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Community Bank System Inc  (NYSE:CBU)
Q3 2018 Earnings Conference Call
Oct. 22, 2018, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Welcome to the Community Bank System Third Quarter 2018 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.

Today's call presenters are Mark Tryniski, President and Chief Executive Officer and Joseph Sutaris, Executive Vice President and Chief Financial Officer. Gentlemen, you may begin.

Mark E. Tryniski -- President and Chief Executive Officer

Thank you, Melissa. Good morning everyone, and thank you for joining our Q3 conference call. Third quarter results were generally quite solid. Year-over-year operating EPS, which excludes the impact of acquisition expenses and securities gains and losses, was up over 17%. We're very happy with these results, as both periods include the impact of the NRS and Merchants transactions in the first half of 2017 and reflect the positive benefit of a lower tax (technical difficulty) and strong organic execution across the Company.

Compared to this year's Q2, operating EPS was down $0.05, all of which was attributable to the $3.4 million impact of Durbin on our interchange revenue, which began this quarter. Supporting our results this quarter were very strong fee income growth, lower credit costs, and well-managed operating expenses. We delivered loan growth across the board as well, with which we're satisfied, but we're hoping for a bit more strength.

Our deposit base remains solid with average balances declining over the (technical difficulty) quarter, attributable entirely to public funds, as seasonally expected. Average non-public deposits were up for the quarter and our funding costs are growing slowly, but betas are well contained.

Looking forward, we have significant revenue and earnings momentum, reasonable credit demand, a solid funding base and we continue to accrete capital at a substantial pace. The strategic focus for 2019 will be on capital allocation to ensure the continuation of above-average shareholder returns with below-average balance sheet and operating risk. Joe?

Joseph E. Sutaris -- Executive Vice President and Chief Financial Officer

Thank you, Mark, and good morning everyone. As Mark noted, the third quarter of 2018 was another solid operating quarter for us. We reported net income of $43.1 million and fully diluted earnings per share of $0.83. This was up $0.15 per share or 22.1% over the same quarter in 2017. On a linked quarter basis, net income decreased $1.5 million or 3.3%, and fully diluted earnings per share decreased $0.03 or 3.5%. An increase in our non-banking fee revenues and a decrease in operating expenses were offset by a decrease in net interest income, lower banking-related non-interest revenues, due to a $3.4 million or $0.05 per share Durbin-related reduction in debit interchange fees and higher income tax expense.

Return on tangible equity for the third quarter of 2018 was 19.06%. Asset quality remained strong and we continue to capitalize on our strong core deposit franchise. I'll provide additional color on the Company's earnings performance in a few minutes, but will start with a few brief comments about our balance sheet and asset quality.

We closed the third quarter of 2018 with total assets of $10.66 billion. This was up $26.5 million or 0.2% from the end of the second quarter of 2018, but down $86.6 million or 0.8% from the end of the fourth quarter of 2017, due entirely to a $133 million decrease in investment securities balance this year.

Average earning assets for the third quarter of 2018 were $9.33 billion, which was down $122.2 million or 1.3%, when compared to the linked second quarter of 2018. Average total loans were up $39.1 million or 0.6% for the quarter, while average total investments were down $161.3 million or 5%, including a $143.9 million decrease in cash equivalents, due to a seasonal outflow of municipal deposits.

Ending loans at September 30, 2018, were up $62.9 million or 1% from the end of the second quarter, and up $44.1 million or 0.7% year-to-date. During the third quarter, outstanding balances in our business lending, consumer mortgage, consumer indirect, and consumer direct portfolios increased, while home equity balances were down slightly. The business lending portfolio increased $19 million or 0.8% during the quarter and the consumer loan portfolios were up $43.9 million or 1.1%, consistent with seasonal expectations.

Total deposits decreased $142.2 million or 1.7% between September 30, 2017 and September 30, 2018. Some of our large commercial and municipal depositors opted to sweep a portion of their depository funds to an off-balance sheet money market mutual fund suite vehicle we offer through a third-party arrangement.

Checking and savings account balances were up $114.6 million and sweep balances were up $102 million between the periods. Checking and savings accounts represented 67.4% of our total deposits at September 30, 2018 versus 65.1% one year prior.

Total borrowings and repurchase agreements decreased $62.6 million or 14.3% between September 30, 2017 and September 30, 2018. This include a $24.9 million reduction in the Company's trust preferred debt. Shareholders' equity increased $75.1 million or 4.7% between the periods, due largely to an increase in retained earnings.

As of September 30, 2018, our investment portfolio stood at $2.95 billion. The portfolio is largely comprised of treasury securities, agency mortgage-backed securities and municipal securities. The effective duration of the portfolio was 3.5 years at the end of the third quarter. The third quarter tax equivalent yield on the investment portfolio, including cash equivalents, was 2.54%. Principal cash flows from the existing investment securities portfolio are expected to total $49 million for the fourth quarter of 2018, $179 million for 2019 and $772 million in 2020. We anticipate reinvesting and potentially pre-investing a portion of these anticipated cash flows in similar types of securities during 2019, but at higher yields.

Our asset quality remain strong. At the end of the third quarter of 2018, non-performing loans, comprised of both legacy and acquired loans, totaled $24.9 million or 0.40% of total loans. This is 7 basis points lower than the ratio reported at the end of the linked quarter of 2018 and 3 basis points higher than the ratio reported at the end of the third quarter of 2017.

Our reserves for loan losses represent 0.80% of total loans outstanding and 0.96% of legacy loans outstanding. Our reserves remain adequate and exceed the most recent trailing four quarters of charge-offs by a multiple of 4. We recorded $2.2 million in the provision for loan losses during the third quarter of 2018 versus $2.3 million in the third quarter of 2017. The allowance for loan losses to non-performing loans was 201% at September 30, 2018. This compares to 169% at the end of the linked second quarter and 205% at the end of the third quarter of 2017.

We recorded net charge-offs of $1.7 million or 11 basis points annualized on the loan portfolio during the third quarter of 2018 versus $1.8 million in net charge-offs or 11 basis points annualized during the third quarter of 2017. Year-to-date net charge-offs totaled $5.8 million or 12 basis points. We do not currently have any commercial OREO properties and the internal loan risk ratings portend stable asset quality.

Our capital levels in the third quarter of 2018 continue to be very strong. The Tier 1 leverage ratio was 10.72% at the end of the quarter, over 2 times the well-capitalized regulatory standard. Tangible equity to net tangible assets ended the quarter at a solid 9.13%. This was up from 9% at the end of the second quarter of 2018 and 8.61% at the end of 2017.

Shifting to the income statement. Net income increased $7.9 million and fully diluted earnings per share increased $0.15 or 22.1% between the third quarter of 2017 and the third quarter of 2018. We recorded net income of $43.1 million, or earnings per share of $0.83 in the third quarter of 2018 versus $35.2 million in net income and earnings per share of $0.68 in the third quarter of 2017.

During the third quarter of 2018, the Company recovered $0.8 million of vendor contract termination charges that were recorded in acquisition expenses during the second quarter of 2017, and $0.7 million in net unrealized gains on the Company's equity securities portfolio and $0.3 million loss on debt extinguishment. Excluding these items, third quarter 2018 fully diluted earnings per share was $0.81, as compared to $0.69 per share in the third quarter of 2017, resulting in a $0.12 per share or a 17.4% increase between the periods on an operating basis.

On a linked quarter basis, fully diluted earnings per share decreased $0.03 or 3.5%, or $0.05 on an operating basis from $0.86 per share to $0.81 per share. As mentioned earlier, Durbin-related debit interchange price controls negatively impacted third quarter 2018 earnings by $0.05 per share. In addition, second quarter 2018 earnings were favorably impacted by $0.04 per share due to the receipt of the Company's Federal Reserve Bank semi-annual dividend payment, higher levels of income tax benefits related to stock option exercise and acquired impaired loan recoveries.

Net interest margin for the third quarter of 2018 was 3.71%. This compares to 3.64% in the third quarter of 2017, a 7 basis-point increase between the comparable quarters. The average yield on earning assets increased 10 basis points between comparable annual quarters, from 3.81% in the third quarter of 2017 to 3.91% in the third quarter of 2018, while the Company's total cost of funds increased 3 basis points from 18 basis points to 21 basis points over the same period. The Company's total cost of funds and total cost of deposits of 13 basis points remains among the best in the industry.

On a linked-quarter basis, net interest margin decreased 2 basis points from 3.73% in the second quarter of 2018 to 3.71% in the third quarter of 2018. However, net interest margin in the second quarter was favorably impacted by 4 basis points, due to receipt of the Company's Federal Reserve Bank's semi-annual dividend and $0.5 million of additional acquired impaired loan recoveries. Excluding these items, core net interest margin increased 2 basis points on a linked quarter basis. Although we face competitive pressure on loan pricing, our new loan origination rates are generally exceeding the rates on maturing and amortizing loans. Although, we believe the Company's funding cost will rise in the fourth quarter of 2018, we also believe that our proactive and disciplined approach to managing funding costs continue to have a positive effect on margin results. In spite of eight 25 basis point increases in the target Fed funds rate since the fourth quarter of 2015, as well as a general increase in market interest rates, our cost of deposits has remained between 10 basis points and 13 basis points for 11 consecutive quarters.

We recorded $55.8 million in non-interest revenues during the third quarter of 2018. This represents a $2.9 million or 5.4% increase over the third quarter of 2017. The increase in non-interest revenues was due to organic revenue growth in our employee benefit services businesses -- business, as well as the acquired inorganic growth in our wealth management and insurance businesses. Revenues in our employee benefits services business was up $2.5 million, or 12% and revenues in our wealth management insurance businesses was also up $2.5 million or 19.8%. The significant increases in these lines of business was partially offset by lower banking segment non-interest revenues. Deposit service fees decreased $2.3 million or 12.4%, due to the Durbin amendment debit interchange price restrictions. On a comparative year-to-date basis, non-interest revenues were up $21.4 million, or 14.4%. Consistent with the first two quarters of 2018 and full year 2017 results, non-interest revenues contributed approximately 40% of the Company's total operating revenues in the third quarter.

Total operating expenses for the third quarter of 2018 were $85.2 million. This compares to $83.8 million in total operating expenses recorded in the third quarter of 2017. The increase is primarily reflective of merit and incentive-based increase in salaries and employee benefits and increased occupancy and equipment expense, offset by a decrease in amortization of intangible assets. Excluding acquisition expenses, operating expenses increased $2.9 million or 3.4% compared to the third quarter of 2017. Excluding the aforementioned recovery of vendor contract termination charges, operating expenses were flat to the linked quarter, $86.1 million. On a comparative year-to-date basis, operating expenses excluding acquisition expenses were up $23.4 million or 10%, due largely to the acquisitions of Northeast Retirement Services in the first quarter of 2017 and Merchants Bank shares in the second quarter of 2017.

Our effective tax rate in the third quarter of 2018 was 21% versus 31.2% in the third quarter of 2017. The net reduction in the effective tax rate between the periods is primarily due to the passage of the Tax Cuts and Jobs Act signed (ph) in the fourth quarter of 2017, which lowered corporate tax rates from 35% to 21%. The effective tax rate was up 1.3% from 18.7% in the second quarter of 2018, due to lower levels of stock option exercise activity in the third quarter of 2018 and the related reduction in income tax expense. Excluding equity plan activities, we expect our effective tax rate to be in the range of 21.5% to 22% for the fourth quarter of 2018.

We anticipate fourth quarter net interest margin would be similar to the second and third quarters in the low to mid-3.70s. Although, we anticipate some loan yield lift on approximately $900 million of variable rate loans, we also expect to face repricing pressure on our non-maturity deposits portfolios and overnight repurchase agreement instruments, totaling approximately $8 billion. Although, we will continue to take a measured approach with respect to deposit pricing retention and growth, it's unlikely that we will be able to maintain a single-digit deposit beta during 2019. From an asset quality perspective, we do not see any major headwinds on the horizon.

In summary, we believe the Company remains very well positioned from both a capital and operational perspective for the remainder of 2018 and beyond. And as Mark mentioned, we look forward to continue to execute on earnings improvement opportunities for the remainder of 2018 and into 2019.

I'll now turn it back to Melissa to open the lines for questions.

Questions and Answers:

Operator

(Operator Instructions) And our first question will come from Alex Twerdahl with Sandler O'Neill.

Alex Twerdahl -- Sandler O'Neill -- Analyst

Hey, good morning guys.

Mark E. Tryniski -- President and Chief Executive Officer

Good morning, Alex.

Alex Twerdahl -- Sandler O'Neill -- Analyst

Hey. First just want to drill, and Mark in your prepared remarks you made a comment about capital allocation being a focus in 2019. Does that imply anything changing from the way you guys have been managing capital all along?

Mark E. Tryniski -- President and Chief Executive Officer

No. We will continue to be disciplined as we always have. I think the point I was just trying to make is, if you look at our capital levels right now, which I think we are at an all-time high, and I made this comment a couple of times back in, I guess it was 2016, where our capital levels were growing past where we need them to be and we'd talked about focusing on capital deployment. That was prior to the Merchants and NRS transactions. Now we're 18 months out from those, or so, and we're continuing to accrete capital at a substantial pace. We continue to raise our dividend, significant increase this year. We, with an ROA of 1.60% (ph) something, even after the dividend increases, with lower organic growth you're creating capital quickly.

So our Tier 1 tangible level is pushing 11%, which is I think higher than where we need to be on a sustainable basis, given the lower risk profile of our balance sheet and our operating model. So it was really just referenced generally Alex to the need to ensure that we continue to create high levels of shareholder returns and it, to me, incumbent upon us as management to allocate that capital efficiently and effectively, because if it's just sitting there and we don't need it, in terms of capitalizing our business, we need to get -- provide a return on that capital and we're at a level now where the capital is continuing to accrete, it's growing rapidly and so I think the point was just looking out into 2019. We need to be mindful of how we're going to get a return on that capital for the benefit of our shareholders, but it certainly doesn't apply anything different than what we've ever done, which is raise the dividend, do high-value disciplined transactions that can be accretive to earnings and dividend capacity. If you look at, we've got significant maturities coming over the next 24 months in the investment portfolio. Given where rates are and may be going, is there an opportunity there to layer in some utilization of that capital in the securities markets? There may be, I don't know that we're there yet. But it's possible that we get there, and that's also an opportunity. Then there's always M&A, but we will continue to be, as we have in the past, judicious and disciplined on identifying kind of for us lower risk, higher value transactions where there is an asymmetric risk-reward profile.

Alex Twerdahl -- Sandler O'Neill -- Analyst

Great. That's a very complete answer, Mark. Thank you. And then the securities that matured in the third quarter, they were coming off higher yields. When you -- Joe, you gave the sort of the breakdown of security maturities over the next quarter and the next year. Are those all coming off at higher yields than where you would be able to put them on today and kind of to what tune would -- what would be the magnitude of the difference?

Joseph E. Sutaris -- Executive Vice President and Chief Financial Officer

Yes, they are generally coming off the lower net effective yields and you would have the opportunity to put them back on. The difference is about 50 basis points from the maturing rate to the opportunities that we would see as a comparable security. There also might be some opportunities to pick up a few additional basis points if we were to go, for example, into some agency backed -- mortgage-backed securities with similar average lives and durations. So the maturing rate is effectively lower than the opportunity rates we see in the markets. As Mark noted, if rates -- market rates drift up a little bit further those opportunities will be improved.

Alex Twerdahl -- Sandler O'Neill -- Analyst

Okay. So the maturities in the third quarter was just a bullet and that's kind of a one-time higher yielding maturity, it's not indicative of what the rest of the portfolio looks like?

Joseph E. Sutaris -- Executive Vice President and Chief Financial Officer

Correct.

Alex Twerdahl -- Sandler O'Neill -- Analyst

Okay. And then just final question from me. It looks like salaries and benefits were down about $1 million sequentially. Is that due to lower headcount or just lower healthcare expenses, lower claim in -- claims on the insurance, anything like that, can you just talk about that a little bit?

Joseph E. Sutaris -- Executive Vice President and Chief Financial Officer

Yeah, Alex, I think you're absolutely correct. It is due to lower benefits expense, particularly our -- we've had good experience on our healthcare expenses. We also had some higher levels of incentive-based compensation in the second quarter. And we have not had any significant acquisitions to increase the FTEs salaries and payroll in the third quarter. So it's just of course discipline around new hires and the like.

Alex Twerdahl -- Sandler O'Neill -- Analyst

Great. Thanks for taking my questions.

Mark E. Tryniski -- President and Chief Executive Officer

Thanks, Alex.

Operator

Our next question will come from Erik Zwick with Boenning & Scattergood.

Erik Zwick -- Boenning & Scattergood -- Analyst

Good morning, guys.

Mark E. Tryniski -- President and Chief Executive Officer

Hello, Erik.

Joseph E. Sutaris -- Executive Vice President and Chief Financial Officer

Good morning.

Erik Zwick -- Boenning & Scattergood -- Analyst

Just a quick follow-up on the investment securities portfolio. Given that balances had declined for, I guess, about five quarters now, but given kind of the comments in the earlier discussion from Alex's question, should we expect that the balance should stay flat at this level or should start to grow kind of commensurate with total balance sheet growth or how should we think about that?

Joseph E. Sutaris -- Executive Vice President and Chief Financial Officer

Yes, I think, Erik, a flat projection is the original projection at least for the next quarter. As Mark mentioned, we may see some opportunities to invest or what we potentially call pre-invest some of those maturities that are out in 2020, in the 2019 fiscal year. So we potentially could see that investment securities portfolio drift up a bit in 2019 and it also would optimize our capital position as well if we were to grow that portfolio. So flat for the fourth quarter is a reasonable expectation. And a drift-off in 2019, I think is a reasonable expectation.

Mark E. Tryniski -- President and Chief Executive Officer

Yes, I would agree, unless there is a change in the market rates and we clearly are at an inflection point where we feel it's an opportunistic time to layer into the market for whatever reason. We don't think we're there yet, but given the continued upward movement of rates, it's certainly possible that that happens in the fourth quarter as well.

Erik Zwick -- Boenning & Scattergood -- Analyst

That's helpful. And then switching gears a little bit, understandably a big focus on deposit pricing and competition in industry today. I guess I'm curious about kind of the impact of the rising rates that you're seeing in loan origination yield. It sounds like you're starting to see some, maybe some better yields out there in the market. Could you provide any kind of colors or numbers around what you're seeing maybe for C&I loans and investor CRE?

Mark E. Tryniski -- President and Chief Executive Officer

Yes, right now, Erik, at least in this quarter, we saw what I would say as a nice uptick in origination yields versus what the all-in-portfolio yield is. So for the quarter anyway, again in one quarter it's certainly a function of what kind of loans you're putting out and renewing. But the differential in the third quarter was about 40 basis points. So I think it was similar for the auto business and the mortgage. So we are seeing, at least right now, a little bit of uptick in differential between what's going on in the overall portfolio yield, which hopefully is helpful. I think over the last four quarters, as I recall, our loan yields are up about 20 basis points. So we would hope that that trend continues, because, as Joe said, we do expect that we will continue to have upward pressure on the deposit pricing. So -- but as long as we can kind of get it on both sides, I think we can manage that well in terms of the margin.

Erik Zwick -- Boenning & Scattergood -- Analyst

Got it. And then just one last question on the net interest margin in the third quarter. The press release indicated there was no impaired kind of loan accretion recorded in the quarter. Does that include both scheduled and accelerated?

Joseph E. Sutaris -- Executive Vice President and Chief Financial Officer

That included -- in the second quarter, we had some accelerated impaired loan accretion and there was a modest amount of scheduled, modest in the neighborhood of about $100,000 (ph) or so. So, most of that in the second quarter was due to a recovery and we effectively do not have a similar outcome in the third quarter.

Erik Zwick -- Boenning & Scattergood -- Analyst

Great. That's helpful. Thank you for taking my questions.

Mark E. Tryniski -- President and Chief Executive Officer

Thank you.

Operator

Our next question will come from Russell Gunther with D.A. Davidson.

Russell Gunther -- D.A. Davidson -- Analyst

Hey, good morning guys.

Joseph E. Sutaris -- Executive Vice President and Chief Financial Officer

Good morning, Russell.

Russell Gunther -- D.A. Davidson -- Analyst

Just focusing on the loan growth going forward. Could you guys give us just a general sense of where the commercial pipeline stands today versus maybe where you were coming into the quarter? And then perhaps just touch on where you'd expect some of the geographic contributors to come from, as we look ahead.

Mark E. Tryniski -- President and Chief Executive Officer

Sure. The pipeline as it stands at the end of the third quarter is more than 30% higher than where it was at the end of the second quarter, which is good. So the pipeline is pretty strong, although interestingly enough, last handful of years and it never used to be like this, but fourth quarter and commercial was always light and we almost always had kind of net run-off in that portfolio in the fourth quarter. That's kind of changed in the last few years. I'm not suggesting this year it's going to change back, but the pipeline is up nicely from second to third quarter, which is good. So if recent history holds, we'll have a fair Q4 on the commercial side.

The mortgage pipeline is lower, which you would expect, given the seasonality of that business, particularly for us. It's also lower than where it was this quarter last year. So, the mortgage business is a little bit slower. I mean, it's always kind of within a certain range, other than you get to kind of fourth quarter and first quarter where there's really very little activity. But the pipeline, that tends a little bit lower than it was in the prior year's similar quarter. My understanding is that there's not enough inventory out there, there is more demand than inventory. But still (inaudible) it's kind of in a -- continue -- the mortgage pipeline seems to always run between $80-something-million and $120 million all year long and just kind of ebbs and flows between that. So I think we're doing OK. Clearly on the auto lending and indirect paper side the third and fourth quarter are slower and we're starting to see a little bit of that right now, although I think we did have about $30 million of growth in that portfolio in the third quarter, which was actually a little bit of a surprise, but a little stronger than what we expected I think there.

Russell Gunther -- D.A. Davidson -- Analyst

Thanks, Mark. I appreciate the color.

Mark E. Tryniski -- President and Chief Executive Officer

Yes, no, I apologize. I didn't answer the other part of your question, I apologize, which was geographic. Actually, all year along, we've seen a fair bit of strength across the marketplace. Upstate New York has been good, Northern New York has been good, Pennsylvania has been strong. We're still in New England fighting off an above-average level of pay-offs, most related to business sales, in that bank changes, but we are getting some traction there. I think, we actually had an increase in commercial in New England in the third quarter as well. So it's coming from across the footprint really, which is not good. It's typically more discrete pockets of growth in there. We don't usually kind of see it as broad-based as it is right now, which is great. Hopefully, it continues.

Russell Gunther -- D.A. Davidson -- Analyst

I appreciate all the color there, Mark. Thank you. And then last one for me. I heard you guys loud and clear that the kind of capital management priority list hasn't changed and maybe focusing in just on depository deals and where your appetite stands today and whether there are any particular geographies that you're focused on at this point?

Mark E. Tryniski -- President and Chief Executive Officer

Sure. I don't know that we need to do a depository oriented transaction. We have plenty of -- the loan to deposit ratio actually (ph) -- I think we will be more inclined to do a credit-oriented transaction, which I would suggest Merchants was last year. They also had a really nice low-cost core deposit base. One of the challenges for us, honestly as we look at modeling M&A opportunities is just our funding costs are so good and so low that when you model another transaction with funding costs that are 40, or 50 or 60 basis points, we don't really like the dilution of the metrics, which doesn't mean we wouldn't do something like that if we thought ultimately it was the right thing to do for our shareholders. But that's one of the challenges. I think we -- right now we're not looking to do deposit deals, we're not looking to do -- we're not looking to do any deal, other than a high value lower risk kind of transaction that can help us accrete earnings and cash flows on a sustainable basis going forward. So that will continue to be the model.

Russell Gunther -- D.A. Davidson -- Analyst

Great. That's it for me. Thanks for taking my questions.

Mark E. Tryniski -- President and Chief Executive Officer

Thank you.

Operator

Next, we'll take a question from Collyn Gilbert with KBW.

Collyn Gilbert -- KBW -- Analyst

Thanks. Good morning gentlemen. Just wanted to start off -- hey there, just to clarify a couple of things. One is on the accretion comment, Joe. So it's been running kind of $2 million or so consistently each quarter. Is that what you're expecting in the fourth quarter as well?

Joseph E. Sutaris -- Executive Vice President and Chief Financial Officer

Yes. Collyn, it could be down slightly, a couple hundred thousand dollars would be our projection for the fourth quarter in terms of the non-impaired loan accretion. And the impaired loan accretion is a very modest number from quarter-to-quarter, but it does affect margin in a positive sense when we have a full recovery on an impaired loan repayment, which happened in the second quarter. So you run rated that $1.8 million to $2 million is I think a reasonable expectation for next quarter, for the fourth quarter.

Collyn Gilbert -- KBW -- Analyst

Okay, that's helpful. And then just to walk to through again, if you don't mind just reconciling the muni exposure on the loan side and then on the deposit side. It just seems kind of a little bit more challenging to kind of discern some of those trends quarter-to-quarter. Because I think seasonally usually have the loan -- muni loan paydowns in the second quarter, which I would have thought would have reversed a little bit this quarter. Anyway, if you could just walk through some of those balances and remind us again of how those trends flow through?

Joseph E. Sutaris -- Executive Vice President and Chief Financial Officer

Sure. Regarding the muni loan portfolio, let me start on the loan side. The portfolio has a -- or I should say, our borrowers in New England have a fiscal cycle that ends on June 30, begins on July 1. And we have one-year instruments that represent about $40 million, and those instruments are typically paid down late in the second quarter and then renew in the third quarter, and assuming that we have a good retention on those, they renew in about the same level, so $40 million goes back on in the third quarter. So that's really the most significant component of seasonality with respect to the municipal loans.

Collyn Gilbert -- KBW -- Analyst

Sorry, I don't mean to interrupt, but just on that point, so then did you see those $40 million renew in the third quarter as you anticipated?

Joseph E. Sutaris -- Executive Vice President and Chief Financial Officer

Yes, yes, we did. And we also had a -- just a very modest increase in just other municipal loans, but very modest. So that did occur.

With respect to the deposit side, and I will include our repurchase agreements, because a significant amount of our repurchase agreement balances are with municipalities. And a lion's share of our municipal deposits and repurchase agreements are still in New York State and there's tax collection cycles that hit effectively in the fourth quarter, so tax bills go out in September, they are collected in the October time frame and we typically get a lift in the fourth quarter as our taxpayers pay the municipalities. So it comes out of the pocket of the individual taxpayers and businesses, these are property -- excuse me -- school taxes and net-net we wind up typically in an increased overall deposit position as our municipal deposits increase in the fourth quarter.

They then begin to level off throughout the end of the fourth quarter and then in the first quarter, also in New York State, we have a property tax collection cycle and we see a boost again in the first quarter, and that could be $100 million to $200 million as a reasonable range. And then also when we hit the end of the second quarter, so June 30, we do begin to see a little bit of a drift or increase in some of our education funding balances, particularly in our New England market, and so we to see a little bit of a drift down in the third quarter for municipal holdings.

Mark E. Tryniski -- President and Chief Executive Officer

And you could see that actually. You can see it actually if you look at -- I think it's on the tables, but maybe it isn't. The average public funds for the quarter were down substantially with the end of period result. And on the non-public funds, the average was up, but the ending was down. So that dynamic just says about, your customers take it and they give to municipalities, you can kind of see that playing out between the quarters.

Collyn Gilbert -- KBW -- Analyst

Okay, that's helpful. Thank you for going through that. And just the -- and if it is in the table I apologize. The muni deposit in repos, the bulk of that or the balance is what?

Joseph E. Sutaris -- Executive Vice President and Chief Financial Officer

So depending on the time of year in the cycle, we sit on between $1.1 billion and $1.4 billion in total deposits and repurchase agreements. The repurchase agreement book has a subset of that number, ranges from about $200 million to $300 million, depending on the time of year in the cycle. The remaining balance is in deposits and the lion's share of that is in operating type and money market accounts. We have a very, very small municipal CD book as we sit here today.

Collyn Gilbert -- KBW -- Analyst

Okay. That's helpful. And then just going to the NIM discussion. If you look in the press release, kind of the components of the NIM or at least on the asset yield side, speaking to that, we're all down, I mean, loan yield was down slightly, but yet the earning asset yield was kind of flat. I'm just trying to understand what's going on there, why that is.

Joseph E. Sutaris -- Executive Vice President and Chief Financial Officer

Well, we had on the loan side, effectively, the yields for the quarter were relatively flat. We do have -- we're seeing new rates go on -- higher rates than the maturing rates, but it just takes a little while for that to increase. But we also had the -- I'll call it the negative effect on the overall yield, because we didn't have the accretion related to the non-impaired -- excuse me -- to the impaired loans in the third quarter that we had in the second quarter. So if we were to extract that impaired loan accretion, we would have saw a net increase in the effective yield on loans.

Collyn Gilbert -- KBW -- Analyst

Have any basis was that -- I thought that was a small amount, but now is it -- how many basis points of yield?

Joseph E. Sutaris -- Executive Vice President and Chief Financial Officer

Yes, it's a couple of basis points, Collyn.

Collyn Gilbert -- KBW -- Analyst

Okay. And then the drop in the cash and the investment yield again seems a little bit more meaningful, then why you were still able to keep the earning asset yield flat?

Joseph E. Sutaris -- Executive Vice President and Chief Financial Officer

Yes. In the second quarter of 2018, we had an elevated level of cash equivalents, due to higher levels of municipal deposits. As they drift down, our overnight Fed funds position is reduced. Actually we wind up in a borrowed position at some points in the third quarter. But what the idea is -- it dragged down the effective yield on a blended basis, as we saw less monies available for -- in the overnight portfolio, or I should say (multiple speakers) interest income was down.

Collyn Gilbert -- KBW -- Analyst

Okay. So I guess maybe the short of it is just that the cash component and the securities component is just not significant enough to -- the drop in those two yields is just offset by the more stable loan yield. Anyway, I can -- it's all right, we can discuss this later. I don't want to take up time on the call. Okay. And then just going back to the NIM. So that 3.71% seems like that's pretty much a clean number this quarter and then in the fourth quarter you'll get that the FRB dividend, which is it -- are you still anticipating about a $450,000 dividend?

Joseph E. Sutaris -- Executive Vice President and Chief Financial Officer

Yes, that's a reasonable expectation for the fourth quarter.

Collyn Gilbert -- KBW -- Analyst

Okay. That's helpful. Okay, I think that was all I had. Thank you. One question just on the loan book where -- what's the duration on the loan book right now?

Mark E. Tryniski -- President and Chief Executive Officer

We'd have to get that to you, I'm not sure exactly -- I mean, certainly we have (ph) the components of that. I think the --I'm not going to even speculate Collyn. We'll circle back with you on that.

Collyn Gilbert -- KBW -- Analyst

Okay. All right, very good. I'll leave it there. Thanks guys.

Mark E. Tryniski -- President and Chief Executive Officer

Thanks Collyn.

Operator

Our next question will come from Brody Preston with Piper Jaffray.

Brody Preston -- Piper Jaffray -- Analyst

Good morning everyone. How are you?

Mark E. Tryniski -- President and Chief Executive Officer

Good morning Brody.

Joseph E. Sutaris -- Executive Vice President and Chief Financial Officer

Good morning Brody.

Brody Preston -- Piper Jaffray -- Analyst

I just wanted to, I guess, maybe go back on the loan book. I know in the past I think we've talked about $900 million of the portfolio is variable rate. I just wanted to confirm this amount and ask what index this is tied to?

Joseph E. Sutaris -- Executive Vice President and Chief Financial Officer

Yes, Brody, that number is a good proxy for the variable rate loan portfolio. I don't have the mix in front of me, but there are prime-based instruments and LIBOR-based instruments, and a few other indices in that variable rate portfolio, but we can get back to you with respect to the breakdown.

Brody Preston -- Piper Jaffray -- Analyst

Okay, thank you very much. And then I guess -- yes, go ahead.

Joseph E. Sutaris -- Executive Vice President and Chief Financial Officer

It's safe to say the majority of it -- more of it is prime-based than LIBOR.

Brody Preston -- Piper Jaffray -- Analyst

Okay, that's good. Thank you. I guess I just wanted to circle back to your comments on the deposit beta. I think cycle to-date you guys have something like a 1% deposit beta and you said you don't expect something similar to continue. But this quarter I think it was closer to 7%. So I just wanted to get an idea if that was going to be sort of your new run rate moving forward or if you thought it would continue to move incrementally higher?

Joseph E. Sutaris -- Executive Vice President and Chief Financial Officer

Brody, I would think incrementally higher is the safer path to take. We were pretty -- very disciplined and have been disciplined through eight increases in the target Fed funds rate. Obviously, at some point if we're in year three of that -- of those rate increases, we're going to see competitive pressures around deposits, probably and likely in all markets, we're seeing that already. And we are seeing also some larger customers look for higher-yielding instruments. So the expectation would be that would be a little bit higher looking out into 2019 in terms of our deposit beta that we have been and certainly in '17 and '18.

Mark E. Tryniski -- President and Chief Executive Officer

Beta is also difficult to predict. With some it's a function when the timing of when the rate increases are. You are talking about cumulative positive beta or quarter-over-quarter deposit beta and it just -- I think our focus is really on optimizing the balance between cost of funds and deposit retention and that's what we focus on, as opposed to some targets around beta which -- it means less, it's kind of a computational effort that doesn't mean nothing. But day to day it's about what are the strategies we are using out with our people in the field who are customer facing folks, what tools do we give them, what training, what do we give them so that they can optimize that balance between cost of funds and deposit retention. I think so far we've done probably a little better than what I expected we would. But in terms of some estimate of deposit beta going forward, I just know that we will continue to do our best and be proactive in trying to manage well that -- both of those objectives, which is low cost of funds and deposit retention.

Brody Preston -- Piper Jaffray -- Analyst

Okay. Great, thank you for your comments there. Just circling back to loan growth. I think Mark, you gave sort of some comments earlier about the pipeline, I think is better today than where it was just start 3Q, but it's lower than where it was in prior years. I guess I wanted to firm up maybe sort of your expectations for fourth quarter loan growth?

Mark E. Tryniski -- President and Chief Executive Officer

Yes, just to clarify Brody, the comment about lower than prior years that was mortgage and not commercial, commercial was actually a little higher by actually quite a bit. So the commercial pipeline higher than it was last year and the year before and the year before that. It is also up from second quarter to third quarter, but it was the mortgage pipeline specifically I was commenting on relative to, it's less in the third quarter of '18 than it was in the third '17, not by a lot, but it is less.

Brody Preston -- Piper Jaffray -- Analyst

Okay. So it sounds like if everything sort of settles, then we can see deposit -- loan growth continue to accelerate maybe marginally.

Mark E. Tryniski -- President and Chief Executive Officer

Yes, we don't like to use the word acceleration when we talk about loan growth. I mean it just goes on our market that's never been our experience, we don't try to manage to anything where we would use the word acceleration. Growth is good, modest disciplined growth is good. Acceleration is not good in our markets. I mean, if you're growing too fast in our markets, you're probably doing things that you're going to regret at some point in the future. So if we can grow the loan book overall 2% to 4% a year, I know that doesn't sound like much, and other banks and other markets where they are looking at double digits, those are not our markets. That's not -- we don't have that opportunity. If we can grow 2% to 4%, along with operational discipline, non-interest income growth, high-value M&A, I mean that's how we -- that's the strategy in terms of how do you get to a double-digit shareholder return over time.

So it's not very exciting and we don't use the word acceleration. But we'll do our best to continue the modest loan growth that we had this quarter. Second quarter was disappointing. It should have been better, but we've talked about that in terms of the number of early payoffs in that quarter, which we didn't have to the same degree this quarter, which was helpful. But the pipeline is, as I said, is pretty strong heading into the fourth quarter and last few years the fourth quarter has been good. Now, when I say good, this isn't -- we're talking about modest growth here. But if the fourth quarter is higher than the third quarter in commercial, we'll be happy with that.

Brody Preston -- Piper Jaffray -- Analyst

All right, great. And I guess maybe just going back to the fee income side of the equation, now employee services, especially continues to at least exceed our expectations within our model and I wanted to get an idea is that is it exceeding your expectation and what can we expect from that group moving forward? Is a $25 million run rate sort of what you expect?

Mark E. Tryniski -- President and Chief Executive Officer

Well, we would expect that we would continue to grow, and $25 million a quarter is about the run rate on that right now. So it's -- the NRS transaction continues to grow at a double-digit pace itself. The other elements of the benefits business also continue to grow, not at the same pace. So all in, the benefits business continues to be very good. The wealth management business, also very good. Insurance business improving. The revenue growth has been OK. The margin growth is not. So I think we need to do a better job there. But all in, those businesses continue to grow revenues faster than expenses, which is the plan and I think looking toward the markets, for the benefits business, continue -- I think the outlook continues to be good. Wealth management continues to be strong. We have a lot of momentum there. So we're focused on improving the margin characteristics of the insurance business. So I think looking ahead, 2019, we expect could be also a reasonable growth year for those non-banking businesses.

Brody Preston -- Piper Jaffray -- Analyst

Alright, great. And then last one for me. I think last quarter we had talked about, maybe on the non-interest income M&A front, private equity firms have been pretty aggressive in these markets. I just wanted to know if that has abated at all?

Mark E. Tryniski -- President and Chief Executive Officer

We haven't really had the opportunity to experience that first hand in the last quarter or so. So I can't speak from actual experience recently, directly. But from what I understand, broadly, that continues to be the case. I know specifically if I see other transactions and the pricing of those transactions that are kind of in our space, if you will, the non-banking space and you look at what the EBITDA and cash flow and revenue multiples of those deals are, they are levels that we'd be unlikely to participate at. From what I understand in the market is that's still the case.

Brody Preston -- Piper Jaffray -- Analyst

Alright, great. Thank you very much guys.

Mark E. Tryniski -- President and Chief Executive Officer

Thank you.

Operator

And that does conclude our question and answer session. At this time, I'd like to turn the conference back over to management for any additional or closing remarks.

Mark E. Tryniski -- President and Chief Executive Officer

Thank you, Melissa, no additional comments. Appreciate you all participating and we will talk again in January. Thank you.

Operator

That does conclude our conference for today. Thank you for your participation.

Duration: 54 minutes

Call participants:

Mark E. Tryniski -- President and Chief Executive Officer

Joseph E. Sutaris -- Executive Vice President and Chief Financial Officer

Alex Twerdahl -- Sandler O'Neill -- Analyst

Erik Zwick -- Boenning & Scattergood -- Analyst

Russell Gunther -- D.A. Davidson -- Analyst

Collyn Gilbert -- KBW -- Analyst

Brody Preston -- Piper Jaffray -- Analyst

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