Community Bank System, Inc. (NYSE:CBU)
Q4 2015 Earnings Conference Call
January 21, 2016 11:00 AM ET
Mark Tryniski - CEO
Scott Kingsley - CFO
Alex Twerdahl - Sandler O’Neill
Joe Fenech - Hovde Group
Collyn Gilbert - KBW
Matthew Breese - Piper Jaffray
Welcome to the Community Bank System Fourth Quarter and year end 2015 Earnings Conference Call. Please note that this presentation contains forward-looking statements within the provisions of the Private Securities Litigation Reform Act of 1995 that are based on current expectations, estimates and projections about the industry, markets and economic environment, in which the company operates.
Such statements involve risks and uncertainties that could cause actual results to differ materially from those 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.
Today's call presenters are Mark Tryniski, President and Chief Executive Officer; and Scott Kingsley, Executive Vice President and Chief Financial Officer.
Gentlemen, you may begin.
Thank you, Jamie. Good morning, everyone and thank you all for joining our Q4 and full year conference call. The fourth quarter was a busy and productive one for us with the December 4, close of the Oneida Financial acquisition previously announced in Q1. The immigration went very well adding 12 branches, $400 million of loans, $700 million of deposits and a $20 million revenue, insurance and benefits business.
This business called Oneida is a significant strategic platform for growth including revenue synergies with our existing benefits administration business. Fourth quarter results were a bit noisy with the acquisition and a tax rate adjustment, but very strong on an operating basis, particularly the performance of our commercial banking business which grew sequentially, more than 4% over Q3.
Year-over-year net operating earnings grew $0.04 to a record $2.30 per share inclusive of negative tax rate impact of $0.05 per share. So we are very pleased with our full year operating performance. Organically loans grew 4% with business lending up 6%, core deposits grew 5% and our benefit administration business had a record year with 7% revenue growth and 8% earnings growth.
We also raised our dividend from the 23rd consecutive year, Forbes recently ranked us as the 8th strongest large bank in the country and the MSR Group ranked us as the most trusted bank in the North-East and in the top four national. So in all respects it was a very productive year for Community Bank System and our shareholders.
With respect to the $10 billion thresholds we are making good progress as it relates to implementing DFAST systems and strengthening our risk management and compliance operations in order to be fully prepared to effectively hurdle this threshold at the appropriate time. We will however remain focused and are growing our earnings and dividends in a disciplined and sustainable fashions of the benefit of our shareholders and not on growth for its own sake.
We remain committed at the appropriate time and the appropriate manner to hurdle this $10 billion threshold in a fashion that optimizes the economic outcome for our shareholders. We are very well positioned for 2016 and beyond. Balance sheet growth, record capital levels, earnings momentum, asset quality, cost control and Oneida transaction will all serve as well. But we also expect to be challenged by a continuing contraction in margin, a higher expected tax rate and cost associated with DFAST and other regulatory and compliance investment. As always the burden remains on us to execute in a focused and disciplined fashion to create growing and sustainable value for our shareholders. Scott?
Thank you, Mark, and good morning, everyone. As Mark mentioned, the fourth quarter of 2015 was a very solid operating quarter for us, but certainly included some atypical items for us with the Oneida Financial acquisition clearly being the most significant. Whole year operating EPS of $2.30 per share was a new all-time high for us and was $0.04 above 2014's operating EPS of $2.26 a share, despite absorbing a $0.05 per share year-over-year negative comparison from the full year effective tax rate moving to 31.0% versus 2014’s 29.6% rate.
I'll first cover some balance sheet items. Average earning assets of $7.30 billion for the fourth quarter were 9.2% up from the fourth quarter of 2014 and 2.5% higher than the third quarter of 2015. Average loans grew 236 million year-over-year or 5.6%. Ending loans were up 488 million from the end of the third quarter of this year with approximately 400 million of that related to the Oneida acquisition and the remainder from a very productive organic in growth fourth quarter.
Organically, loans grew 2.1% on a linked quarter basis with positive growth in all portfolios. Average investment securities were 15.3% compared to the fourth quarter of 2014, principally a result of our decision to pre-invest the expected and now actual net liquidity provided by the Oneida Financial transaction. Ending deposits were up $938 million or 15.8% from the end of 2014 and included approximately $700 million from the Oneida transaction and the remainder from solid core deposit growth in 2015.
Because of the timing of the Oneida closing for modeling purposes, it will be more productive to use our ending balance sheet as the starting point for averages going into 2016. Year end loans in our business lending portfolio of 1.50 billion were $235 million were 18.6% above the end of 2014 with approximately $150 million of that increase coming from the Oneida transaction. Despite the one large charge-off previously mentioned, asset quality results in this portfolio continued to be very favorable with net charge-offs of 11 basis points of average loans for 2015 and 13 basis points of loss over the last nine quarters.
Our total consumer real-estate portfolio of $2.17 billion comprised of $1.70 billion of consumer mortgages and $404 million of home equity instruments were also up on a linked quarter basis and included approximately $185 million of loans from Oneida. We continue to retain in portfolio most of our short and mid duration mortgage production, while selling secondary eligible 30 year instruments. Asset quality results continue to be very favorable in these portfolios with total net charge-offs over the past nine quarters of just under 8 basis points of average loans.
Our consumer indirect portfolio of $936 million was up $63 million from the end of the third quarter of 2015 and included $45 million of outstanding from the Oneida transaction. A solid fourth quarter resulted in full year organic growth of 6.8%, which was an excellent finish to a year that started noticeably challenged in the first fiscal quarter. Despite solid new car sales again in 2015, used car valuations were the largest majority of our lending is concentrated continue to be generally stable.
Net charge-offs in this portfolio were 33 basis points of average loans in 2015 and have been 35 basis points of loss over the past nine quarters, a level we consider very productive. Despite the larger than typical net charge-off level we reported in the fourth quarter, which again included a $1.0 million partial net charge-off on a commercial relationship we had previously reserved for and discussed, 2015 was a continuation of the favorable overall asset quality result that is part of our credit DNA. Full year net charge-offs of 15 basis points of average loans were consistent with the level reported in 2014.
Non-performing loans comprised of both legacy and acquired loans ended the fourth quarter at $23.9 million or $0.50% of total loans. Our reserves for loan losses represent 1.05% of our legacy loans and 0.95% of total outstanding after the Oneida acquisition and based on the trailing four quarters results still represent over seven years of annualized net charge-offs.
We continue to closely monitor our oil and gas related credit exposure in the Marcellus Shale region of Northeast Pennsylvania which totaled approximately $66 million at year end, with roughly $46 million of that amount outstanding as of December 31. Our exposure is comprised of 24 specific relationships which include pipeline contractors, construction equipment and materials providers, stone and quarry enterprises, fuel and water transportation companies and hospitality-related properties. The weighted average risk rating in this small segment which is less than 1% of our total outstanding continue to be consistent with our overall commercial portfolio.
As of December 31, our investment portfolio stood at $2.85 billion and was comprised of $224 million of U.S. agency and agency-backed mortgage obligations or 8% of the total, $663 million of municipal bonds or 23% and $1.90 billion of U.S. treasuries 67% of the total. The remaining 2% was in corporate debt securities.
The portfolio contains net unrealized gains of $65 million as of yearend, although it was fairly consistent with the end of 2014, and circling somewhat higher today. Our capital levels in the fourth quarter of 2015 continued to be very strong. The Tier 1 leverage ratio stood at 10.32% at quarter end and tangible equity to net tangible assets ended June -- December at 8.59%. Tangible book value per share was $15.90 per share at yearend and includes $39.7 million of deferred tax liabilities generated from tax deductible goodwill or $0.91 per share.
Shifting to the income statement, our reported net interest margin for the fourth quarter was 3.70%, which was down 19 basis points from the fourth quarter of last year and 5 basis points higher than the third quarter of 2015. The decision to pre-invest the expected liquidity from the Oneida transaction into treasury securities during the second and third quarters in 2015 contributed to the overall decline in net interest margin that persisted into the fourth quarters in 2015, but was also a clearly additive to net interest income generation.
Consistent with historical results, the second and fourth quarter of each year include our semi-annual dividend from the federal reserve bank that were approximately $0.5 million which added 3 basis points of net interest margin to the fourth quarter results compared to the linked third quarter. We also recognized approximately $0.5 million of incremental loan interest income from certain unscheduled commercial pay-offs in the fourth quarter compared to the linked third quarter, which also added roughly 3 basis points to net interest margin results.
Proactive and disciplined management of deposit funding costs continue to have a positive effect on margin results, but has generally not been able to fully offset declining asset yields. The month of December’s net interest margin was approximately -- the month of December's net interest margin was approximately 3.62% excluding the Federal Reserve Banks dividends and the previously mentioned incremental and commercial loan income and included arriving loans and deposits for 27 calendar days.
Fourth quarter non-interest income was up 10.8% from last year’s fourth quarter and was meaningfully impacted by the Oneida acquisition. The company's employee benefits, administration and consulting businesses posted a 6.6% increase in revenues from new customer additions and additional service offerings a very solid finish to another record year performance.
Our wealth management and insurance group revenues were 57.2% above the fourth quarter of 2014 with almost all of that improvement related to the Oneida acquisition. Consistent with the Oneida’s historical results the month of December was again seasonally strong in the acquired insurance services business. Our fourth quarter revenues from deposit service fees were up from the levels reported in the fourth quarter of 2014, but all of that increase came from the Oneida acquisition as higher card-related revenues did not completely offset lower utilization of core accounts overdraft protection programs.
Mortgage banking and other banking services revenues were down $984,000 from the linked third quarter of this year which again included our annual dividend from certain pooled retail insurance programs which amounts to just over $0.01 per share.
Quarterly operating expenses of $65.0 million included $5.7 million of acquisition expenses as well as the operating activities of the Oneida acquisition for 27 calendar days including 19 payroll days for the approximately 275 employees that were added. Despite the delay in the closing of the Oneida transactions from our originally announced expectations we believe we are already very close to achieving the forecasted cost synergies we expected at announcement. The consolidation of the certain small peripheral systems and other infrastructure efficiencies will still include the first half of 2016, but we not expected to have a material impact on consolidated operating cost going forward.
Our effective tax rate in the fourth quarter of 2015 was 32.7% versus 28.8% in last year’s fourth quarter, bringing the full year rate to 31.0% versus last year's 29.6% full year effected rate. Certain legislative changes to state tax rate and structures over the past two years resulted in the majority of this result in higher rates including those related to our overall asset size. We continue to expect net interest margin challenges to persist into 2016. All of the majority of our new loan originations and of consumer lending portfolios are at yields consistent with those of the existing instruments, yields of new commercial originations remain below blended portfolio yields.
Core net interest margin excluding the impact of the previously mentioned investment decisions declined 2 to 4 basis points per quarter in 2015. Although we are not forecasting similar declines for all the 2016, we believe our core net interest margin for the month of December 2015 is a reasonable proxy for our 2016 expectations. Also as a reminder, a meaningful portions of the $0.07 of expected GAAP earnings accretion from the completed Oneida transaction was realized in the second through the fourth quarters of 2015 from securities pre-investment.
Our funding mix and comps remain at very favorable levels today from which we do not expect significant improvement. Our growth in all sources of recurring non-interest revenues has been positive. And we believe we are positioned to continue to expand in all areas.
While operating expenses will continue to be managed in a disciplined fashion, we do expect to continue to consistently invest in all of our businesses. We continue to expect Federal Reserve banks semi-annual dividends in the second and the fourth quarters each year.
Our full year 2015 net charge-off results were again favorable and although we do not see signs of asset quality headwinds on the horizon, it would be difficult to expect improvements to current asset quality results.
Tax rate management will continue to be subject to successful reinvestment of our cash flows into high quality municipal securities, which has been a challenge at times during this period of sustainable rates. In addition, as we mentioned in our third quarter call, our consolidated asset size will further eliminate certain state tax planning opportunities resulting in an estimate 1.5 to 2 percentage point increase in our full year effective tax rate in 2016. Despite some of these apparent challenges, we believe we remain very well positioned from both a capital and an operational perspective going into 2016.
I’ll now turn it back over to Jamie to open the line for questions.
[Operator Instructions] And we’ll take our first question from Alex Twerdahl with Sandler O’Neill.
A couple of questions here. First of the million dollars in net charge offs that you took this quarter related to the commercial loan. Is that the same $2.5 million credit that was oil and gas related that migrated during the third quarter?
It is one and the same Alex.
Okay. And then can you just give us a little more color. I mean, I think last quarter you said that your outstanding loans on oil and gas related was about 35 million and then you said in your prepared comments that they ramped to 46 million in this quarter just in the outstanding. Can you just maybe given example of one of those loans and why it might have gone up in the fourth quarter, just so we can get a little bit more comfortable with those credits?
Sure Alex, absolutely. I think as we have said before our total credit exposure of 66 million is a combination of working capital line of credit and some equipment lines of credit and then some fixed term mortgages which principally are related to the hospitality related credits. But as an example in the fourth quarter one of our very well established, very profitable customers threw down their working capital line almost $10 million. And it has been consistently going along with pipeline expectations that are in the marketplace is much as the drilling and the new fracing has certainly backed up as the cost of -- or the selling prices of natural gas is gone down so much, the pipeline guys are still very busy along with certain of the other contractors in the infrastructure business.
So in fairness, really happy to get a drawdown of the line from this specific customer, but in that line. So no other changes relative to the monitoring characteristics that we’ve got with that portfolio. Again it’s less than 1% of our total outstanding, weighted average risk ratings as that move to material during 2015 on any of those credits with the exception of the one who turned over on us. So other than that Alex, I think we feel pretty good, we think we’re lending money to the right folks in that area, like our base of customers on a holistic basis and we’ll just continue to have very robust monitoring.
Okay, that’s extremely helpful. And then I’m sorry if I missed this earlier, but you were talking about the loan growth in the fourth quarter and it was very strong. Is that indicative of strong pipelines going into the first quarter or was there a lot of stuff that maybe got -- that closed ahead of schedule and caused a little bit more in the fourth quarter and that we should expect a little bit of slowdown in organic loan growth in the first quarter, on commercial specifically?
Yes. Alex, I think as it relates to the Commercial Banking business that was during the fourth quarter, something that was timing related. As you recall we got off to a very difficult start to the year in 2015, I think our overall loan book was down $70 million in the first quarter. And really, really nice recovery in all our portfolios to end up the year organically up about a 165 million, half of that was in business lending, a good part of that increase actually happened in the fourth quarter, a lot of that was just timing on some long-term credits that has been in the pipeline enclosed in the fourth quarter.
But in terms of pipeline, the business lending pipeline is still very strong, we think we’re going to have a decent first quarter certainly relative to last year’s first quarter. The mortgage pipeline interesting enough is still also quite strong given the seasonality of that business certainly relative to 2015.
So we’re in pretty good shape heading into the first quarter, I would tell you that the early results for the quarter relative to next year are very favorable, which is good. So I think to answer your question a lot of the significant, I would call outperformance for us in the fourth quarter on the credit side was with the timing of a lot to the larger business banking credits that closed in Q4.
Okay thank you for all that color. That’s all my questions for right now thanks.
Our next question comes from Joe Fenech of Hovde Group.
Just fielding on one of those last questions guys, on the 46 million outstanding. I understand the reasoning and what you said that the 10 million coming from the one strong customer, but just sort of a conception question for you. What's sort of safe guards are in place just to make sure that borrowers are paying, aren’t just pulling down lines, which obviously in this environment you could arguably comment that had a tough time? In another words I guess you have the ability to shut down a lot of these guys if you see things you don’t like with respect to their specific financial situation or the environment generally, and what would be a trigger for that?
Yes, really big question Joe. And I’ll give you an example of that. We -- when we reported last in the third quarter we had said we had $71 million of credit exposure and now we’re saying we have 66 million. A $5 million portion of an operating line was actually terminated during the quarter. Some of that was based on utilization the customer, so it's not -- we’d be less than transparent if we said we shut somebody off. But I think just to management -- the relationship management of understanding where some of these people are from a cash flow standpoint in a more challenging operating environment than they’ve been used to in the last five years. I think that’s indicative of our style.
But that being said we had in the asset that we ended up partially charging off. The financial results of the borrowers were great going into the quarter where we made the loan or extended the credits. So I think it’s on the ground monitoring job more than anything else. I wouldn't say there is anything in the system that automatically triggers that we are still, quote, the slaves of updated financial information, but when we do see something that suggests a cash flow weakness or a business operating weakness, certainly we react to it from a capacity standpoint.
But are you concerned at all if that sort of maybe, Scott, a little bit of a lagging indicator like, I guess contracts are contracts right, so you can’t say $28 oil or whatever the price of natural gas is today. You can’t say we don’t like that and then kind of -- you have to kind a wait for a demonstrated issue, cash flow issue from this borrowers to sort a take action or are there other safe guards that maybe you can take to maybe get ahead on this potential issue?
Joe, so many of them are formula based on the working capital size that if revenues declined and therefore you had a borrowing base that was receivable base you would get an automatic decline in the capacity that that borrower could go to. The other thing is sort of separating this discussion for us between pipeline and infrastructure contractors and field management services enterprises. But that’s majority of what we’re doing, our infrastructure pipeline related people have being in that business for quite a while. These are not people that found an opportunity when fracing started in Northeast Pennsylvania to sort of ground up doing new business venture.
So I think you know a lot of them have other sources of cash flow that also support the overall credit relationship. And again as much as energy prices across the gamut [ph] are certainly unbelievably challenged rate now, remember that the Marcellus shale activity in Northeast Pennsylvania wasn’t completely build out, this isn’t West Texas or the Dakota. So you aren’t running at 105% of capacity and to shut it back to 30, this was still a building process, one could argue you’re only five to seven years into the exploration side of Marcellus.
So the available capacity was not at very high level relative to field services folks and equipment providers in that market, anyway it was actually still growing.
And any kind of stress test assumptions you could give us Scott in terms of like oil is at sub-30 six months from now or a year from now. Have you guys any expectation of credit migration of that book under certain set of assumptions as we move through '16?
I think that would be difficult to stress test. As you look at the price of natural gas in Marcellus right now I think it’s like $12. It's already close to zero. I think what we do is we have a formalized structure for evaluating the financial performance of all these credits on a quarterly basis with the credit administration team and the lending team and we react to the outcome of that. I think we’re only talking in about two dozen credits in total and so it's not as -- I don’t think it a big of a challenge in terms of management administration. I mean clearly there are -- certainly it could be other operators that we have relationship with in that area that could be challenged. But we’re doing everything and all that we can to monitor that on a continual basis and we react very quickly.
And then any sort of on the commercial real-estate side that may touch the shale activity, I know you talked about the hospitality credits, but is any of that just anecdotally the vibrancy of these towns and cities have kind of had as a result of the shale boom? Is that dissipating at all as of yet and if that does happen, where would you expect to see it and how do you think about quantifying what sort of ancillary exposure it could be?
That's a good question. I mean I would tell you anecdotally and even from the perspective of on the ground in that region, there are a couple of things that have happened -- that the drilling is down. The other thing that’s down is some of the gas companies that own the mineral rights in that region are letting leases expire -- land leases expire. So generally there is less activity on the ground in that region because of the collapse and the price of gas and particularly the collapse of the price in the Marcellus shale region relative to gas more broadly.
So if there has been deterioration of activity, no question and we'll see what the future brings. As Scott mentioned, the -- part of the problem in the Marcellus area is there isn’t enough infrastructure yet in terms of pipeline, which is I think over half of our outstanding exposure is to the pipeline companies most of which have extremely strong balance sheets and financial capacity, so we're happy about that. But so the pipeline side continues and we expect will continue into the future. I mean there's more gas than there is infrastructure right now and that needs to get built out, that will happen over the next couple of years, there will be a lot more pipeline capacity.
So I mean I think we're reasonably well positioned, as I said we monitor very closely. We did have one tip over. It's not impossible if there's others into the future, but we as I said keep very tight -- we have very tight control over the monitoring of that exposure and we don’t expect that at this juncture there'll be any material impacts because of our exposure in that industry.
We'll take our next question from Collyn Gilbert with KBW.
Scott just of the net interest income that you guys posted this quarter, how much of that was from accretable yield tied to Oneida? And then maybe what your outlook is for that going forward?
That actually Collyn that very little of that is from accretable yield from Oneida, one deal was only a month’s worth of activity and two, increasing outcome with the Oneida purchase accounting, the accretive -- the interest rate mark was actually larger than the credit market. So that will not be something that moves the needle for us going forward. When I mentioned incremental loan income in the fourth quarter that actually related to some pay offs of loans that were part of the Wilber transaction, so a little bit of accretable yield there and then it’s really the collection of the loan fees for early terminations of obligations. Do somebody can refinance somewhere outside of our bank and was willing to pay re-payment penalty.
And then I know you touched on this, just on the mortgage banking line, what was the amount of dollars that were tied to the insurance pool this quarter?
On that line for this quarter, it's a very minuscule amount Collyn. What happens is typically the pool does a dividend once a year to its participants based on the production level of activity and so we picked up about $750,000 in the third quarter.
There is an ongoing revenue stream attached to that, but it's probably under a $100,000 a quarter outside of the third quarter.
And just a general outlook for -- I know you had indicated that the mortgage pipeline was strong, but just maybe just a general outlook having Oneida come over on where you think that business line can go? [Multiple speakers] the core mortgage banking.
The mortgage banking?
We’ve always had a very strong mortgage banking business. We think that will continue to grow. We bring over a number of accounts that it qualify as originators with the Oneida transaction and they've already hit the ground running. We fully implemented all the TRID regulations on time including some of the systems adjustments that I know a lot of banks have had trouble with because of the systems providers weren’t able to revive the systems on time.
So we're pretty good, we're in really good shape in terms of TRID in the regulations. The unfortunate impact has been to extend the commitment timeline, the closing for the mortgage business and I think that's an industry wide challenge right now and it takes longer to close a mortgage, so the pipeline grows and it creates difficulty and frustration and all those kinds of things.
I mean I would just say more broadly, we'll continue to see growth in our mortgage business, I think that's certainly true. The originating yields right now in the mortgage business are about almost exactly what the all in portfolio yield is, so I don’t think we're going to see absent material changes in the rate environment, we’re not going to see further compression in the -- we don’t expect to see further compression in yields.
But the costs of that business are higher in terms of regulation, in terms of training, the complexity of the products, the compliance needs, certification registration of your mortgage originators. So it's gotten to be a more difficult business to make money and in terms of its returns, but in our markets, that's a core product in our markets, mortgage and home equity loans, we’ll continue to pursue that business. I think that business will continue to grow for us and we’re going to have to work to optimize the returns of that business given the new operating environment.
Okay, that's great color. Thank you for that. And then just to go back to the oil and gas and I apologize if it feels like you guys are beating a dead horse on it, but I think you are a good resource for all of us that are not operating in the Texas market. So just to understand a little bit better the $10 million draw down that you saw in the quarter from one year borrowers, what was the intend use for those dollars? I'm just curious.
It’s fairly common [ph], just to support the existing balance sheet from a working capital standpoint and I will say this and I don’t know this specifically to the dollars the extent of this one, but what you will find a lot of times is that generally contractors at the end of the year will try to improve the balance sheet that they’re presenting to bonding companies for the next year. So a drawdown of the working capital line creates some working capital for them from a balance sheet perspective and that's always deemed to be a net positive relative to most of the bonding services.
I don’t think that was all of the drawdown here, but it seems relatively consistent with activity we have had from that borrower in other fiscal yearend and some of years we hold on to that level of line utilization into mid-year of the following year and other years not so much, but we didn’t see anything inconsistent with the behavioral patterns of anybody's working capital or equipment lines in the Marcellus shale around the southern tier border of New York state, this quarter end versus what we got in previous quarter end.
And that particular customers is one of that's not the strongest of the two dozen I mentioned in terms of their financial capacity and their equity and the collateral strength of the credit. So we are not concerned of what's the number about that particular customer.
Got it. Okay, that's really helpful. And then just one final thing on this and then we’re hopefully done. So the million dollar charge off you took this quarter you had -- the full outstanding was what again? And kind of walk through the process in the third quarter, I think you said 2.5 million you would put aside or just -- if you could just run through those numbers just to understand [Multiple Speakers].
I’ll take a shot to bring granularity on this one. If it helps, the total of credit was just over 2.5 million we had reserve roughly $600,000 or $700,000 at the end of the third quarter when was very early in the stages of where this was going from a remediation standpoint. With this particular customer we got a little better and understanding where we were from a collateral position and what the suggested operating outcome of this operator is going to be over the next six to 12 months, reorganization plan and so we decided which is again very consistent with our decisions, we call a spade a spade. We think that there is reason to believe that we should actually process a charge off as opposed to leave a larger reserves on the books for the end of the fourth quarter, so hope that helps a little.
Yes. It's great. Okay that's all I had. Thanks gentlemen.
Will take our next question from Matthew Breese with Piper Jaffray.
Just thinking about credit quality and some of the detail on the Marcellus, how should we be thinking about the provision and your expectations for the provision in 2016 and is the last two quarters indicative of what we might see as a run rate?
A lot of moving pieces on that one Matt. Do we have an expectation that we had the need for provision for something that's north of $1 million dollars, definitely not in our forecasting on a single credit basis. What I would look at from us Matt, as a proxy would be -- we start with the process that says if all their asset quality metrics are remaining consistent we think about providing a provision for net charge offs and incremental loan growth.
So that's kind of been our contingent behind it and then obviously you will qualitatively adjust some of those things based on what we're seeing in terms of the credit trend. Understanding that we've been a fairly consistent conservative provider of allowance overtime, none of that has really changed I look at this as, Matt, more than thing to say we acknowledge our first quarter and second quarter net charge offs and therefore the resulting provisions in 2015 were exceptionally low. We would have loved to, as I said we continue that into infinity, but that was highly unlikely. We kind of blend it across the fourth quarter basis and say 15 basis points of net charge offs, the balance sheet grew to Mark’s point 4% organically is our provision in line with those types of dynamics. So that’s what you should expect from us on a going forward basis.
Yes. If you look at the last two quarters, the average charge offs have been about what 25 basis points between last two quarters, to your question and Scott’s point, I think we would expect something less than that, 15 is kind of historical if you look at the last couple of years. We don’t necessarily see any changes to asset quality trends beyond that. So I would say that the third and fourth quarters were somewhat atypical and we certainly hope not a reflection of a run rate out into the future, but we expect 15 basis points, that’s what we task ourselves on its 15.
No, it’s good color. I appreciate that. And then touching on expenses. First, what are the remaining one-time merger-related costs tied to the Oneida transaction and then given Oneida was only integrated for part of the quarter, what would you expect for overall expenses for quarter headed into 2016?
That’s a good question. We think we got almost everything on the one timers, we think they’re still maybe a handful of cost associated with conversion of peripheral systems that wouldn’t represent a capital expenditure upon that conversion, that might need some small ones. But what we think, we picked up all of the conversion related technical costs, we think we’ve picked up all of the contract termination costs, we think we’ve picked up all of the things associated with severance of people.
So we think we’re pretty all in composing on that, would not expect a lot more there. Your color relative to the fourth quarter expense run rate and trying to put some parameters around that. It’s actually we have a month’s worth of activity in Oneida, both on the revenue and the expense side. That change in operating expenses, if you just look at our third quarter versus the fourth quarter, you get roughly a $3.7 million increase.
Now some of that was going to be related to the core growth of our own businesses, but the lion’s share of that should be associated with the acquisition on a run rate basis. So as you sort of put in a quarterly results behind $3.7 million of monthly expenses, length was something between $11 million and $11.5 million of quarterly expectations of expense growth. I expect that we’re going to do roughly a 3% across the Board merit increase, so the salaries and wages line of our P&L probably should have trends based outcomes of 3% attached to it. Historically, we’ve done a little better than that on the all other lines, we have not trended at 3%, we’ve probably trended at half of that.
So I think for modeling standpoint those would kind of be the parameters I would use and essentially all the parameters we’re using to monitor our success out of the gate. I would just throw a little bit of caution out there for those who love to model, we’re at a little more expensive date in the first quarter and yes winter did show up, I know people there is a lot of people on the call expecting two feet of snow somewhere in the country in this week, we already got it this week.
So, but from a practical standpoint remember that we’ve got a couple of cents a share of seasonality attached to our operating expense run rate. So I won’t be surprised if our first quarter looks little bit higher than what I just describe.
Got it, okay. And then on the margin hoping for something stable at 3.62% for the whole year. Now does that includes the FRB dividends or is that exclusive of that?
It would not have that. So I think if you kind of put that back in, it’s pretty fair to put another million dollars’ worth of FRB dividend back into the -- that composite outcome, that would be a fair assessment, Matt. You get that in the second and the fourth quarter. And again I think for us that’s, we ended the year with roughly $300 million of short-term credit instruments, essentially overnight borrowing as a whole loan banking. If we’re a little bit more successful than maybe our track record run rate have been we could actually generating of deposit funding to limit the risk of the upside against those variable rate instruments and find ourselves with an opportunity to actually not have some projected increase in funding costs, just because we have an instrument out there is a slowed.
I think we said before whether the Fed going to move up rates, 25 basis points a quarter or whether it’s certainly the market I think it seems to be expecting maybe 2 to 3 instead of 4. With that I think we’ve said at 25 basis points, that one that’s already happened, we didn’t touch deposit rate. The next 25 not expecting the touch deposit rate. The third 25 we hold open to after review and see where we are.
We enjoy a 70% loan-to-deposit ratio right now, so you wouldn’t think we have to sprint to the front of that line, there is some other geographies not that far from us where people have 105% or 110% loan-to-deposit ratio, I think they’re probably going to have to react a little quicker than we will.
So kind of brings those types of concept together Matt, I think we think that where we are today is tough to improve on, but at the same point in time we think we probably we’ll hold our own to it.
Okay and then my last one, with Oneida closed can you give us an updated sense for your appetite on future M&A? And how you’re thinking about approaching and crossing the $10 billion threshold with M&A in mind?
Sure, I think as you know our history, we operate in slow or lower growth market and to create the kind of double digit returns that we have over the last 10 or 15 maybe even 20 years. We need to argument our limited organic growth with high value acquisition opportunities. So we will continue to focus on that strategy. I don’t think anything has changed there, I think Oneida was a really good example of a high value in-market acquisitions strategy that had a really strong platform for future growth above and beyond. The market rates of growth in our banking business. So we’ll continue to look for those high value opportunities, they need to make sense for our shareholders. As I said we’re not going to grow just for the sake of getting bigger. If it makes sense for our shareholders then it can create growing and sustainable earnings and dividend capacity, than we’re interested.
As it relates to the $10 billion threshold, I think as many have observed just stepping over it will be painful for our shareholders and so we don’t plan to just step over it, we are going to need to do something in terms of an optimal outcome for our shareholders would be a, let's call it $2 billion to $3 billion size acquisition that has the capacity to offset the cost and revenue impacts of exceeding the $10 billion threshold. So we -- that’s where we expect to go and in our market and in contiguous markets there is only so many of those opportunities, we know exactly what they are and where they and who they are. And we’ll continue to work towards that eventual outcome. As I’ve said previously we’re not in a hurry, we don’t need to run past 10 billon, it needs to happen in its own time, again in a way that is really about shareholder values. So if it happens tomorrow that will be great, if it happens in two years that will be great.
In the meantime, as I said we’re making really good progress on DFAST, we are making good progress on enhancing and strengthen some our risk management and compliance related systems so that we are fully in a position at that juncture to become a bank that has over $10 billion in assets in terms of what the regulatory expectations are, but just as importantly our shareholder expectations. So that’s I guess a broad outline of our thinking at this juncture.
Very helpful I appreciate the color. Thank you guys.
[Operator instruction]. And at this time there are no further questions over the phone.
Excellent, well thank you all, appreciate your participation and look forward to the first quarter call. Thank you.
Thank you for your participation. This does conclude today's call.
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