COMMUNITY FINANCIAL SYSTEM, INC. quarterly report, Q2 FY2023

Business Context and Reporting Period

Community Bank System, Inc. (the filing text does not identify Community Financial System, Inc.) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2023. The company operates diversified banking, employee benefit services, insurance, and wealth management businesses, primarily through Community Bank, N.A., BPAS, and OneGroup.

The filing compares the three and six months ended June 30, 2023 with the comparable 2022 periods and the June 30, 2023 balance sheet with December 31, 2022. The company reported effective disclosure controls and no material changes in internal control over financial reporting.

Financial Performance and Position

Metric	Q2 2023	Q2 2022	Six Months 2023	Six Months 2022
Net interest income	$109.3 million	$103.1 million	$220.3 million	$198.0 million
Provision for credit losses	$0.8 million	$6.0 million	$4.3 million	$6.9 million
Noninterest revenues	$66.0 million	$64.1 million	$79.5 million	$129.8 million
Noninterest expenses	$113.0 million	$110.4 million	$227.1 million	$210.2 million
Net income	$48.3 million	$39.8 million	$54.1 million	$86.9 million
Diluted EPS	$0.89	$0.73	$1.00	$1.60
Net interest margin	3.14%	2.86%	3.16%	2.78%

Q2 net income increased 21.3%; year-to-date net income declined 37.7%, primarily because of a $52.3 million pretax realized loss on investment securities recognized in the first quarter.
Adjusted net income was $51.3 million in Q2 and $100.2 million year-to-date. Diluted adjusted EPS was $0.95 in Q2 and $1.85 year-to-date.
Q2 GAAP efficiency ratio was 64.5%; year-to-date GAAP efficiency ratio was 75.8%. The non-GAAP operating efficiency ratios were 61.7% and 62.1%, respectively.
Total assets were $15.11 billion at June 30, 2023, down from $15.84 billion at December 31, 2022. Gross loans increased to $9.17 billion from $8.81 billion, while net loans were $9.11 billion.
Total deposits were $12.87 billion, compared with $13.01 billion at year-end 2022. Noninterest-bearing deposits were $3.86 billion and interest-bearing deposits were $9.02 billion.
Shareholders’ equity was $1.62 billion, up from $1.55 billion at year-end 2022. The GAAP equity-to-assets ratio was 10.71%; tangible equity-to-assets was 5.34%.
Regulatory capital remained strong. The company’s June 30, 2023 Tier 1 leverage ratio was 9.35%, common equity Tier 1 ratio was 15.20%, and total risk-based capital ratio was 15.90%. The company and bank were considered well capitalized.

Cash Flow, Liquidity, Debt, and Credit

Operating cash flow for the first six months was $118.9 million, compared with $98.9 million in the prior-year period.
Investing activities provided $755.9 million, primarily from $733.8 million of available-for-sale securities sales, $394.5 million of security maturities and paydowns, and a $374.0 million net increase in loans.
Financing activities used $861.8 million, including reductions of deposits, overnight borrowings, repurchase agreements, and other borrowings, plus $47.4 million of dividends and $20.7 million of treasury-stock purchases.
Cash and cash equivalents ended at $222.8 million, compared with $209.9 million at December 31, 2022.
Immediately available liquidity was approximately $4.23 billion, more than twice estimated uninsured deposits of approximately $2.05 billion. Available sources included $1.65 billion of unused FHLB capacity, $1.43 billion of Federal Reserve discount-window capacity, approximately $1.05 billion of additional securities capacity, and a $25 million unsecured correspondent line.
Borrowings excluding customer repurchase agreements totaled $251.3 million at quarter-end, including $234.0 million of overnight borrowings. Customer repurchase agreements were $233.5 million.
The allowance for credit losses on loans was $63.3 million, or 0.69% of loans, versus $61.1 million at year-end 2022. Total allowance coverage of nonperforming loans was 190%.
Nonperforming loans were 0.36% of total loans, nonaccrual loans were 0.33%, and delinquent loans were 0.83%. Second-quarter net charge-offs were $0.7 million, or an annualized 0.03% of average loans.

Material Changes Versus Prior Comparable Period

Net interest income increased 6.0% in Q2 and 11.3% year-to-date as higher loan and investment yields more than offset higher deposit and borrowing costs.
Net interest margin expanded 28 basis points in Q2 and 38 basis points year-to-date. Management expects deposit costs and the deposit beta to continue rising as competition for funding remains elevated.
Loans grew 12.6% from June 30, 2022, led by business lending and consumer installment loans. Ending deposits declined 1.1% from December 31, 2022 and average Q2 deposits declined 3.3% year over year.
Insurance services revenue increased 21.3% in Q2 and 15.8% year-to-date, benefiting from organic and acquired growth. Employee benefit and wealth management revenue declined modestly.
Noninterest expenses increased 2.4% in Q2 and 8.0% year-to-date, driven principally by higher salaries and benefits, staffing, technology, legal and professional fees, marketing, inflation, and FDIC insurance costs.
Investment securities declined materially following the strategic sale of $786.1 million of available-for-sale U.S. Treasury and agency securities in January and February 2023. The company recognized a $52.3 million pretax loss and used the proceeds to repay overnight borrowings.
Accumulated other comprehensive loss improved to $611.7 million from $686.4 million at year-end 2022, primarily because of improved unrealized investment-security valuations.

Guidance, Outlook, Risks, and Unusual Items

Management does not provide formal earnings guidance in the filing. Interest-rate sensitivity modeling indicates projected annualized net interest income would decline 6.1% under a 200-basis-point rate increase and increase 2.8% under a 200-basis-point rate decrease; management states this analysis is not a forecast.
Management expects deposit costs and potentially wholesale funding costs to increase, which could pressure net interest margin. The company expects no additional investment-security purchases in its modeled 12-month scenario and expects investment cash flows to support loan growth and repay overnight borrowings.
Key risks include deposit outflows and funding costs, interest-rate and liquidity risk, banking-industry developments, credit losses, commercial real estate and consumer-credit performance, securities valuation changes, economic conditions, technology and cybersecurity risks, regulatory changes, litigation, and acquisition integration.
The company completed acquisitions of Axiom Realty Group and Hyde Park Insurance Services in 2023 for aggregate cash consideration of approximately $6.1 million, recognizing approximately $2.2 million of goodwill and $4.1 million of other intangibles.
The FDIC proposed a special assessment related to uninsured deposit losses at failed banks. If adopted as proposed, management does not expect the impact to be material, although the timing and amount remain uncertain.
The company repurchased 200,000 shares under its 2023 authorization during the first six months at an average price of $51.42. The authorization covered up to 2.697 million shares.
Legal proceedings are considered unlikely to have a material effect on consolidated financial position, but the company cannot rule out a material effect on results in a particular future period.

Important Facts for Investors to Verify

Confirm the issuer identity: the filing text identifies Community Bank System, Inc., while the request metadata identifies Community Financial System, Inc.
Assess the sustainability of loan growth and whether credit losses, particularly in consumer indirect lending and commercial real estate, remain consistent with current allowance coverage.
Monitor deposit balances, deposit beta, uninsured deposits, wholesale borrowing usage, and the company’s ability to preserve its liquidity surplus.
Evaluate the effect of higher funding costs and interest-rate changes on future net interest margin and earnings.
Separate recurring operating performance from the $52.3 million securities-sale loss and other non-GAAP adjustments.
Review the investment portfolio’s duration, unrealized losses, pledged securities, and sensitivity to further interest-rate movements.
Track acquisition performance, contingent consideration, goodwill, intangible amortization, and integration costs.
Verify the final FDIC special-assessment rule and any resulting financial impact.