Community Bank System, Inc. (CBU) Q2 2023 Earnings Call Transcript

Community Bank System, Inc. (NYSE:CBU) Q2 2023 Earnings Conference Call July 31, 2023 11:00 AM ET

Company Participants

Mark Tryniski – President and CEO

Joseph Sutaris – Executive Vice President and CFO

Dimitar Karaivanov – Executive Vice President and COO

Conference Call Participants

Nick Cucharale – The Hovde Group

Steve Moss – Raymond James

Alex Twerdahl – Piper Sandler

Manuel Navas – D.A. Davidson

Matthew Breese – Stephens

Chris O’Connell – KBW

Operator

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 Security 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

Thank you, all. Good morning, everyone. And thank you all for joining our second quarter conference call. I am not going to say much about our quarterly performance other than it was very good. Joe and Dimitar will comment in more detail.

But I did want to acknowledge the announcement we made early last month regarding my retirement from the company effective this December 31st, but I will remain on the Board through 2024 to support the transition.

Most importantly, we are thrilled that Dimitar Karaivanov will be appointed President and Chief Executive Officer of Community Bank System and Community Bank effective January 1, 2024. Succession is something we have been working on for many years as it’s one of the most important responsibilities of the CEO and the Board of Directors.

I have known Dimitar for at least 15 years, starting in his prior life as a financial adviser 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 distute 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

Thank you, Mark. It has been more than a privilege to work alongside Mark and the team, and I am grateful for the trust and confidence that the Board has granted me. I have been involved with this company for 15 years and I feel very strongly that we have the best team we have ever had and our ability to service clients, win in the marketplace and provide growth opportunities for our colleagues and communities has never been better. The future of our company is bright and I am 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 remained 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 are encouraged by the momentum across all of our businesses. The banking pipelines are healthy and our funding base is secured. The improvement in market values bodes well for our benefits and wealth businesses, and our Insurance business, we are benefiting from organic growth, increased premiums and inorganic activities.

Joe will now provide you with more details on the financials. Joe?

Joseph Sutaris

Thank you, Dimitar, and 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 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 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 measures 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 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, 3.18% in the second quarter.

For context, the nationwide median cost of funds for banks in the second quarter was approximately 2% and 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 an organic — despite organic customer growth in the Employee Benefits 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 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 of total operating expenses in the prior year 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 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.

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 $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 quarter — during the second quarter, driven by a $453.5 million decrease in average — in the average book value investment securities, partially offset by $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 $85.8 million or 2.3% increase in the business lending portfolio and $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 of 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 $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 tended seasonally decline in the second quarter, while business to 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 compositions to build 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 broker or wholesale deposits on its balance sheet. The cycle-to-date interest-bearing deposit 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 discount window, unused borrowing capacity to 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 on insured 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 companies and the bank’s 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 defined in 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, the — during the second quarter of 2023, the company reported net charge-offs of $0.7 million or 3 basis points of average 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 days to 89 days delinquent were 47 basis points of total loans outstanding at June 30, 2022 – 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 remained 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 to 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.

Thank you. I will now turn it back to Allan to open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Nick Cucharale of The Hovde Group. Go ahead.

Nick Cucharale

Good morning, everyone. How are you today?

Joseph Sutaris

Good morning, Nick.

Mark Tryniski

Good morning, Nick.

Nick Cucharale

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 and can you help us think about a full year growth rate?

Dimitar Karaivanov

Sure. Nick, it’s Dimitar. You are spot on. We have benefited from a couple of things. One is our own capabilities, but the second is the competitive environment. And the reality is a lot of banks, predominantly smaller ones have run out of liquidity. They don’t have enough funding that they can extend to clients.

So a number of folks are focused on only existing clients, a number of folks are just not lending. So we are seeing an opportunity to leverage our strength of the balance sheet to service our clients and to extend new relationships for relationships in all of our markets.

So, in terms of growth rate, I think, 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 midpoint of the single digits. Just the momentum is strong and the pipeline actually increased quarter-over-quarter as we sit here today, I mean, all of our businesses.

Nick Cucharale

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

Joseph Sutaris

Yeah. I don’t think any — this is Joe, Nick. I don’t think anything has changed with our — around our expectations for operating expenses. I think we kind of acknowledge that, Q1 was up a bit, but we expected that to level off throughout the remaining three quarters. I think we are still on path generally to have a flattish outcome, if you will, for the remaining two quarters, and so on a full year run rate basis, still kind of that 5% to 9%, I think, is a reasonable expectation.

Nick Cucharale

Okay. Great. And then lastly for me, I know it’s price dependent, but the repurchase has been pretty consistent in 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

Yes. Nick, it’s Dimitar, again. All — we look at all of those things. The dividend is part of our core value proposition and investment thesis, which is above average returns and below average risk. So we try to manage volatility across our businesses 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. So it’s a really important part of what we aim to achieve for our shareholders.

I think on share repurchases, we have communicated that our goal is to at least offset the equity dilution from our annual grants. So I think right now we are kind of on our way — well on our way as it relates to that this year.

The stock we believe continues to be attractive as we personally look at it and from a company’s perspective. So we probably have a little bit more to do there with these levels on the share repurchase side.

And then on capital allocation, in terms of M&A, we remain very opportunistic across all of our businesses. We deploy capital in the bank every day as we grow the balance sheet. So that’s part of what we do in the bank and then we are actively looking at M&A across all of our businesses.

We do some small roll-ups in our Insurance business, our Benefits business. We looked some practices and folks on our Wealth side. So 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.

Nick Cucharale

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

Operator

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

Steve Moss

Hi. Good morning.

Mark Tryniski

Good morning, Steve.

Steve Moss

Just on the margin here. Good morning. Maybe just on the margin here. Just curious, Joe, you mentioned that, deposit costs — it sounds like deposit costs are a little bit of a headwind. Curious as to where you are thinking deposit costs are headed over the next two quarters or so?

Joseph Sutaris

Yeah. So it’s a very fair question, Steve. I mean the — our experience is that even if the Fed pauses that there will be a continuation of higher deposit rates just as we continue to see migration from low or non-interest-bearing deposits into higher rate certificates and so we do continue to expect increases.

I am not sure I have an exact call with respect to how much deposit going to increase over the third quarter, but they are — they were trending higher in the second quarter and we expect some of that to continue into the first quarter.

But with that said, if the Fed does pause over time, that pressure abates a bit and I will call it the pace at which monies move from low interest-bearing to non-interest-bearing slows a bit and call it the repricing of the non-maturity deposits perhaps slows a bit as well. So we think those pressures will abate over time, but in the third and potentially into the fourth quarter, we do see that to continue to be a headwind.

So with respect to our margin and NII expectations, we are kind of thinking more of a kind of flat to sideways outcome for at least the next quarter or two, and then, hopefully, we can see some expansion in 2024 as some of those funding pressures just abate a bit.

Steve Moss

Okay. And then in terms of just curious on loan pricing here, what’s the — what were origination yields for the quarter and where do you guys see that shaking out here going forward?

Joseph Sutaris

Yeah. So on a blended basis, we booked new loans at about just under 7% for the quarter and we are — so we are seeing pretty good rate improvement, if you will, on the book over time, because the book yield is, I think, just sub-5%.

So we are picking up about 200 basis points on the repricing activity plus volume has been increasing and if we do have kind of a mid-single-digit kind of growth outcome, that’s going to help over time.

So we also have approximately $2 billion, about 25% of our loan portfolio that are repriceable, of which roughly $1 billion will reprice in the next 12 months or so. Some of those are kind of the — they might be 10-year terms with a five-year repricing reset and some of that occurs in years out, but we have about $1 billion repricing in the next 12 months or so.

Steve Moss

Okay. That’s helpful. And then maybe just on the Employee Benefit Services business, flattish year-over-year, but you guys have talked in the past on — about the pipeline of new business coming in, and I apologize if I missed it. Just curious as to the trends — the underlying organic trends you are seeing there?

Dimitar Karaivanov

Yeah. The — good morning, Steve. The underlying trends remain very strong. As Joe said, some of the — some of that has been masked by the market. But I think as we are sitting here in July, I wouldn’t be surprised if we have a record month in that business for us, and if the asset values stay where they are, which are still lower than the market peaks. We are already doing better than we were back in Q4 of 2021.

So there are some things in that business that are also, I would call them sometimes more consulting based. So that impacted our revenues a little bit here in the first six months compared to the last year, but we are were down a little bit compared to 2022. Again, right now, we are in as good of a position as we have been. My expectation is we are going to more than make it up by the end of 2023 should the market value stay where they are.

Steve Moss

Great. Appreciate all the color. Nice quarter guys.

Dimitar Karaivanov

Thank you, Steve.

Operator

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

Alex Twerdahl

Hey. Good morning, guys.

Dimitar Karaivanov

Good morning, Alex.

Mark Tryniski

Hi, Alex.

Alex Twerdahl

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 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 to $400 million of loan growth later this year based on your growth targets. I am just wondering if the securities cash flows will be sufficient and sort of the outlook for funding?

Joseph Sutaris

Yeah. So in the third quarter — Alex, this quarter we have about another of maturity that’s going to certainly help for the funding at least for the balance of 2023. And then as we get into 2024, we do have a little bit of a slower cash flow coming off the securities portfolio, less than about $100 million in 2024.

But we do have some plans basically to continue to grow, and with the higher loan yields, we can continue to bridge to cash flows a little further out just through some, probably, some wholesale borrowings, given where rates are, it’s still fairly attractive to do that.

Alex Twerdahl

Can you say the number from the third quarter just broke up a little bit? I am not sure if that was just my line or everyone’s line.

Joseph Sutaris

Sorry. Yeah. So the third quarter is about $150 million, Alex…

Alex Twerdahl

Okay.

Joseph Sutaris

…maturities.

Alex Twerdahl

And anything in the fourth quarter?

Joseph Sutaris

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

Alex Twerdahl

And with the expectation in terms of other deposit flows that the $146 — $147 million of municipal deposits that went out in the second quarter that you just remind us that usually builds into the end of October, is that correct?

Joseph Sutaris

That’s correct, Alex. Yeah. It throws — it’s somewhat seasonal in the second quarter being the low point for municipal deposits, and then in New York State, in particular, tax collection occurs in the third quarter and in the first quarter. So we tend to see a little bit of a rebound, if you will, in municipal deposits.

And for that matter also on the municipal repurchase agreements, particularly in our Vermont market, our New England market, they bounced back a little bit in the third quarter as well. So we do have some expectations that municipal funding is going to roll back in the door, if you will, in the third quarter.

Alex Twerdahl

Okay. Do you happen to have the just sort of the exit net interest margin from the quarter and exit cost of funds?

Joseph Sutaris

Yeah. It was relatively flat. I will say, May to June from an NII perspective. So cost of funds, we kind of exited the quarter at about 90 basis points at reserves here. I am sorry, I am off about 80 basis points total cost of funds exiting at the end of the quarter.

Alex Twerdahl

Okay. That’s perfect.

Dimitar Karaivanov

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

Joseph Sutaris

Right.

Alex Twerdahl

Okay. Yeah. It’s pretty flat across the quarter. I wasn’t sure if there’s anything funky in there from the deleveraging transaction you guys did back in the first quarter that would make the numbers not seem as straightforward as they look. And then just the final question I had is on fees. I know last quarter, you guys mentioned some adjustments to NSF fees and I think you guided to like a $6 million to $8 million hit across the year on NSF and 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 looks stronger than the second quarter a year ago and much stronger than the first quarter. So I am just curious if there’s something else in there that we should be thinking about or if there’s any change to that full year guidance for the hit to deposit service charges from that?

Joseph Sutaris

We also had a little higher debit interchange outcome for the second quarter. So that sort of offset some of the reduction for the NSF changes.

Alex Twerdahl

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

Joseph Sutaris

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

Alex Twerdahl

Perfect. Thank you for taking my question.

Joseph Sutaris

Welcome.

Operator

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

Manuel Navas

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

Dimitar Karaivanov

Yeah. So, good morning, Manuel. The — you are 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. But we have gained even more momentum on the mortgage side.

So I think we are going to have a pretty robust quarter here in Q3 and going into Q4 that’s usually when we book the most on the mortgage side anyways, but the pipelines are actually stronger than they were a year ago, and as you can imagine, it’s 85% purchase money. So all of that is additive to the balance sheet. So 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, our car business, that also is in pretty good shape. We 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, and when you do that, you kind of create an opening in the segments that we play in, because as you know, we don’t play everywhere between the segments that we play in are part of the market.

So that’s created some opportunities for us. So that business remains in good shape. It is hard to predict, as we said before. We are trying to manage risk and return there on an active basis for rate and the segments we focus on. So we expect that to be in line with the second quarter, frankly, as we sit here today.

Manuel Navas

Also what are new yields are you getting on auto loans on new paper?

Dimitar Karaivanov

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

Manuel Navas

Okay. That’s great. I appreciate the update. Thank you.

Operator

[Operator Instructions] Our next question comes from Matthew Breese of Stephens. Go ahead.

Matthew Breese

Good morning.

Dimitar Karaivanov

Good morning, Matt.

Mark Tryniski

Good morning, Matt.

Matthew Breese

I think the credit metrics largely speak for themselves. With that in mind, I’d be curious about your thoughts around the provisioning outlook and then 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

Yeah. Matt, this is Joe. The expectations right now are flat. I mean, we have not seen, fortunately, any sort of terms in credit. In fact, when you look at kind of our risk ratings on a year-over-year basis, we have seen some improvement, which is good. Net charge-offs are still fairly low. I think things are normalizing a little bit in the indirect business.

But our indirect net charge-offs of 10 basis points to average about 30 basis points over a long period of time. So we are really not seeing any sort of headwinds knock on wood on the credit front right now and so given that our expectations are kind of about the same until we see some changes.

Matthew Breese

Okay. And then, look, I think, your stance on tangible common equity as a capital ratio and impacts from AOCI are pretty well known at this point. But I would be curious, one, as it stands today, what the duration of the securities portfolio is, and then 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 lessen things here, the impact?

Dimitar Karaivanov

Yeah. Hey, Matt. It’s Dimitar. I mean, we are not going to surprise you here. There’s no change in how we look at our business and we also have to dissegregate the bank from the aggregate business.

And keep in mind, the balance sheet only shows one of our four businesses. So we have 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.

So if you were to think about that. Frankly, the — and back to the balance sheet, the numbers are very strong and those businesses provide tremendous amount of capital every year to the rest of the company. So we are focused on regulatory ratios.

We don’t believe because a third of our revenue, more than a third of our revenue is coming from non-balance sheet activities. We don’t believe that the balance sheet itself fully reflects the economic value of the company.

Our regulatory ratios remain very strong. They continue to increase. We are — 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 a year sooner than we would have gotten otherwise.

And secondly, allowed us the flexibility to now service more clients when a lot of people are pulling back. So we don’t feel like we need to do anything similar here for the next couple of quarters at the very least. So capital is growing at a very robust pace. We have not been able to deploy it through M&A. So it just keeps accruing to our company.

Matthew Breese

Great. I appreciate that. One last one before I sign off. 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

Yeah. Matt, that’s a fair question. I — there is a reason why I feel like I have 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 similar light.

So you are not going to see much in the way of change for us. Our 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 and 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, be it tangential to them or 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 the Insurance market. So I think we are going to have an increased focus on that diversification, an increased focus on managing the low volatility and risk across our businesses.

So it’s really an evolution. I think one of the differences that we have today than we did historically, and that’s kudos to Mark and the team. We are much better at organic growth. So we are going to continue to lean into that. We are going to continue to look at new markets and new opportunities to expand organically.

We allocate capital in multiple ways. One of this is through the P&L investments in people and new businesses through the P&L, which we are doing daily. And then as we have opportunities to deploy that excess capital that we generate into transactions, we are going to continue looking at that as we have communicated really more strategically focused and tactically focused, because of the lesser need to generate earnings growth through M&A.

Matthew Breese

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

Mark Tryniski

Thank you.

Operator

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

Chris O’Connell

Good morning, and yeah, congratulations to you Mark in 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 guys have been doing a really good job of keeping the margin kind of held up where it is here this past quarter and year-to-date, as well as it seems like the spot margin ended June. I mean, given that there’s still some funding pressure coming in the back half of the year. I mean, do you expect the margin to remain under pressure into the back half of the year or do you think you can keep it held up more or less around the current levels?

Joseph Sutaris

Yeah. I think, Chris, our best expectation at this point is kind of, I will say, flat to, call it, sideways for a couple of quarters, which I think is potentially going outperform the rest of the market just because of our — the strength and resilience of our funding base.

If those pressures do abate, which the Fed pauses and they do abate, the expectation would be that the rate at which funding costs increase in 2024 will slow significantly. In the meantime, we are still turning over the loan portfolio at a pretty healthy clip with basically a 200-basis-point pickup on the turnover. So the hope and expectation is that NII net interest income will hopefully improve as we look into 2024 and beyond.

But obviously, rates don’t go one direction, and it’s sometimes there’s fluctuations. But based on where we are today, the expectation is that we would go effectively sideways maybe down a few basis points on the NIM, maybe a couple of basis points in the next couple of quarters, but generally sideways.

Chris O’Connell

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

Joseph Sutaris

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

Chris O’Connell

Got it. And what’s the average or blended cost of like the municipal deposit book versus the rest of the portfolio?

Joseph Sutaris

It’s a fair question, Chris. But to be perfectly frank, I need to look it up, but it’s, let’s see…

Mark Tryniski

You should have kept that.

Joseph Sutaris

I am not sure I have the breakout in front of me, Chris, but it certainly is…

Chris O’Connell

Okay, Joe.

Joseph Sutaris

… much more, it’s slightly more than that of the IPC deposits and certainly less than overnight borrowings.

Chris O’Connell

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

Dimitar Karaivanov

Chris, I think, on the bank side, there is a little bit of a slight uptick, I would call it, in the sense of sellers being more willing to engage in discussions. I think the challenges there remain similar to what they have done for the past couple of quarters, which is you have got a lot of unknowns as to what the balance sheet looks like, what the margin looks like.

I think this cycle is showcasing that some balance sheets can change quite drastically in the matter of a couple of quarters and when earnings are going down for simple 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 are focused on consistency, first and foremost, in our results.

So I think that’s one challenge. I think the second challenge is for a lot of folks, there is not of capital left once you mark the balance sheet. So we have to essentially pay for the deal twice. So 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, it’s also hard to figure out in today’s environment when you announce a transaction a bank or bank deal what does that do to the deposit base, given that it’s like sounding the starting signal for all call the competitors and high rate customers to start looking around yet again. So I think that’s kind of hard to put your arms around.

And 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. So that creates another challenge in terms of you don’t know when you are going to close the transaction, and that puts pressure on retaining clients, retaining people, having to pay a lot more for our customers. So that’s another unknown that’s really kind of creating that unfavorable risk and reward right now.

With that said, we continue to look. On the flip side, we know now some franchises that their balance sheets are holding up better than expected and better than others. So that’s something that we are going to remember for a long time, and when the opportunity comes, we will be active and hopefully in a better environment.

Chris O’Connell

Great. Thanks for your time. I appreciate you taking my questions.

Operator

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

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

Operator

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