uninsured deposits that have collateralized in intercompany deposits at the end of the third quarter. The company's loan-to-deposit ratio at the end of the third quarter was 76.5%, 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 1 leverage ratio increased 4 basis points during the third quarter to 9.46%, which is significantly higher than the regulatory well-capitalized standard of 5%. The company's asset quality metrics were generally stable during the third quarter. Non-performing loans total $56.1 million or 52 basis points of total loans outstanding at the end of the third quarter. This represents a $2.7 million or 1 basis point increase from the end of the linked second quarter. Comparatively, non-performing loans were $62.8 million or 61 basis points of total loans outstanding one year prior. Loans 30-89 days delinquent decreased on a linked quarter basis from $53.3 million or 51 basis points of total loans at the end of the second quarter to $51.6 million or 48 basis points of total loans at the end of the third quarter.

The company recorded net charge-offs of $2.5 million or 9 basis points of average loans annualized during the third quarter. This represents decreases of $0.3 million from the prior year's third quarter and $2.6 million from the linked second quarter. The company's allowance for credit losses was $84.9 million or 79 basis points of total loans outstanding at the end of the third quarter, an increase of $3.1 million during the quarter and an increase of $8.8 million from one year prior. The increases were primarily attributed to reserve building in the business's lending portfolio, reflecting the growth in size and volume of recently originated commercial loans. The allowance for credit losses at the end of the third quarter represented over 6x the company's trailing 12-month net charge-off.

We are pleased with the third quarter results and momentum behind recent initiatives that reinforce our commitment to scale as a diversified financial services company. We anticipate closing on the acquisition of seven Santander branches in the Lehigh Valley market on November 7th, which accelerates our retail strategy in the banking services business in a market we anticipate significant growth. Additionally, we are excited to announce a minority investment in Leap Holdings, Inc, which intentionally complements our insurance services business. Looking forward, we believe the company's diversified revenue profile, strong liquidity, regulatory capital reserves, stable core deposit bank, and historically good asset quality provide a solid foundation for the continued earnings growth. That concludes my prepared earnings comments. Dimitar and I will now take questions. Bailey, I will turn it back to you to open the line. Thank you.

Operator (participant)

Okay. We'll now begin the question and answer session. To ask a question, you may press star then one on your touch-tone phone. If you are using a speaker phone, please pick up your handset before pressing your 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. First question comes from Tyler Cacciatori with Stephens. Please go ahead.

Tyler Cacciatori (Equity Research Associate)

Good morning. This is Tyler on for Matthew Breese.

Dimitar Karaivanov (President and CEO)

Morning, Tyler.

Marya Wlos (CFO)

Morning.

Tyler Cacciatori (Equity Research Associate)

If I could just start on the minority investment into Leap, I think you touched on it a bit in the prepared remarks. Should we look at this as a first step to something bigger, maybe a precursor to a larger investment if things work out? Are you able to provide what the impacts to revenues and expenses are as we move forward?

Dimitar Karaivanov (President and CEO)

Thanks, Tyler. The way I would think about it is we invested in a business that we believe is highly attractive, growing at very high growth rates, with a tremendous team, that fits squarely in our thesis to grow insurance services. We took a stake in something that we really like and love, and obviously, we would love to have more of it if we're so lucky sometime down the line. I think at this point, we are where we are in terms of our investment in Leap. We'll see what the future holds for us. As it relates to financial impact, I think the best way to think about it is roughly neutral. You know, some of the ins and outs of the way the accounting works kind of leads it to that outcome, and given its relative size, it doesn't really dramatically change things for us.

I wouldn't really expect much in the way of contribution for 2026.

Tyler Cacciatori (Equity Research Associate)

Great. Thank you. Just moving to deposit costs, if you could just talk about how deposit costs and how the legacy footprint is doing versus more concerted efforts in areas like Albany, Buffalo, and Rochester. Is there a notable difference in the cost of deposits there, and how should we think about cost of deposits overall moving forward?

Dimitar Karaivanov (President and CEO)

I don't think that we have seen any dramatic difference in the cost of deposits, if you're referring to kind of our legacy footprint versus the de novo expansion. We're pursuing very much the same strategies. I will say we're a little bit more intentional around commercial growth in those de novo markets. That kind of leads maybe a little bit on the margin of higher cost, while the retail side builds up, you know, one small checking account at a time. That will take just a little bit more time. That's kind of the strategy. With all of that said, as we've discussed before, our de novo initiative is not really moving the needle in the way of cost of deposits for the aggregate company because of its relative size, right?

Over 10 years, we're hopeful that it's going to be a very meaningful contributor to us, but right now, it's not, and it's not going to be for a little bit. By the time those 10 years have come, we're going to have built the retail checking accounts, as I talked about, you know, kind of one, $1,000 account at a time. Right now, our expectation is that deposit costs are going to continue to trend down, with some of the rate cuts as expected by the market, and the de novo initiative doesn't really impact that trend for us.

Tyler Cacciatori (Equity Research Associate)

That's helpful. Thank you. If I could just squeeze one more in, I was wondering if you're seeing any spread compression on incremental CRE loans, and if so, to what extent? If you could provide us what your current CRE loan yields are.

Dimitar Karaivanov (President and CEO)

Yeah. The way I would think about loan yields is everything's priced roughly, you know, spread over three or five years, right? If you look at the three things that we do, and I'll touch on not just commercial but kind of the overall portfolios. I'm sure everybody's got a similar question here. If you look at, let's start with the commercial side. You basically have a fixed and kind of a variable component to those. You're typically pricing somewhere 225, you know, 230, 240 over the, you know, three or five-year part of the curve. As you can easily see, those parts of the curve have moved down dramatically since the beginning of the year.

If you're looking at, you know, 350-ish on those rates in the market and you're putting your biggest spread, now you're looking at kind of high fives, now low sixes, in terms of commercial originations. This quarter was a little bit higher, but I expect that we'll continue to kind of see a downtrend in those rates as just the market is evolving. We do have some aggressive competitors on the CRE side in particular in our markets, particularly in upstate New York, and to some extent Vermont. You're seeing, you know, rates there, promotional rates that are now in the mid fives. That's not where we are, but that's what some folks are in our markets. If you look at our mortgage portfolio, you know, you're typically pricing that kind of 260-ish, 270 over the 10-year. You can do the math.

You're kind of in the, you know, mid sixes right now. That clearly also has a trend towards lower, and I expect that we're going to continue to see that. Again, the back book in that product for us is 530-ish, so there's still plenty of room for us to reprice mortgage cash flows up. In our consumer installment lending business, which is our auto business, we basically have new volume rates that are roughly in line with portfolio rates. Growth there is going to be driven by volume, not by rate.

Tyler Cacciatori (Equity Research Associate)

Great. Thank you. That'll be all from me. I appreciate you taking my questions.

Operator (participant)

Our next question comes from Steve Moss with Raymond James. Please go ahead.

Steve Moss (Analyst)

Good morning.

Dimitar Karaivanov (President and CEO)

Morning, Steve.

Marya Wlos (CFO)

Morning.

Steve Moss (Analyst)

Morning, Dimitar. Morning, Marya. Maybe just, you know, on the loan growth side here, good to see broad-based growth, kind of as you were expecting here, Dimitar. Just kind of curious, where does the pipeline stand, and are you still as optimistic on growth, just given maybe incrementally more competition here?

Dimitar Karaivanov (President and CEO)

Yeah. Steve, we remain very constructive on the growth side. If you look at our pipelines today, our commercial pipeline is at its highest level it's ever been. I expect that will do well, depending on the pull-through, of course. Timing matters, but a lot of that pipeline will come to fruition over the next couple of quarters. When you look at our mortgage pipeline today, the pipeline is actually higher than it was this time last year, which I think says a lot for the execution of our team on the mortgage side as well, given the market we're in. On the consumer, on the auto side, things are a little bit more unpredictable, but typically, the fourth quarter is a little bit slower. We'll see how that goes.

If I was to ballpark it today, I would guess that the fourth quarter is ±$20 million or $30 million, in line with the third quarter. That would be kind of my high-level guess, but we'll see where things shake out. I think our guidance for the year of 4%-5% is very much intact with an expectation for a strong fourth quarter as well. Most of the growth for us has been, is, and will continue to be market share gains. We've talked about this before, but for us, I think if you look at how we're performing versus the majority of folks in our markets, we're outperforming. That is because we're gaining a lot of market share from some of the larger super regionals that we compete with. I expect that to continue.

Steve Moss (Analyst)

Okay. I guess on the margin front, you know, still have relatively favorable yields with loans. You've got the Santander deposits coming in. Just kind of curious, you know, how you guys are thinking about the blended margin here for the quarter. I'm assuming the deal might be a little bit more accretive just given, you know, loans are kind of trending the right way here, and you can deploy some of that liquidity potentially.

Marya Wlos (CFO)

Hey, Steve. I'll take that one. You're correct. We're thinking about things the same way. I think for us, we're still in the 3%-5% range that we guided in Q2. As we continue to look at the balance sheet and bring all the moving parts together, including Santander, we continue to hold funding costs, as we mentioned, at an industry level of 1.17%. That's really helpful for us as we go forward. We expect costs to stay at those levels and likely even to go lower, as we address exception pricing in line with Fed funds cuts and, as Dimitar just noted, price our loan portfolios effectively. We've been really successful from that perspective, and we do expect the results to come through in the margin with Santander coming on about halfway through Q4.

We'll have less overnight borrowings, which will be offset by some fixed assets pricing lower. Again, overall, we're pleased with the expansion year to date, and we do expect to see that in Q4 as well.

Steve Moss (Analyst)

Okay. On the expense side here, Marya, I think I heard you, a $1 million increase in total expenses quarter-over-quarter. I'm assuming that's excluding Santander, if that's correct.

Marya Wlos (CFO)

Yep. That's correct. I just wanted to give a little guidance on what we're going to see in Q4, given that we're going to prepay some charitable contribution commitments due to some tax changes, as I'm sure you're aware. Looking at the compensation adjustments, we accrued heavily in the first half of the year, and as we trued up in Q3, we expect that might increase again in Q4 as we get our final scorecards in line and everything, you know, looking like we're going to close up.

Steve Moss (Analyst)

Okay. On the C income side here, definitely continue to see good, good, good growth with employee benefit services. Just kind of curious, Dimitar, I'm assuming it's steady as she goes, but just, anything unique with that business that maybe adds a little more upside or, I mean, market's obviously been favorable to help in asset growth. I'm assuming, you know, pretty much regular investments and regular trends.

Dimitar Karaivanov (President and CEO)

Yeah. I think on the employee benefit services, Steve, we have a little bit more seasonality now in Q4 because a couple of the acquisitions that we did over the past 18 months kind of have lumpy revenue in October as they complete the work. That may even out a little bit more next year, but right now, I think Q4, assuming the market values stay where they are, I expect it to be better than Q3.

Steve Moss (Analyst)

Okay. Great. All my questions for now. I'll step back in the queue.

Operator (participant)

Our next question comes from David Konrad with KBW. Please go ahead.

David Konrad (Analyst)

Yeah. Hey, good morning. Just kind of a little bit of follow-up question on NIM. Just want a little bit of color on the investment portfolio. You know, it looks like it went down quarter-over-quarter in yield, and we're kind of down at the low 2% level. Maybe just an outlook there on maybe cash flows or what the duration is and where we can go from yields from here.

Dimitar Karaivanov (President and CEO)

I think, David, on the investment portfolio, some of that noise is due to dividends that we receive from the FHLB or the [FRB]. The timing of that kind of impacts some of those yields quarter-over-quarter. We haven't really made any meaningful purchases in that portfolio, nor do we expect to do any meaningful purchases. The vast majority of it is treasuries. It's a kind of yield with the yield, so generally, fairly steady. We are going to provide a little bit refreshed disclosure in our investor deck that we are going to file in terms of the cash flows. You can think of it as 2026. It's roughly $350 million of cash flows, heavily weighted towards the fourth quarter. In 2027, we have over $600 million. In 2028, it's another $600 million. In 2029, it's another $300 million-$400 million.

These are all treasury maturities, so we know what we're going to get, when we're going to get it, and we know what it yields. I think those will be the cash flows that for us, ultimately, they're going to have two uses. Highest and best use is for us to redeploy those into loans, which is plan A. Plan B is if loan growth or opportunities are not attractive at that time, we are going to be paying down some of our FHLB borrowings, who also we've turned out to match those cash flows in meaningful ways. In 2027, we have some FHLBs that are kind of in the mid fours. We have similar in 2028.

If we are not deploying those funds from the securities portfolio, which is kind of roughly 150, 160-ish in terms of yield, if they're not going into loans, at the very least, we are going to be very additive just by paying down some of the FHLB borrowings. If that happens, which is plan B, then you're looking at the balance sheet shrinking and margin going up by default as well.

David Konrad (Analyst)

Got it. Okay, thank you.

Operator (participant)

Again, if you have a question, please press star then one. This concludes our question and answer session. I would like to turn the conference back over to Dimitar Karaivanov for any closing remarks.

Dimitar Karaivanov (President and CEO)

Thank you, Bailey, and thank you all for joining us today. At the conclusion, I would like to note that while both Marya and I attend a number of investor conferences and events during the year, we consistently find that dedicated one-on-one time with investors and prospective investors is the best way for us to have a well-prepared for and productive meeting. We're very open and available, so please reach out to us if our story is of interest, and we'll be happy to spend an hour with you. Thank you all, and we'll talk to you again in January.

Operator (participant)

This concludes our questions. This conference is now concluded. Thank you for attending today's presentation. You may now disconnect.