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Community Bank System Inc  (NYSE:CBU)
Q4 2018 Earnings Conference Call
Jan. 23, 2019, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

See all our earnings call transcripts.

Prepared Remarks:

Operator

Welcome to the Community Bank System Fourth Quarter 2018 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 environments 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 Tryniski -- President and Chief Executive Officer

Thank you, Aaron. Good morning, everyone, and thank you all for joining our fourth quarter conference call. I'll start with our comment on Q4 and then comment on 2018 as a whole and our transaction announcement yesterday.

Fourth quarter earnings were about as we expected, but down from Q3 which is typically the case. Operating expenses were $0.02 higher, including $0.01 of severance and $0.01 related to an extra payroll day. Our insurance business also came in $0.01 below a very strong third quarter. We were pleased with the modest margin lift as new loan originations are going on at higher rates than overall portfolio yields. Loan and deposit balances were slightly down also typical in Q4 for us. Our operating EPS for the full year was up 22%, which excludes the impact of acquisition expenses and the deferred tax benefit in Q4 of last year. That 22% growth includes an $0.11 per share hit from Durbin in 2018.

So, overall, it was another very strong year for our shareholders and our ninth consecutive year of improvement in operating EPS.

Loan growth across the year was more volatile between quarters than usual, due to record originations, offset by record payoffs in the commercial book, but our mortgage and auto lending portfolios performance plan.

There are three observations I would like to highlight related to 2018. First, I think our retail team did superb job of managing funding costs throughout the year, which is clearly has been beneficial to margin performance. Second, our non-interest revenues rose 11% over 2017 and that includes the impact of the $7 million Durbin hit. Banking fee revenue was up 3% reported and would have been up 12% without Durbin. Our wealth management and insurance businesses were up 16% and our benefits business was up 14%.

Third, in my view most important for our future, as we announced in May, we made some significant senior leadership changes to our organization, including appointing Scott Kingsley as Executive Vice President and Chief Operating Officer, Joe Sutaris as Executive Vice President and Chief Financial Officer, and Joe Serbun as Executive Vice President and Chief Credit Officer. Transition was extremely smooth and effective, and enhancing the talent of our senior leadership team has already begun to make a meaningful difference across the company that I believe will become clearly apparent into the future.

Lastly, we announced yesterday the acquisition of Kinderhook Bank headquartered in the Albany region of New York State. Kinderhook is a solid performing $640 million asset commercial bank with 11 branches across five counties. In addition to its performance in asset quality, Kinderhook is highly additive to our franchise, both strategically and geographically. We started up a business banking office in Albany in 2018 with Jeff Levy providing leadership who is one of the most respected and experienced bankers in the market. He put together a very strong team and we had a very strong inaugural year and this transaction further enhances our opportunities for continued growth and investment in this market. It's an all-cash deal, so we think it's a very productive low-risk, high-value deployment of capital.

Looking ahead to 2019, we have strong operating momentum across all our businesses. We're hopeful of the margin tailwinds continue to blow modestly. We expect the Kinderhook acquisitions to be solidly additive and we have and continue to generate considerable capital that can be deployed in the patient and disciplined manner for the ongoing benefit of our shareholders. Joe?

Joseph Sutaris -- Executive Vice President and Chief Financial Officer

Thank you, Mark; and good morning, everyone. I'll first provide commentary around our full year and fourth quarter earnings results followed by some additional information regarding our pending merger with Kinderhook Bank Corp. As Mark noted, 2018 was a very good year for the company. We established a new record for the full year earnings and benefited from the full integration of our 2017 acquisitions of Merchants Bancorp and Northeast Retirement Services.

The company recorded full year GAAP net income of $168.6 million and earnings per share of $3.24. Those compares to the net income of $150.7 million and $3.03 in earnings per share for the full year of 2017, which included a $38 million or $0.74 per share of one-time income tax benefit due to the revaluation of the company's deferred tax position after the passage of the Tax Cuts and Jobs Act in the fourth quarter. Excluding this one-time income tax benefit and acquisition-related expenses net of tax effect, full year 2017 operating earnings were $2.64 per share. This compares to $3.23 of operating earnings per share for the full year 2018, a $0.59 per share or 22.3% improvement year-over-year. These results were achieved in spite of the company becoming subject to the Durbin-related debit intercard -- debit card interchange price restrictions in the second half of the year, which negatively impacted 2018 earnings per share by $0.11. Full year 2018 return on assets and return on tangible equity were 1.58% and 19.1%, respectively.

I'll now make a few comments about our balance sheet before discussing quarterly earnings results. We closed the fourth quarter of 2018 with total assets of $10.61 billion. This is down $51.2 million or 0.5% from the end of the third quarter of 2018 and $137.8 million or 1.3% from the end of 2017. Similarly, average earning assets for the fourth quarter of 2018 of $9.31 billion were down $26.2 million or 0.3% when compared to the linked third quarter and $66.9 million or 0.7% in the fourth quarter of 2017.

Ending loans at December 31, 2018, were down $19.8 million or 0.3% from the end of the third quarter and up $24.4 million or 0.4% over the full year period. As Mark mentioned, although the company's business lending originations were strong in 2018, higher levels of unscheduled payouts resulted in a $27.2 million or 1.1% decrease in outstanding balances. This decrease was offset by net growth totaling $51.6 million or 1.3% in our consumable loan portfolios.

On-balance sheet deposits decreased $141.5 million or 1.7% on a linked quarter basis and $122 million or 1.4% on a full-year basis. During 2018, certain large commercial deposits asset to utilize an off-balance sheet suite vehicle we offered for a third-party arrangements. These off-balance sheet arrangements increased to $163.2 million between December 2017 and December 2018.

Checking and savings account represents 68.3% of our total deposits at December 31, 2018, which is a solid increase from 65.7% one year prior.

As of December 31st, our investment portfolio stood at $2.98 billion. The portfolio is largely comprised of treasury securities, agency mortgage-backed securities and municipal securities. The effective duration of the portfolio was 3.3 years at December 31, 2018.

The fourth quarter 2018 tax equivalent yield on the investment portfolio, including cash equivalents, was 2.61%. Flexible cash flows from existing investment securities -- from the existing investment securities portfolio are expected to total approximately $200 million for 2019 and $780 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.

In the fourth quarter of 2018, the company recorded $40.8 million of net income and $0.78 per share in earnings. This compares to net income of $72 million or $1.40 in GAAP earnings per share in the fourth quarter of 2017. Exclusive of the one-time income tax benefit, acquisition-related expenses and unrealized gain on equity securities, operating earnings per share was $0.78 in the fourth quarter of 2018 as compared to $0.67 for the fourth quarter of 2017: $0.11 per share or 16.4% improvement in operating earnings per share was driven by increases in net interest income and non-interest revenues, a lower provision for loan losses and a decrease in income taxes, excluding the one-time tax benefit, offset in part by higher operating expenses and increase in fully diluted average shares outstanding.

Compared to the fourth quarter of 2017, net interest income was up 10 basis -- was up due to a 10 basis point increase in earning asset yields, offset in part by a 7 basis point increase in the cost of funds and a $66.9 million or 0.7% decrease in average earning assets. Net interest margin on a fully tax equivalent basis increased 3 basis points between comparable annual quarters from 3.74% in the fourth quarter of 2017 to 3.77% in the fourth quarter of 2018.

Non-interest revenues in the non-banking businesses were up $2.5 million or 7.3%, but were offset by a $2.2 million or 11.2% decrease in banking related non-interest revenues, due to a decrease in debit interchange fees in connection with the company being subject to the Durbin amendment beginning July 1, 2018.

Despite the Durbin reduction, non-interest revenues contributed 39.5% of the company's total operating revenues during 2018.

Compared to the prior fourth quarter, total operating expenses, excluding acquisition expenses, rose $1.5 million or 1.7%.

Increases in salaries and employee benefits, occupancy and equipment expenses and other expenses totaling $2.1 million were offset in part by $0.6 million decrease in the amortization of intangible assets. The $2.9 million decrease in the provision for loan losses was primarily due to lower net charge-offs in the business lending portfolio. In the fourth quarter of 2017, the company charge-off $3.1 million on loans to a signal borrower.

Moving to the linked quarter. Consistent with the historical trends, fourth quarter operating earnings were modestly below our linked third quarter results. The company recorded total operating expenses of $87.6 million in the fourth quarter compared to $85.2 million in total operating expenses in the late third quarter, a $2.4 million increase, which include additional day of payroll and benefit costs. Net interest income was up $1.2 million or 1.4% on a linked quarter basis. This is reflective of higher core net interest margin and the receipt of the Federal Reserve Bank semi-annual dividend in the amount of $0.4 million. Net interest margin increased 6 basis points on a linked quarter basis to 3.77%, 4 basis points of which were attributable to the core net interest margin rate and volume factors and 2 basis points attributable to the FRB dividend.

The yield on earning assets increased 8 basis points from 3.91% in the third quarter to 3.99% in the fourth quarter. This increase was partially offset by a 2 basis point increase in the cost of funds between the linked quarters. The company's average cost of deposits for the fourth quarter remained low at 16 basis points. This compares to an average cost of deposits of 13 basis points during the third quarter.

Non-interest revenues were down $1.6 million in the linked quarter basis. This was attributable to a $1 million seasonal decline in the insurance revenues from a very strong third quarter and a $0.5 million decrease in revenues from mortgage and other banking services. During the third quarter, the company's insurance services revenues were up as compared to linked second and fourth quarters due to higher levels of new policy sales and renewals.

Excluding the $0.8 million acquisition-related recovery reported in the third quarter, total operating expenses increased $1.6 million or 1.8% on a linked quarter basis. Salaries and employee benefits, occupancy and equipment and other expenses were up in the quarter. It is not a typical for the company to experience modestly higher operating expenses in the fourth quarter as compared to the third quarter.

Our asset quality remained strong at the end of the fourth quarter of 2018. Non-performing loans comprised of both legacy and acquired loans totaled $25 million or 0.4% of total loans. This is the same ratio reported at the end of the linked third quarter of 2018 and 4 basis points lower than the ratio reported at the end of the fourth quarter of 2017.

Our reserves for loan losses represent 0.78% of total loans outstanding and 0.93% of legacy loans outstanding. Our reserves remain adequate and exceed the most recent trailing four quarters of charge-offs by a multiple of 5. The allowance for loan losses to non-performing loans was 197% at December 31, 2018. This compares to 201% at the end of the linked third quarter and 173% at the end of 2017.

The recorded net charge-offs of $3.3 million or 21 basis points annualized on the loan portfolio. During the fourth quarter of 2018, a $9.1 million or 15 basis points on a full year basis. This was down from 18 basis points on a full year basis in 2017. We do not currently have any commercial OREO properties and the internal loan risk ratings portends stable asset quality.

From an asset quality perspective, we do not see any major headwinds on the horizon.

Shareholders' equity increased $79.5 million or 4.9% on a full-year basis, due largely to an increase in retained earnings. Our capital ratios also remained strong in the fourth quarter. The company's Tier 1 leverage ratio was 11.09% at the end of the quarter, over 2 times to well capitalized regulatory standard. Tangible equity to net tangible assets ended the quarter at a solid 9.69%. This is up from 9.13% at the end of the third quarter of 2018 and 8.61% at the end of 2017.

Looking ahead, we anticipate 2019 net interest margin to be similar to the second half of 2018, in the mid-3.70s. Although we anticipate continued lift in loan yields, we also expect to face repricing pressure on our non-maturity deposit portfolios in overnight repurchase agreement instruments. Since the Durbin restrictions do not become effective until the second half of 2018, we also expect that full year 2019 earnings per share will be unfavorably impacted by an additional $0.11 per share.

In summary, we believe that company remains very well positioned to effectively integrate the Kinderhook Bank Corp. merger in the second quarter of 2019 and improve upon its organic results in the quarters ahead.

Now, I'd like to briefly comment on the operating deal metrics regarding Kinderhook. As noted in yesterday's press release, Kinderhook is an 11 branch franchise operating in the Greater Capital District in New York. The geography in which Kinderhook operates is contiguous to our current geography, but provides better banking opportunities from a demographic perspective in most regions with our existing footprint. We believe that Kinderhook franchise fills the hole on our geography and significantly augments our presence in the Greater Capital District region of New York.

At the end of the third quarter, the Kinderhook Bank had total assets of $636 million, including total loans of $491 million and $560 million in total deposits. Kinderhook's loan portfolio was largely a commercial book with $257 million or 52% of its total loan portfolio in commercial real estate and $45 million or 9% in commercial and industrial, and other loans.

Kinderhook also has approximately $180 million or 37% of its total loan portfolio in one-to-four family residential real estate loans, including approximately $17 million in home equity loans. There is also very small consumer direct loan book totaling approximately $9 million. Approximately 75% of Kinderhook's total deposits are in checking, savings and money market deposits with the remaining 25% in time deposits.

Kinderhook's third quarter fully tax equivalent net interest margin was 3.55%, total earning assets were 4.33%, including a 4.84% yield on loans and a 2.25% yield on its investment portfolio. Kinderhook Bank's deposit funding costs for the third quarter was 61 basis points or 0.61%, but total funding costs for Kinderhook Bank were 0.77%, inclusive of interest expense and approximately $50 million of sub-debt and trusts.

As noted in our press release, aggregate consideration for Kinderhook is anticipated to be $93.4 million. This assumes full conversion of the company's convertible preferred shares into common shares prior to the merger and a $62 purchase price for all common shares. The purchase multiples for the pending merger at 10.5 times earnings with the fully based in cost savings estimated at 30% and 1.93 times tangible book value as of September 30, 2018. The transaction is expected to be $0.07 to $0.08 GAAP accretive on a first full-year basis and $0.09 to $0.10 on a cash EPS basis. The pro forma consolidated balance sheet is estimated to increase Community Bank's total assets to over $11 billion, total loans to $6.8 billion and total deposits to $8.9 million.

I'll now turn it back to Aaron to open the line for questions.

Questions and Answers:

Operator

Thank you, sir. (Operator Instructions) And we'll go first to Alex Twerdahl with Sandler O'Neill.

Alex Twerdahl -- Sandler O'Neill -- Analyst

Hey, good morning, guys.

Mark Tryniski -- President and Chief Executive Officer

Good morning, Alex.

Joseph Sutaris -- Executive Vice President and Chief Financial Officer

Good morning, Alex.

Alex Twerdahl -- Sandler O'Neill -- Analyst

And, firstly, I was wondering, if you can give us a little bit more commentary around your deposit strategies? Obviously 16 basis point cost of deposit is very enviable and while it's risen, it's certainly lagged the rest of the industry pretty dramatically. Do you foresee there being some catch-up in 2019 for those rates to go higher or do you think that a lot of the catch-up has already happened or maybe you can just sort of give us a little bit of color and thinking about, kind of, from where you are standing or sitting about those rates going forward?

Mark Tryniski -- President and Chief Executive Officer

Yeah, I think, for your question, Alex -- it's Mark. I think we would love to be able to play more catch-up, because that means that we need the funding for growing loan portfolio. As you know, 2018, I would say, it was a less than we expected in terms of lending performance. We had record, as I previously mentioned, record levels of originations, but record levels of payoffs as well and it was just kind of a volatile year in terms of both originations and pay-offs. So, I think we've tried to be disciplined in our deposit strategy around the balancing off the need for funding and the maintenance of that funding with the cost of that funding. And I think, as I said in my comments, I think that would -- that I would suggest that's one of the highlights for us for 2018 was the management by our retail team of that funding cost relative to what the funding needs were.

So I think we're going to continue to get upward pressure on those rates over time, as we've seen modestly in the last couple of quarters. I would suspect we'll still lag the market, overall, in terms of betas. I would love to be more aggressive on the deposit side to fund better loan growth.

The other thing I think that's relevant, I think, Joe had mentioned this in his comments, almost 70% of our funding is checking and savings, not money markets. I mean, it's core checking and savings accounts, which actually grew last year the same way they grow almost every year, because it's something that we really focus a lot on in terms of our retail strategy. So I think that's a beneficial composition of our deposit funding. So 70% of that funding, we aren't going to have to really manage, it's the other 30% that we're going to have to manage.

So to answer your question, yes, I would love to be, have to be more aggressive in terms of deposit funding and I hope we have that opportunity in 2019, because it means that we'll grow our loans better than what we did in 2018.

Alex Twerdahl -- Sandler O'Neill -- Analyst

Okay. And then just kind of feeling of that question, you talked a little bit about the loan growth and the opportunities out there and how 2018 has lot of payoffs, that kind of hampered the origination volumes that you did have. Do you foresee maybe with the addition of this new lending office in Albany area as well, the Kinderhook acquisition, to more opportunities in a slightly faster pace market to push that loan growth closer to at least the 3% that's kind of been the target over the last couple of years?

Mark Tryniski -- President and Chief Executive Officer

Yeah, I think that's the whole -- I think we were -- we had lot of payoffs, unscheduled payoffs in the first half of the year. We were hoping that was going to moderate in the second half of the year and it didn't really. And so that was a little disappointing. We hope, again, that doesn't -- it doesn't continue at the same pace into 2019. I think the Albany transaction is going to be very helpful. We have a very strong team there. Kinderhook has a very strong team and it's a good market. We've been doing more in Buffalo as well. We've been doing a little more in Rochester. We've been kind of growing slowly and modestly in the Syracuse market now for a fair bit of time. So I think they're all steps that we take, Alex, to try to incrementally invest in opportunities for that growth.

And the -- one of the challenges strategically for us is that we do business in a lot of non-metropolitan and rural markets, and when you have -- you get to be $11 billion to grow 3%, 4% or 5%, 2% is a big number and it's difficult to accomplish in those smaller markets. So the core funding is very good in those markets and the deposit retention is very good in those markets, but the growth is less. So there's a trade-off there. So we've tried to continue to invest in and maintain those that are metropolitan markets, which is really our core banking strategy and supplement that with modest investments in some of the larger markets where we have the opportunity for some more growth and I think the Albany transaction just kind of highlights that evolution of our strategic thinking around how we continue to grow loans.

Alex Twerdahl -- Sandler O'Neill -- Analyst

Okay. Thanks for taking my questions.

Joseph Sutaris -- Executive Vice President and Chief Financial Officer

Thanks, Alex.

Operator

We'll go next to Russell Gunther with Davidson.

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

Hey, good morning, guys.

Mark Tryniski -- President and Chief Executive Officer

Good morning, Russell.

Joseph Sutaris -- Executive Vice President and Chief Financial Officer

Good morning, Russell.

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

Just a quick follow-up on the margin commentary and I appreciate the color there, mid-3.70%s. Could you just share with us what you're assuming if anything out of the Fed in 2019? And then whether that guidance, as well, includes assumptions around purchase accounting both for past deals and the more recent deal?

Joseph Sutaris -- Executive Vice President and Chief Financial Officer

Yes. Regarding the Fed, I mean our sense of things is, maybe, two additional 25 basis point increases in year. The timing of which, I think, we can all kind of speculate as to when those will come through, but we are anticipating just a little bit of increase from the FOMC on the shorter term rate -- shorter term rates. From a mid-3.70%s perspective, we are anticipating some continued pickup in our loan yields, exclusive of any FOMC changes. Our new rates, our new originations, are going on in levels higher than our existing book yields. I think Mark had mentioned in the last earnings call that those were north of about 30 or 40 basis points, north of the book yields. We've actually seen that increase a little bit in the fourth quarter to, in some cases, 50 to 60 basis points higher than the book yields. So we're anticipating some continued pickup there. We had maturities in repayments of loans that totaling about $330 million in the fourth quarter. So there's -- and that's been a fairly reasonable expectation on quarterly basis. So we are anticipating as those loans run off when we book no -- new loans, pickup the yield on those new originations.

From the deposit side, I think Mark touched on this, we are in the position where we don't have to rash it up, our deposit rates, as quickly as some of our competitors. We do, however, recognize that we do have or had historically very low deposit beta and inevitably, there is some lag in the market even from a competitor standpoint, which will drive up our deposit rates. We do have some large depositors, which have, in the fourth quarter, vast, for some improvements and we've made those accommodations, so we're moving ahead. I think that 3.70%s -- mid-3.70%s is reasonable.

Regarding the purchase loan accretion, we would expect that to continue to trail off a bit with respect to the existing accretion to the tune of about a couple of hundred thousand dollars on a quarterly basis. Obviously that's dependant on the pay-off levels, but I think it's reasonable to expect that to drift down a bit on a quarterly basis.

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

All right. Thank you very much, I appreciate the color there. And then just switching gears to the current business this year. If you have it handy, if you could break out for us the wealth and insurance revenues and then comment on your expectations for those fee verticals on an organic basis for 2019?

Joseph Sutaris -- Executive Vice President and Chief Financial Officer

Right. We've had a, obviously, solid growth in our employee benefit services businesses and in our insurance businesses. Some of that's been acquired, some of that's been organic in nature. Those businesses continue to perform in kind of that mid-single-digit level. From a revenue perspective, we anticipate those levels to be similar in 2019. On the banking fee side, as we mentioned, we have an additional Durbin hit, for the full year another $0.11 there, so it's going to be difficult to move the -- or excuse me, the banking fee line item during 2019, because of the negative impact of Durbin. But on a quarter basis, excluding Durban, 2% to 3% a year has been kind of our history and on a core basis we don't expect that to change considerably in 2019.

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

Okay. Got it. And then just last one for me, ticky-tacky question, but any initial thoughts on the tax rate for 2019?

Joseph Sutaris -- Executive Vice President and Chief Financial Officer

So we came in all in close to 21% this year and the expectations for 2019 are similar, maybe slightly higher. We are going to have some continued amortization or municipal securities portfolio, which will the affect -- the effective tax rate will potentially drag that up a little bit, but I think the expectations for 2019 are similar to 2018.

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

Great. All right. Thanks, guys. That's it for me.

Mark Tryniski -- President and Chief Executive Officer

Thanks, Russell.

Operator

We'll take our next question from Collyn Gilbert with KBW.

Collyn Gilbert -- KBW -- Analyst

Thanks. Good morning, guys. Maybe just first go back to Russell's question on the purchase accretion, Joe. I know, you just said, expect it to trail off $200,000 to $300,000 a quarter, but what was the balance this fourth quarter?

Joseph Sutaris -- Executive Vice President and Chief Financial Officer

It was a $1 million -- it can change, Collyn.

Collyn Gilbert -- KBW -- Analyst

Comparable to the third quarter.

Joseph Sutaris -- Executive Vice President and Chief Financial Officer

Right. Yes. $1.338 million.

Collyn Gilbert -- KBW -- Analyst

Okay. Got it. Okay. And then just back to loan growth, can you -- I know you touched a little bit on this, but just how you're thinking about kind of mix, perhaps, of growth in '19? I know you guys just had a couple of things. Obviously, you sort of changed your pricing and indirect, but you're still seeing good demand. I'm curious if maybe some of that demand is starting to fall off a little bit? Also kind of your outlook for resi mortgages, if you're still assuming really moderate growth there? And then we just kind of -- how you're overlaying the commercial thought? I know paydowns is a big variable here, but just if we think about it more just from your origination initiatives, how we see that shaping for 2019?

Mark Tryniski -- President and Chief Executive Officer

Sure. I'll start with commercial, Collyn. I think, as I said, we had record originations last year with a lot of really strong organic business development success in 2018, which was unfortunately offset by a lot of -- and they were really a lot of more larger payoffs. Companies that were bought by some of our larger customers, bought by private equity, bought by Warren Buffett, bought by strategic buyers, so -- and that is difficult to predict and, as I said, I would hope we don't get the same outcome in 2019. I think if that's the case, I think 2019 will be a better year than 2018 was.

As it relates to the mortgage business, we have -- that business always kind of moves up generally 2%, 3%, 4% in the year. Sometimes we sell more into the secondary market to Fannie Mae and other times depending on what the yield curve looks like it at the time, but generally the originations are pretty consistent and I would expect that we have relatively similar performance in 2019 on the mortgage business, up 3%.

On the indirect auto side, that's really a wild card. I mean, we -- there are years where that portfolio runs off, because auto sales fall off or there are any other much -- they are very tightly tied kind of to the economics in the economy overall and employment and those kinds of things. So that one is really difficult to project. Yeah, we do our own, kind of, internal budgets every year, net business, it's usually a kind of 5 percent-ish type budgetary expectation. Sometimes it comes in at 15 and sometimes it comes in at minus 10. So, both of which are OK. If the opportunity is there to put those assets on the book, the rate figure is attractive in our view, then we'll do that. And if the demand isn't out there or the spreads are too thin, which sometimes happens, whether the demand isn't there or the spread become -- gets thinner, because everybody is chasing that demand. So we tend to back off a little bit. So that one is tough to predict. I think, I don't know if we put in the budget this year for that, but it's probably the usual kind of 3%, 4%, 5% in that business. But, whatever, it's going to be -- it's gong to be -- so -- I mean, I would say, I think, circling back to the leadership transitions that we had in the middle of the year, I think that we've got some folks on the team who have different views on business generation, business development and how we go after different markets. And so, we started to see some of that success in the second half of 2018. I understand that it didn't hit the balance sheet. And I hope that we'll see the benefit of those leadership transitions in 2019.

Collyn Gilbert -- KBW -- Analyst

Okay. That's helpful. And then just shifting gears to Kinderhook. Just trying to understand, I think when we are kind of running the numbers we're coming up with higher EPS accretion than what you guys are offering. Can you give us a little bit more of what's going into your sanctions, I guess maybe beyond the 30% cost saves? And I know there are some volatility or variability there just given that Kinderhook close their own acquisition in the fourth quarter of '17. So -- but just trying to kind of think through that a little bit more. I'm assuming that the Durbin impact is pretty nominal given the commercial orientation of the company, but I don't know, Joe, if you could give us any more sort of assumptions going into those numbers?

Joseph Sutaris -- Executive Vice President and Chief Financial Officer

Yeah. As in most opportunities, we try to be conservative in our assumption side just to make sure of that we're doing the right transactions. So we do assume some modest hit relative to Durbin, a few hundred thousand dollars on a full-year basis, so there's a little bit of that. We also maintain margin expectations similar to current margins. There are some sub-debt and some troughs, which we're going to hold onto until we have the opportunity -- until we have the opportunity to pay those off. So we're keeping margin about the same. We always have the modest assumption around some run-off on loans of deposits just through the transition and then sort of pickup opportunities and growth going forward. So, we have some of that baked in as well.

And then, of course, because this is a cash transaction there we also have a use of cash or I should say a cost of cash comparable to the fed funds rate, so we won't have the ability to utilize that $93 million on an overnight basis, so that also pulls back some of the accretive nature from a GAAP perspective.

Collyn Gilbert -- KBW -- Analyst

Okay. Okay, that's helpful. That's helpful. And then just I guess broadly, Mark, maybe thinking about M&A, I think you guys had said last quarter that as you were looking at M&A, you guys are in a tough spot, because given your funding basis just so superb that anything you would acquire would likely dilute that. How are you thinking then Kinderhook comes along? Obviously, you saw value there that would offset any potential balance sheet change that you're going to see, but how are you thinking about M&A going forward? I mean, it's -- you're sitting with a very healthy currency, certainly relative to so many of your targets, if we are starting to enter into -- I mean, your growth has always been more moderate anyway, but more broadly or slower economic environment, I mean, do we -- could we see any acceleration of M&A for you guys, maybe larger transactions or -- and then maybe also feed into what you're seeing on the non-bank side in terms of deal likelihood for '19, as you said, you've got plenty of capital to deploy.

Mark Tryniski -- President and Chief Executive Officer

Sure. Good question, Collyn. I think our strategy around M&A has not really changed a lot. It's really about risk/reward. It's about our confidence and our ability to grow using M&A in a way that it creates flowing and sustainable cash flow per share for our shareholders, and that's the kind of the lens that we use to evaluate opportunities. And there was lot of elements sticking with that kind of risk/reward, and some of its execution and integration risk, for example, if we were to do something in geography, which is two states away, that creates an awful lot more risk, which just requires that much more rewards.

So we spend a lot of time evaluating the risk/reward profile of opportunities, but always through the lens of, do we have confidence that this can create growing and sustainable cash flow per share for our shareholders? So, we are in at enviable position in a sense, I would prefer to use the capital buildup in accumulating capital to fund organic growth. But that's never been a significant part of our model. It's certainly part of the model and we have to pull a lot of levers, one of them is organic growth, one of them is M&A, one of them is our non-banking businesses, another one is funding costs, asset quality. So we're pulling a lot of levers to try to create that double-digit return to shareholders over time. And M&A is not an unimportant part of that strategy. So the Kinderhook transaction, I think, as I said, is geographically and strategically very sound for us. It's not a large transaction, but it's a solid strategic transaction and I think the economic benefit in terms of the accretion and cash flow generation per share is pretty good for a transaction of this size for us.

As you recall, the Merchants transaction has won a couple of billion dollars or close to it in terms of assets that we did in 2017. That was the largest transaction we've ever done. We certainly have, particularly given the strength of our currency, the opportunity to do bigger things. But to do bigger things means we have to have more confidence on our ability to execute effectively and to create debt growing a sustainable value for our shareholders. So I wouldn't count out a larger transaction. We look at a lot of things on an on going basis and some of them are larger than the Merchants transaction in $2 billion and some of them are smaller. So I would say the overall philosophy hasn't changed as much. And, as you know, we've never been impatient. We are not going to grow for the sake of growing. That is something we are never going to do. It has to be -- I mean, we're not going to squander -- our shareholders have entrusted us with a strong currency and we're not going to use it in a way it doesn't make sense for us and for our ability to continue to execute and create above average returns. So, we continue to be very judicious.

I mean, the challenge -- and you understand this, but you have a valuation we have, everything we do is accretive. The question is, what's the risk? How does it fit into our strategy? Is the risk/reward sufficient? Is there enough accretion? Because that's just about is it accretive, it's about is it accretive enough. So we frequently walked away from discussions around price. So we will continue to be very judicious in terms of how we use our capital and our currency, and we're always mindful of the confidence that our shareholders have placed in us relative to our -- to that valuation. So, we'll continue to be judicious and if there is an acceleration of opportunity that fits the profile of our thinking around M&A, then we could accelerate. If that opportunity doesn't arise, then we will look to other opportunities and other of those levers that we pull.

I think, Collyn you had the follow-up questions on the non-banking opportunities. We did do a number of, probably four or five, smallish, very smallish, let's call it, adds to our insurance and wealth management business in 2018 that were pretty additive to those franchises, but really small. I think, the benefits business now is by far the largest of our non-banking businesses. We continue to have opportunities really across the country that we look at in terms of the benefits business, but the challenge with that is that the private equity players have become very involved in that space. And so some of the things that we've looked at has been priced accordingly. So that could be a potential headwind and benefits transactions.

But we continue to have dialog with some in the space that we know, because we've been in the space for long time and people know who we are and we know who they are and we continue to have conversations with sellers who want to sell to a strategic partner and not to fund. So I think we'll continue to have those and look for those opportunities. It is difficult to predict the flow of those at all. I think, we will probably continue to add some of these sensible smallish insurance and wealth management opportunities as they arise and we'll keep looking, I mean, the benefit space as well and keep talking. And that -- we've always been able to grow that business pretty well organically. And so, in between opportunities that are M&A related, we expect to continue to grow all those not banking businesses organically, but I would suggest the same discipline that I discussed as it relates to the bank, but also apply to those businesses. And in some of those spaces, the pricing is just -- it's not even believable. So it makes it a little bit more of a challenge. But I would say, on the whole, similar M&A strategy to what we've had in the past has to be high value opportunities and we're going to be disciplined about how we execute on those opportunities.

Collyn Gilbert -- KBW -- Analyst

Okay. That's helpful. I'll leave it there. Thank you, guys.

Mark Tryniski -- President and Chief Executive Officer

Thanks, Collyn.

Joseph Sutaris -- Executive Vice President and Chief Financial Officer

Thank you.

Operator

We'll take our next question from Matthew Breese with Piper Jaffray.

Matthew Breese -- Piper Jaffray -- Analyst

Good morning, everybody.

Mark Tryniski -- President and Chief Executive Officer

Good morning, Matt.

Joseph Sutaris -- Executive Vice President and Chief Financial Officer

Good morning, Matt.

Matthew Breese -- Piper Jaffray -- Analyst

Just to follow on the M&A question. As I think about Kinderhook in the long line of bank acquisitions, it makes a lot of sense and the markets you're going into fit in with, I think, a lot of the CBU markets that you play in now. I guess, my question is, if the loan growth doesn't materialize and payoffs continue at such a robust pace, might we see a change in strategy and acquisitions in, perhaps, more economically vibrant areas of the Northeast? I mean, might we see you had more toward Boston or Philly?

Mark Tryniski -- President and Chief Executive Officer

I would say, as we get larger over time, I guess, we're not, again, this isn't about growth, it's about growth or it's about discipline and control growth, it's not about using our currency just to get bigger, the shareholders don't benefit. The same way we have to move from some of these really, kind of, rural markets into Syracuse and Buffalo and Rochester, now Albany in terms of lending and less on a retail basis. Over time, when we get to be -- if we go from $11 billion to $15 billion or $20 billion, might we now need to start taking a look at, well, do we need to be in Boston or New York or Pittsburgh or Philadelphia or something, an actual larger urban cities. I don't see it on the horizon, honestly.

In the near term, I think there's a lot of opportunity for us in some of these upstate markets. I think, there is opportunities in markets in Pennsylvania. We have Vermont pretty much covered, right now, when we've talked about our interest overtime in Ohio and we continue to have dialog and try to understand that market a little bit better in terms of where opportunities are. So I think it would be part, maybe, well into the future of our strategy, but I don't think it's something that going into it. I mean, we don't know how to lend in Boston. I don't think we know anything about it and we don't know anything about New York City and I think it's different. And I think we're comfortable with the, kind of, second tier cities.

I know we can lend in Buffalo, in Syracuse, in Rochester, in Albany, in Burlington and Springfield, Massachusetts and Scranton and Wilkes-Barre, Pennsylvania. I know we can lend there, we do lend there, I think we're good at lending there. And so expanding that into similar geographies, I think, make sense, we'd probably do that at on continuous basis. We did -- as I said, we started up the Albany LPO last year, in 2018. And I think, strategically, we will be looking to do something similar to that in 2019 in other region that affords us better growth opportunities. So I think it's all just part of transition over time of our business model. I would suggest it to going on for 20 years and will probably go on in the next 20. So -- but we don't certainly have any near-term thoughts of being in Boston or New York.

Matthew Breese -- Piper Jaffray -- Analyst

Understood. And as we think about the paydowns and all the reasons behind the paydowns, is it mostly takeout driven or are there any common threads behind the customers that you can look to and make an educated guess as to whether or not the pace of paydowns could accelerate or decrease in the year ahead?

Mark Tryniski -- President and Chief Executive Officer

I mean, I would argue it's a little bit of everything. It's a little bit of everything. I think if you look at the big ones, it was private equity, it was Warren Buffett, it was much larger strategic buyers coming and looking to accelerate growth themselves and paying significant premiums. Some of the smaller stock was, gee, our business is doing really well and we can pay you down. Some of it was takeouts by other banks who were offering terms that we weren't prepared to match just because of the economics. So, it's a little bit of everything, the big ones were clearly takeouts though.

Matthew Breese -- Piper Jaffray -- Analyst

Okay. And I guess as a follow-up to that, if the loan growth does remain somewhat sluggish on a net basis and capital builds, are there other avenues we might see change in the year ahead, meaning to increase the size of the securities portfolio, do you do anything with the share buyback or continue to increase the dividend at a pace that's a little bit ahead of what we've seen in recent years?

Mark Tryniski -- President and Chief Executive Officer

I think, we've -- Joe mentioned -- referenced to maybe pre-investing on some of the securities cash flows that mature in '19 and into '20, and so that's something that we've looked at as a way to utilize that capital and you think about that. We have a couple of hundred million, maybe more of capital really above and beyond of what we need to really carry. Particularly if you look at the composition of our balance sheet, the low risk composition of our balance sheet, probably that's one more disciplined lending, but, two, we're in good markets in terms of volatility in the history of losses. So we have a low risk balance sheet. And so, we're clearly carrying capital that -- it might be -- our shareholders aren't getting a return on right now. So we've looked at that in terms of the investment portfolio. There is actually some spots in the market right now where it might make sense to do that. There is things that are high-quality assets that are disconnected from the treasury yield curve, that's very flat and I talked about things like agency-backed mortgages, mortgage securities and things like that.

So there are spots in the market, where, I think, that we think our Chief Investment Officer thinks would be deployable at this point. So though Joe made reference there, whether that happens or not in 2019, I think this is the function of what happens in the markets, but that's something that we're looking at and I think it is a reasonable deployment of capital for us and our shareholders.

The stock buyback, we haven't bought back stock in a long, long time. I don't know that we just don't really look that as a strategy, it's kind of a one-time hit and I would rather deploy capital into savings that can, one, be more leveraged, for example, even in the securities market, or, number two, invest in a business that has the capacity to grow over time, but just buying back your stock have never -- I never thought that was a fabulous strategy to create shareholder value. But I think if there was a significant change in the market, then we would probably consider that, the debt that's -- it's not first on our list in terms of capital deployment.

Matthew Breese -- Piper Jaffray -- Analyst

Understood. Okay. That's really all I had. I appreciate for taking my questions. Thank you.

Mark Tryniski -- President and Chief Executive Officer

Thank you.

Operator

We'll go next to Erik Zwick with Boenning & Scattergood.

Erik Zwick -- Boenning & Scattergood -- Analyst

Hey, good morning, guys.

Mark Tryniski -- President and Chief Executive Officer

Good morning, Erik.

Joseph Sutaris -- Executive Vice President and Chief Financial Officer

Good morning, Erik.

Erik Zwick -- Boenning & Scattergood -- Analyst

And just a couple of quick ones from me. Most of my questions have been answered at this point. On Kinderhook, within the 8-K you filed yesterday, there was a comment about projected capital ratios remaining well above regulatory requirements, can you provide any quantitative expectations for the impact to tangible book value and the capital ratios at closing?

Joseph Sutaris -- Executive Vice President and Chief Financial Officer

Yes. We're anticipating about 100 basis point change in our tangible equity to net tangible assets ratio. We finished Q4 '18 at 9.69%. So we would expect that. We're anticipating a tangible book value per share change of about -- a dilution of about 95 basis points, but all of that -- the Tier 1 leverage ratios at the holding company level are going to remain well above -- above well capitalized standards in the range of 10%. So from a capital perspective, but it basically stalls back the clock a couple of quarters.

Erik Zwick -- Boenning & Scattergood -- Analyst

That's helpful. And then just on the potential sources and timing of their projected cost savings?

Joseph Sutaris -- Executive Vice President and Chief Financial Officer

Well, I think, we anticipate the transaction closing in June, at some point in June, and it's not a large transaction. So there maybe more of those cost saves that you get more immediately than in other transactions, but I would suggest that they will be fully executed by the end of the year, the very late. So, let's say, it's going to take a quarter or two to get everything in.

Erik Zwick -- Boenning & Scattergood -- Analyst

Okay. That's fair. And since you don't have much of a real estate presence in the Capital District Area at this point, what is the -- so I assume, maybe, you're not closing too many branches, what are the potential -- or I guess what are the targeted sources for the savings?

Joseph Sutaris -- Executive Vice President and Chief Financial Officer

It's mostly IT-related costs and other operating expenses. There will be, as there always is, redundancy of personnel in certain places. So, it's going to be mostly just operating expenses. There is no overlap in facilities. Well, there's one. We have an office, a small office in Albany right now and we'll probably consolidate that somewhere, but there's no meaningful real estate savings to speak of it, mostly other operating expenses.

Erik Zwick -- Boenning & Scattergood -- Analyst

Great. I appreciate it. Thank you.

Mark Tryniski -- President and Chief Executive Officer

Thank you.

Operator

And with no further questions in queue, Mr. Tryniski, Mr. Sutaris, I'd like to turn it back to you gentlemen for any additional or closing remarks.

Mark Tryniski -- President and Chief Executive Officer

Excellent. Thank you, Aaron. Thank you, everyone, for joining the fourth quarter conference call, and we will talk to you again in April. Thank you.

Joseph Sutaris -- Executive Vice President and Chief Financial Officer

Thank you.

Operator

This concludes (ph) the today's conference. We thank you for your participation. You may now disconnect.

Duration: 60 minutes

Call participants:

Mark Tryniski -- President and Chief Executive Officer

Joseph Sutaris -- Executive Vice President and Chief Financial Officer

Alex Twerdahl -- Sandler O'Neill -- Analyst

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

Collyn Gilbert -- KBW -- Analyst

Matthew Breese -- Piper Jaffray -- Analyst

Erik Zwick -- Boenning & Scattergood -- Analyst

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