Community Bank System Inc

NYSE:CBU

Earnings Call Transcript 2021-Q2

[Operator]

Good day, and welcome to the Community Bank System Second Quarter 2021 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 Joseph Sutaris, Executive Vice President and Chief Financial Officer. They will also be joined by Joseph Serbun, Executive Vice President and Chief Banking Officer, for the question-and-answer session. Gentlemen, you may begin.

[Mark Tryniski, President & CEO]

Thank you, Cole. Good morning, everyone, and thank you all for joining our second quarter conference call. Hope you're all well. I'll start with a brief comment on earnings, and Joe will provide more detail. The quarter was above, as we expected, with the reported earnings strength driven by reserve release. Beyond that, the margin continues to be a headwind for credit overall, deposit fees and strength in our financial services businesses, are tailwinds.

From a business line perspective, commercial was flat ex-PPPs and muni loans, but the pipeline is growing back post-COVID quicker than we expected. That's good news. The mortgage business is strong, with the biggest pipeline we've ever had. The payoffs are elevated also. So, the book is growing more slowly than it might otherwise. The indirect lending business had a great Q2, with outstandings up 8% over Q1. Deposit service fees continue to rebound from the pandemic impact and were up 18% from a depressed Q2 in 2020. And like the entire industry, deposits are up.

Our financial services businesses were the star performers of the quarter, with combined revenues up 14%, and pre-tax earnings up 25% over 2020. We were also pleased to have announced earlier this month, the acquisition of Fringe Benefits Design of Minnesota, a provider of retirement plan administration and consulting services, with offices in Minneapolis and South Dakota. The benefit space is very active right now in terms of opportunities, and we expect more to come.

The benefits of a diversified revenue model have never been so apparent. As we announced last week, our board has approved $0.01 per quarter increase in our dividend, which marks the 29th consecutive year of dividend increases, and we think a validation of our disciplined and diversified business model. As we announced in March, we have appointed Dimitar Karaivanov as our Executive Vice President for Financial Services and Corporate Development, and be began in this role in June. He joined us from Lazard, where he was a Managing Director in the Financial Institutions Group, and has over a dozen years of experience in investment banking, serving clients in the banking, benefits, and Fintech space. I've known and worked with Dimitar for nearly his entire career, and thrilled to have him on board, supporting our growth initiatives.

Looking ahead, we will be doing our best to manage the changing winds. We have the headwind and margin pressure, but growth, credit, the momentum of our financial services businesses, and liquidity deployments, are all tailwinds. Joe?

[Joseph Sutaris, EVP & CFO]

Thank you, Mark, and good morning, everyone. As Mark noted, the second quarter earnings results were solid, with fully diluted GAAP and operating earnings per share of $0.88. The GAAP earnings results were $0.22 per share, or 33.3% higher than the second quarter of 2020 GAAP earnings results, and $0.12 per share, or 15.8% better on an operating basis.

The improvement in earnings per share was led by lower credit related costs and a significant increase in non-interest revenues, particularly in the company's non-banking businesses. Comparatively, the company reported GAAP earnings and operating earnings per share of $0.97 in linked first quarter of 2021.

The company reported total revenues of $151.6 million in the second quarter of 2021, a $6.7 million or 4.6% increase over the prior year second quarter revenues of $144.9 million. The increase in total revenues between the periods was driven by a $5.3 million, or 13.7% increase in financial services business revenues, and a $1.2 million or 8.6% increase in banking related non-interest revenues.

Net interest income of $92.1 million, was up $0.2 million or 0.2% over the second quarter of 2020 results. Total revenues were down $0.9 million or 0.6% from the linked quarter first quarter, driven by a $1.9 million decrease in net interest income, offset in part by higher non-interest revenues. Although net interest income was up slightly over the same quarter last year, the results were achieved on a lower net interest margin outcome.

The company's tax equivalent net interest margin for the second quarter of 2021 was 2.79%. This compares to 3.03% in the first quarter of 2021, and 3.37% one year prior. Net interest margin results continue to be negatively impacted by the low interest rate environment and the abundance of low yield cash equivalents being maintained on the company's balance sheet.

The tax equivalent yield on earning assets was 2.89% in the second quarter of 2021, as compared to 3.15% in the linked first quarter, and 3.56% one year prior. During the second quarter, the company recognized $3.9 million of PPP-related interest income, including $2.9 million of net deferred loan fees. This comprised of $6.9 million of PPP-related interest income recognized in the first quarter, including $5.9 million of net deferred loan fees. The company's total cost of deposits remained low, averaging 10 basis points during the second quarter of 2021.

Employee benefit services revenues were up $3.4 million or 14.2% over the prior year second quarter, driven by increases in employee benefit trust and custodial fees. Wealth management revenues were also up $1.9 million or 29.2%, driven by a higher investment in management advisory trust services revenues. Insurance services revenues were consistent with the prior year's results. The increase in banking related non-interest revenues was driven by a $2.3 million or 17.6% increase in deposit service and other banking fees, offset in part by a $1 million decrease in mortgage banking income.

During the second quarter of 2021, the company reported a net benefit in the provision for credit losses of $4.3 million. This compares to a $9.8 million provision for credit losses reported in the second quarter of 2020, $3.2 million of which was due to the acquisition of Steuben Trust Corporation, with the remaining $6.6 million largely driven by pandemic-related factors.

During the second quarter of 2021, the company recorded three basis points of net loan recoveries, and the post-vaccine economic outlook remained positive. In addition, at the end of the second quarter, there were only 12 borrowers representing $2.4 million in loans outstanding that remained in the pandemic-related forbearance. This compares to 47 borrowers of pandemic-related forbearance, representing $75.6 million at the end of the first quarter, and 3,700 borrowers, with approximately $700 million of loans standing one year earlier. These factors drove down the expected loan losses, resulting in the recording of a net benefit and provision of credit losses for the quarter.

The company recorded $93.5 million in total operating expenses in the second quarter of 2021, as compared to $87.5 million in the second quarter of 2020, excluding $3.4 million of acquisition-related expenses. The $6 million, or 6.9% increase in operating expenses, was attributable to a $3.2 million or 5.8% increase in salaries and employee benefits, a $1.9 million or 17.8% increase in data processing and communications expense, and $0.7 million or 7% increase in other expenses, and a $0.5 million or 5.3% increase in occupancy and equipment expense, offset in part by a $0.3 million or 7.9% decrease in the amortization of intangible assets.

The increase in salaries and employee benefits expense, was driven by increases in merit-related employee wages, higher payroll taxes, including increases in State-related unemployment taxes, higher employee benefit-related expenses, and the Steuben acquisition. Other expenses were up due to the general increase in the level of business activities, including increases in business development and marketing expenses. The increase in data processing and communications expenses was due to the second quarter of 2020 Steuben acquisition, and accompanies implementation of new customer-facing digital technologies and back office systems between comparable periods. The increase in occupancy and equipment expenses was driven by the Steuben acquisition. In comparison, the company reported $93.2 million of total operating expenses in the first quarter of 2021, 0 $0.3 million, or 0.3% lower than the second quarter of 2021 total operating expenses.

The effective tax rate for the second quarter of 2021 was 23.1%, up from 20.3% in the second quarter of 2020. The increase in the effective tax rate was primarily attributable to an increase in certain State income tax rates that were enacted in the second quarter of 2021.

The company closed the second quarter of 2021 with total assets of $14.8 billion. This was up $181.1 million or 1.2% from the end of the linked first quarter, and up $1.36 billion or 10.1% from the year earlier. Average interest earning assets for the second quarter of 2021 of $13.37 billion, were up $680.6 million or 5.4% from the linked first quarter of 2021, and up $2.27 billion or 20.4% from one year prior. The very large increases in total assets and average interest earning assets over the prior 12 months, was driven by the second quarter of 2020 acquisition of Steuben, and large inflows of government stimulus related to deposit funding PPP originations.

The company’s ending loan balances of $7.24 billion, were down $124.2 million or 1.7% from the end of the first quarter. Excluding the net decrease in PPP loans of $126.1 million, and the seasonal decrease in municipal loans totaling $41.2 million, pending loans increased $43.1 million or 0.6%.

As of June 30, 2021, the company's business lending portfolio included 317 first draw PPP loans, with a total balance of $72.5 million, and 2,254 second drop PPP loans with total amount of $212.3 million. The company expects to recognize through interest income, the majority of its rate remaining first draw net deferred PPP fees, totaling $0.9 million during the third quarter of 2021. And the majority of its second draw net deferred PPPs totaling $9.2 million over the next few quarters.

On a linked quarter basis, the average book value of the investment securities portfolio, increased $290.2 million or 7.9% from $3.67 billion during the first quarter, to $3.96 billion during the second quarter. With this said, the company has largely remained on the sidelines with respect to deploying excess liquidity until the market interest rates become more attractive. During the second quarter, the company's average cash balance of $2.07 billion, represented approximately 16% of the company's average earning assets. This compares to $1.67 billion in average cash equivalents during the first quarter of 2021, and $823 million in the second quarter of 2020. The $408 million or 24.5% increase in average cash equivalents during the quarter, was driven by the continued inflow of federal stimulus funds and origination second draw PPP loans, and first draw PPP loan forgiveness.

The company’s capital reserves remained strong in the second quarter. The company's net tangible equity and net tangible assets ratios was 9.02% at June 30, 2021. This was down from 10.08% a year earlier, but up 8.48% at the end of the first quarter. The company’s tier one leverage ratio was 9.36% at June 30, 2021, which is nearly two times the well-capitalized regulatory standard of 5%.

The company has an abundance of liquidity. The combination of the company’s cash and cash equivalents, borrowing availability at the Federal Reserve Bank, borrowing capacity at the Federal Home Loan Bank, and unpledged available for sale investment securities portfolio, provided the company with over $6.1 billion of immediately available sources of liquidity.

At June 30, 2021, the company's allowance for credit losses totaled $51.8 million or 0.71% of total loans outstanding. This compares to $55.1 million or 0.75% of total loans outstanding at the end of the first quarter of 2021, and $64.4 million or 0.86% of total loans outstanding at June 30, 2020. The decrease in the allowance for credit losses is reflective in improving economic outlook, the very low levels of net charge-offs, and a decrease in delinquent loans and loans on pandemic-related forbearance.

Non-performing loans decreased in the second quarter to $70.2 million or 0.97% of loans outstanding, down from $75.5 million or 1.02% of loans outstanding at the end of the linked first quarter of 2021, but up from $26.8 million or 0.36% of loans outstanding at the end of the second quarter of 2020, due primarily to the reclassification of certain hotel loans under extended forbearance from accrual to non-accrual status between periods. The specifically identified reserves held against the company’s non-performing loans, totaled only $2.8 million at June 30, 2021.

Loans 30 to 89 days delinquent, totaled 0.25% of loans outstanding at June 30, 2021. This compares to 0.37% one year prior, and 0.27% at the end of the linked first quarter. Management believes the low levels of delinquent loans and charge-offs, has been supported by the extraordinary federal and State government financial assistance provided to consumers throughout the pandemic.

We remain focused on new loan origination, and we'll continue to monitor market conditions to seek the right opportunities to deploy excess liquidity. Our pipeline - loan pipelines increased considerably during the second quarter, and asset quality remains very strong. We also expect net interest margin pressures to persist or remain well below our pre-pandemic levels, but also believe our abundance of cash equivalents represent a significant future earnings opportunity.

We're also fortunate and pleased to have a strong non-banking business that supported and diversified our streams of non-interest revenue. And lastly, to echo Mark's comments, we're pleased and excited to welcome the customers and employees of FBD to the Community Bank team. Thank you all, and I'll turn it back to Cole for questions.

[Operator]

[Operator Instructions] And our first question today will come from Alex Twerdahl with Piper Sandler. Please go ahead.

[Alex Twerdahl, Piper Sandler]

Hey, good morning, guys. First off, I just want to ask about, as I kind of look at 2022 over 2021, a couple of things like the reserve releases, PPP, some of those things, obviously aren't going to be repeatable in 2022, setting up the possibility of earnings going lower. And I was wondering if that has any impact on how you think about M&A. I know when you guys crossed the $10 billion mark, there was a little bit more of an emphasis to kind of cover the Durbin by doing a slightly larger transaction. And I'm wondering if your outlook on M&A has changed at all, just kind of as you look forward into what earnings may bring next year.

[Mark Tryniski, President & CEO]

No, I think it's a fair question. There were some things this year that clearly are non-recurring and we're going to have to refill the bucket. I think organic growth is going to have to improve. We need to continue the momentum of our financial services businesses deposit fees, continue to rebuild. Joe mentioned the liquidity abundance. So, I think we have some levers to pull in terms of continued momentum relative to earnings, and offsetting some of the non-recurring revenues over the course of the last year. And that's our job, is to grow earnings every year.

It doesn't really change our outlook as it relates to M&A. I mean, I think the M&A is more of a longer term continual strategy to try to create above-average shareholder returns, with below-average risk. And that's really - so we’re not going to forecast the - if we forecasted lower core operating earnings, I don't think a strategy to address that is going to be, try to find something for that purpose. I think we look at M&A more strategically. What’s the fit? What does it contribute into the future? How does it create sustainable and growing shareholder value? So, I would say it doesn't really change at all our outlook on M&A, which is more of a strategic exercise, not really a tactical exercise.

I think with Durbin or with the $10 billion, yes, Durbin, I guess, that was a little bit different. That was a, what Joe, $10 million hit, $12 million hit. There's no operational mechanism to absorb a $10 million or $12 million hit. So, that was a little bit different. But with that said, I think at the time, our articulation to shareholders was, we expect to cross the $10 billion without reducing earnings, and that's our job as management.

So, the only realistic way to do that is through good M&A opportunities. And we were fortunate, let's call it, to be able to, in that timeframe, acquire two really strong franchises and merchants in Vermont and NRS, the management business in Boston, which continues to perform at an extremely high level with respect to growth in revenues and growth in margin. But ordinary of course, M&A is more strategic and less tactical. So, it doesn’t really change our philosophy and how we think about M&A.

[Alex Twerdahl, Piper Sandler]

Okay. And then just kind of on the same - along the same topic, you alluded to some opportunities in the benefits space in your prepared remarks. Are those going to continue to follow the same sort of similar transactions to what we've seen with the most recent one, kind of be sort of relatively bite-sized and over time improve that business, but not be necessarily huge needle movers in the near-term?

[Mark Tryniski, President & CEO]

I think that’s the expectation right now. But with that said, if we had the opportunity to do another larger transaction like the NRS transaction that we did in Boston four years ago, we would definitely do it. So, I mean, I think for the most part - I mean, I think what's driving a lot of these non-banking opportunities right now is just the concern over the cap gains rate. And some of these businesses were started 20 years ago with a dollar, and now they’ve over $20 million or $30 million or more, and it's all cap gain. And if I sell now, I can pay 20%. If I sell sometime in the future, I pay 40%. And so, I mean, I think it's as simple as that in terms of what's driving a lot of the activity right now.

So, and we're also getting a little bit bigger. Our benefits business right now, the run rate is over $110 million in revenues. And the profit margin, the operating margin has actually grown over the last couple of years nicely. So, it's a great business for us, and we've got a fair bit of critical mass in that business. There's a couple of businesses. We are one of the lead players in the US in those spaces, and they continue to have opportunities for us to partner with much larger financial institutions on kind of the institutional trust side, and in some other areas. So, that - we've got a lot of momentum in that business, and we're going to continue to invest in it, whether it's organic, which we've done, some startup business. We started off the Biba business a few years ago with zero revenues. Now, I don’t know, it’s probably about 4, pushing 5 million. Good margin.

So, we'll continue to invest organically in terms of starting up either product lines or other organic startups, and also look at what we think are high value acquisition opportunities. There's a lot of businesses in that space that we wouldn't be interested in for different reasons. We like to acquire - acquiring revenues is great, but we also like to acquire a product line, technology, or consulting resources. And so, if we find a transaction that has some of those value drivers for us, they're much more attractive than just bolting on some revenues, which can also be - I mean, I'm not suggesting we wouldn't do more tactical acquisitions, but we also like really strong consulting form, or product line knowledge consulting, technical sale, sales talent, which is what we got with FBD sales and consulting talent.

So, it's not just a revenue stream, but it's active right now in that space, and doing - it’s been very busy, and we'll continue to hopefully be busy in that space for a while. But the operating momentum in that business is really tremendous right now, not just organically, but in terms of our opportunity to partner with much larger financial institutions and clients. I mean, we have a number of Fortune 500 clients in our benefits business that we do institutional trust work for. So, we'll continue to invest in that business. And right now, the M&A opportunities are pretty good.

[Alex Twerdahl, Piper Sandler]

Awesome. And then just a final question for me. The strong consumer indirect growth you had this quarter, was that reflective of any sort of change in how you guys are thinking about that portfolio, or any pricing changes or anything that we should be aware of for the - as we kind of think how that portfolio could evolve over the next couple of quarters?

[Mark Tryniski, President & CEO]

No, I don't think so. The pricing is really kind of you're at the mercy of the market. I mean, the market goes up, the market goes down. We’ve been in that space for a long time. We don't get in and get out, get in, get out. A lot of players have gotten out, most all of it, which has been a little bit helpful. Our business is - the biggest component is used auto, which right now is very good. There's not much new inventory, less valuable to finance new vehicles than it is used in any event. So, it's just been a really - the last quarter was really good.

It also kind of gets hot and cold pretty quickly. So, next quarter might even be better and could also be worse. It's just - it's more, I could call it, volatile. It's less predictable in some ways. I mean, we've never had to really deal with inventory before as an issue in that business, but now we're dealing with it. And as I said, I think it's in, some respects, working to our advantage because the used car market is pretty good and pretty active, and it's the biggest component of what we finance in that business.

[Alex Twerdahl, Piper Sandler]

Awesome. Thanks for taking my questions.

[Operator]

And our next question will come from Erik Zwick with Boenning & Scattergood. Please go ahead.

[Erik Zwick, Boenning & Scattergood]

Good morning, guys. You mentioned a couple of times in the prepared remarks that the pipelines, the loan pipelines had increased significantly during the quarter, and you're acutely focused on new loan origination going forward. If we back out the expectation that the PPP loans continue to run off if they're forgiven, just curious if you could frame maybe what the opportunity is for net growth in the remaining portfolios in the back half of the year and into next year

[Mark Tryniski, President & CEO]

Joe, you want to take that one?

[Joseph Serbun, EVP & CBO]

Eric, Joe Serbun. How are you this morning?

[Erik Zwick, Boenning & Scattergood]

Hey, Joe.

[Joseph Serbun, EVP & CBO]

Yes. Let me give you a little bit of an insight into the pipeline activity first. Commercial pipeline, we're in the rebuilding stage, if you will. And the pipeline from June of ‘19, June of 2019, to June of 2021, is up about 35%. And if you look at it from June of 2020 to 2021, it's about 3.5%. I'll come back to that in a minute. You have to look at the first half of 2021 to understand what's going on in that business. So, the first half of 2021, there was an 85% increase from the average of Q1 to the average of Q2. So, the pipeline has grown significantly in the commercial business in the months of May and June, and hopefully that will continue on for us. And like I said, since 2019, it's about 35%.

On the residential mortgage side, Mark had mentioned earlier, maybe it was Joe, that the high point of our pipeline, which we are, and as long as I’ve been here, we've never seen a pipeline that large, both in dollars, but also in applications. So, in dollars, we're up about 50%. If you look at it June of ’19 to June of ‘21, we're up about 50%. If you look at just June of ‘20 to ‘21, we’re up 36% in dollars, and we’re up 35% in application. So, it seems as though it's going in the right direction, I would anticipate maybe another net $20 million in the indirect portfolio, maybe another $40 million in the residential portfolio as we come to close out the year. But like Mark said, particularly in the indirect portfolio, that's hot and cold.

So it could be a bigger number or a lesser number. But nonetheless, I think we're positioned nicely, given the pipeline, given the application volume. We’ll see growth and continue to grow up in both of those portfolios. The commercial, as you know, takes a little longer, but I think it's positioned nicely with the size pipeline, as well as the committed not-funded, right, loans already approved. That piece of the pie has increased by about 9% quarter-over-quarter. So, I think we're poised for continued improvement.

[Erik Zwick, Boenning & Scattergood]

Thanks, Joe. I appreciate that color there. And then switching gears to the reserve and the outlook for provisioning going forward, it looks like the reserve now is back where it was at the end of 2019, before the - pretty much kind of released all the build that you had from last year. Is it safe to assume then that the provisioning going forward, will reflect kind of net charge-offs and then growth in the loan portfolio? Are there other items to kind of consider at this point?

[Joseph Sutaris, EVP & CFO]

Eric, this is Joe Sutaris. Based on kind of where we've been and where we are today, I think that's a reasonable expectation. I think that the credit markets obviously when we went for COVID, were in turmoil and we provisioned accordingly. We think we're kind of on the back end of that. I mean, I suppose there could be another surge. I know we're concerned about that. But right now, I think we came out of the pandemic in very good shape from a credit perspective.

So, growth of the portfolio and sort of charge-offs, will likely drive some of the provisioning on a going-forward basis. The economic outlook, we only anticipate having the same level of volatility that we had certainly going through the pandemic. So, that component of the reserve calculation, we anticipate at least as of right now, to sort of stabilize. So, yes, I think that provisioning of the volatility and provisioning should settle down as we look ahead.

[Erik Zwick, Boenning & Scattergood]

Got it. And then thinking about the tax rate, I think it was mentioned in the press release and your comments that there were some changes at the State level, which led to the increase here in 2Q. Was any of that increase in 2Q a catch-up, or is that 23% rate a decent run rate going forward?

[Mark Tryniski, President & CEO]

Yes. So there was a bit of a catch up because you heard it was retroactive for the full year. So, the run rate, in around 22 plus or minus, is reasonable, excluding any sort of employer-related stock option exercise and the benefits related to that. So, full run rate, probably in around 22% on the effective tax rate.

[Erik Zwick, Boenning & Scattergood]

Great. Thank you for taking my questions today.

[Operator]

And our next question will come from Russell Gunther with D.A. Davidson. Please go ahead.

[Russell Gunther, D.A. Davidson]

Hey, good morning guys. Would you guys, Joe perhaps would be able to give some color on the P&L impact of the more recently announced employee-benefit deal from a fee and expense perspective over the next couple quarters. And then kind of sticking with that theme, bigger picture, how the fee and expense outlook for the back half of the year is shaping up.

[Joseph Sutaris, EVP & CFO]

Yes. So, it was a very - Russell, it was a small transaction for us. We paid less than $20 million for the company. We expect the revenue run rate of that business to be less than $10 million on a going forward basis. So, the overall impact of the business will be very marginal. I think as Mark was alluding to, we picked up some strategic benefit of that acquisition. It’s a B-chat in the Midwest with direct sales force, just additive overall to our 401(k) practice within the employee benefit space. But a pretty small acquisition for us, but I think strategically important. I think we believe there'll be additional opportunities kind of similar type transactions down the road. And we're hopeful that that would bring some of those to the table going forward.

[Russell Gunther, D.A. Davidson]

Thanks, Joe. And then you guys had said previously, the real focus on low single digit expenses for the year, and there's been really good discipline here. You're certainly on track for that. As you look out into 2022, similar to a question earlier, is that a range you will continue to target, that low single digit, given some revenue challenges, or are there targeted franchise investment or just inflationary pressures that would push that higher?

[Joseph Sutaris, EVP & CFO]

Russell, that is our hope. The challenge, obviously, as you kind of mentioned, is just keeping particularly payroll and wages, there's more pressure on wages than there's been in the past. That’ll be a challenge for us to continue to manage that appropriately and hire qualified and experienced staff. So, there is some pressure on the wage front, for sure. But we are actively managing all of the line items that we can from an operating expense basis. As we've also mentioned, we’re kind of consolidated some branches over the last year, year and a half. And we're starting to see some of the benefits from a cost perspective kind of get baked into the quarterly earnings. So, our expectation is, this kind of low single digits and excluding any sort of significant acquisitions. And so, we're going to continue to manage that very prudently.

[Russell Gunther, D.A. Davidson]

Thanks, Joe. Last one for me is on the margin. You guys have mentioned, I think, a couple of times, just the headwind that remains there. Can you give us a sense for the back half of the year? Is the expectation for pressure from this 279 prior to some excess liquidity getting deployed, or how do you see the near term trends?

[Mark Tryniski, President & CEO]

Yes. Russell, from a overall margin perspective, it's going to continue to be a challenge to support any sort of growth in the margin, excluding, as you pointed out, any additional investment of securities. We are - the loan pipeline is increasing, as Joe was indicating. We’re starting to see a little bit of loan growth. That will help the margin at least a bit. That roughly $2 billion of cash equivalents, if we tomorrow decided to invest that in a 10-year treasury, represents about $22 million on a pre-tax operating basis. If the 10-year treasury were 150, that's closer to a $30 million improvement in net interest income, but we need the market to kind of work with us a bit on that. And we kind of see that as a significant earnings opportunity and margin improvement opportunity.

And as you're aware, we don't really have anywhere to go on the cost of funds side. And I think you know, our cost of funds and cost of deposits is 10 basis points, is about as low as it's going to go. And so, that's really been the challenge, is deploying that excess liquidity. And obviously, we don't have a lot of room to go down on the deposit side because of the strength of our core deposit franchise. So, from a margin perspective, we certainly hope we're at the low point, but it potentially could drift a bit lower. But we also expect that net interest income, at least we could stabilize it with some loan growth and some deployment of the excess liquidity.

On the back end of the year or two, I think it might be worth noting that we're sitting on about $9 million of net deferred fees on the PPP side that have not been recognized. So, assuming that fourth quarter is the majority of the forgiveness activity, we'll see some of that hit in the back end of the fourth quarter. And that will at least show improvement in the posted margin if we do recognize most of that fee income.

[Joseph Serbun, EVP & CBO]

The only thing I would add is, if you look at the originations this quarter in our commercial book, our mortgage book, in our indirect book, they were all lower than what the aggregate portfolio yield is right now. So, kind of the core - take out PPP and all of the other stuff that kind of confuses the margin right now, the core operating margin is going to go down. I don't see how that doesn't happen, if you look at just what happened this quarter.

With that said, we need to grow. So, the rate's going to go down. The challenge for us and our team is to not let the dollars go down. So, if the rate goes down, but we get enough growth that we can offset that and we can manage the dollars, that, I think, is really default. So, the idea of the $2 billion, yes, we invested $1.5 million or 150, it's $40 million. That's great. Hope is in the strategy. So, that'd be great if the market cooperates and we have the opportunity, that's wonderful. If it doesn’t, we need to plan as to how we grow margin dollars in a declining rate environment, and that's the challenge that we're focused on.

[Russell Gunther, D.A. Davidson]

Understood. Thanks, Mark. Thanks, Joe.

[Operator]

[Operator instructions]. Our next question will come from Matthew Breese with Stephens Inc. Please go ahead.

[Matthew Breese, Stephens Inc.]

Good morning. Hey, I just wanted to stick on this theme of liquidity. I just want to confirm. So, the message for now is that you'll be on the sidelines in terms of investing liquidity and securities, just because of how low yields are. Do I have that right?

[Mark Tryniski, President & CEO]

Yes. At 1.7, you'd have that right.

[Matthew Breese, Stephens Inc.]

Okay. And has there been a turning point yet in terms of liquidity starting to roll off the balance sheet? Have you seen that quarter the days are continuing to stick around and or grow?

[Mark Tryniski, President & CEO]

We have not seen a trend yet in terms of a runoff of any of that excess liquidity. In fact in the past quarter, we saw an increase. So, we have not seen that occurring yet. So, we think most of the $2 billion is here to stay. We don't think all of it necessarily, but most of it is probably here to stay on the balance sheet. So, we do really feel like we're going to need to deploy that at some point when the cycle is right for us.

[Matthew Breese, Stephens Inc.]

Okay.

[Joseph Serbun, EVP & CBO]

Yes. I will say though, if you look at the quarterly run rate deposit, think the deposit inflows, the rate of inflows is decreasing, right. So it's slowing down in terms of the inflowing liquidity.

[Matthew Breese, Stephens Inc.]

Right. Okay. And then Mark, you mentioned that stripping away PPP, new versus existing loan yields, still show some pressure. Could you just give us an update on where you're seeing the most pressure, what that delta is?

[Mark Tryniski, President & CEO]

I'm kind of going by memory here. It was across the board actually, and it was pretty consistent. So, I'd say, on the consumer mortgage side, the delta was about, what is that? 80 basis points? Business lending is 80 basis points, and the indirect business was 80 basis points. So, it's about 80 basis points.

[Matthew Breese, Stephens Inc.]

Okay.

[Mark Tryniski, President & CEO]

The second quarter origination yield versus the aggregate portfolio yield for the quarter. So, it's about 80 basis points.

[Matthew Breese, Stephens Inc.]

Okay. And then last one for me, could you remind us how much of the portfolio is floating or - and or has really short durations? I just want to get a sense as talked-about Fed hikes intensify, how well positioned you are for capturing some of that benefit out of the gate.

[Joseph Sutaris, EVP & CFO]

So, our floating rate loan instruments were about 1 billion, 3 billion, 4 billion, in that neighborhood. So, it's not a significant component of our overall loan portfolio. But obviously, if we do get rate hikes, then the excess liquidity comes into play as well. But from a loan perspective, it's about that level.

[Matthew Breese, Stephens Inc.]

Okay, great.

[Mark Tryniski, President & CEO]

The other thing too, that indirect portfolio turns over really quick. What are the cash flows, Joe, a month? Like $40 million a month or something in cash flows. So, that portfolio turns over really quick also.

[Matthew Breese, Stephens Inc.]

Right. That's like a 12 to 24 month product, correct?

[Joseph Sutaris, EVP & CFO]

It’s longer than that.

[Mark Tryniski, President & CEO]

Yes. It's a little bit more than that, but you also get payoffs. So, I'm not sure what the average maturity contractual versus actually - yes, but …

[Joseph Sutaris, EVP & CFO]

The three years …

[Mark Tryniski, President & CEO]

It's probably 24 to 36 months somewhere.

[Matthew Breese, Stephens Inc.]

Okay, very good. That's all I had. Thank you for taking my questions.

[Operator]

And this will conclude our question-and-answer session. I'd like to turn the conference back over to Mr. Tryniski for any closing remarks.

[Mark Tryniski, President & CEO]

Thank you, Cole. Thank you all for joining, and we will talk again next quarter. Thank you. Have a good summer.

[Operator]

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect your lines at this time.