Hello, everyone and welcome to the Financial Institutions Fourth Quarter and Full Year 2022 Earnings Conference Call. My name is Bruno, and I will be operating your call today. [Operator Instructions] I will now hand over to your host, Pamela Kennard, Investor Relations Analyst. Pamela? Please go ahead.

Thank you for joining us for today's call. Providing prepared comments will be President and CEO, Marty Birmingham; and CFO, Jack Plants. Chief Community Banking Officer Justin Bigham; and Director of Financial Planning and Analysis, Mike Grover will join us for Q&A. Today's prepared comments and Q&A will include forward-looking statements. Actual results may differ materially from forward-looking statements due to a variety of risks uncertainties and other factors. We refer you to yesterday's earnings release and investor presentation as well as historical SEC filings all available on our Investor Relations website for our Safe Harbor description and a detailed discussion of the risk factors relating to forward-looking statements. We'll also discuss certain non-GAAP financial measures intended to supplement and not substitute for comparable GAAP measures. Reconciliations of these measures to GAAP financial measures were provided in the earnings release filed with an exhibit to Form 8-K. Please note that this call includes information that may only be accurate as of today's date January 31, 2023. I'll now turn the call over to President and CEO, Marty Birmingham.

Thank you Pam. Good morning, everyone and thank you for joining us today. Fourth quarter net income available to common shareholders was $11.7 million or $0.76 per diluted share down as compared to linked and prior year quarters. The decline was primarily the result of higher provision for credit losses and lower PPP-related revenue described in detail in our earnings release. Adjusting for revenue related to PPP loans restructuring charges and impact of the third quarter 2022 surrender and redeployment of company-owned life insurance pre-tax pre-provision income for the quarter was $20.8 million $261,000 higher than the linked quarter and $865,000 higher than the prior year period. I believe these are strong results in a challenging operating environment. Organic loan growth was once again a highlight this quarter with 4.7% increase in total loans from September 30. All major loan categories contributed to this growth with increases of 4.8% in commercial business, 7.4% in commercial mortgage, 2.1% in residential real estate and 2.6% in Consumer Indirect. As our loan portfolio has grown over the past several years, I reinforce our commitment to credit discipline and the management of risk. We have continued to invest in credit and risk personnel and develop what we believe is an effective and efficient risk and control environment. A current example is the transition of Randy Phillips to a newly created position of Deputy Chief Credit Officer from his current role of Chief Risk Officer. With 32 years of local commercial credit experience Randy has the skills and experience to help lead and support a continued evolution of our credit delivery function. The Chief Risk Officer role will be assumed on February 6 by a risk professional who has 34 years of progressive experience in compliance consumer credit, audit and operations, while working for international,…

Thank you, Marty. Good morning, everyone. Loan growth contributed to an $81,000 increase in net interest income from the linked quarter. The impact of PPP loans is winding down, as only $1 million of these loans remained as of December 31. During the fourth and third quarters of 2022, $1.6 million and $6 million of PPP loans were forgiven, respectively, with a related fee accretion of $78,000 in the fourth quarter as compared to $312,000 in the third quarter. NIM, on a fully taxable equivalent basis, was 323 basis points in the fourth quarter of 2022, down 5 basis points from the linked quarter due to repricing and the seasonality of our public deposit portfolio, coupled with a shift in mix from lower cost transaction deposit accounts to higher-cost time deposits. Relative to the magnitude of FOMC rate increases that occurred in 2022, our total deposit portfolio has experienced a cycle-to-date beta of 22%, including the cost of time deposits. Excluding the cost of time deposits, the non-maturity deposit portfolio had a beta of 7%. The investment securities portfolio was down slightly from the linked quarter as a result of the use of portfolio cash flow to fund loan originations in the quarter. As I stated in the earnings press release, for 2023 we have modeled cash flows of approximately $1 billion from the investment and loan portfolios for reinvestment and new loan originations at market rates, benefiting NIM. Our cost of funds was 109 basis points in the current quarter, up from 58 basis points in the linked quarter due to the impact of higher rates on public and reciprocal deposits and wholesale borrowings, combined with a shift in overall mix from lower cost transaction deposit accounts to higher-cost time deposits. Non-interest income, which includes revenue from our insurance…

Thank you, Jack. We are proud of our many accomplishments in 2022. In addition to delivering strong financial and operating results in a challenging environment, we achieved the following: in February, Five Star Bank launched a commercial lending platform in Baltimore and Washington D.C. by taking advantage of experience and available talent to hire a team of four commercial banking officers. As previously mentioned, this team is experiencing great success in establishing relationships with strong sponsors and closing loans. During the second quarter, we took advantage of the opportunity to sell a $31 million portfolio of indirect loans and recognize a gain of $586,000 demonstrating our ability to capture gains within this portfolio by leveraging capital market relationships to remix loan exposures. In September, we celebrated the grand opening of Five Star Bank Center, the new home of our Western New York regional administrative office and SDN Insurance Agency. This was an investment in both the Buffalo region, and our future in this important market. The investment underscores our commitment to Western New York and our valued local associates, setting the stage for continued growth in the Buffalo market. Our BaaS pipeline expanded throughout the year and as noted in our investor presentation we have several partnerships in various stages of on-boarding. We also remain steadfast in our mission to support our customers and our communities. For the fifth consecutive year, our Five Star Bank Community Report highlights the ways in which we are fulfilling our purpose in promoting sustainable business practices that deliver long-term value to the communities we serve as well as our shareholders. I encourage you to read the Five Star Bank 2022 community report available on the Five Star Bank website, and our Investor Relations website to better understand the many ways we keep people at the heart of everything we do. Our positive momentum continues in 2023. Just last week, we announced our expansion into the Syracuse market, with a new commercial loan production office in the city's historic Franklin Square. This new office provides entrance into Onondaga County expanding Five Star Bank's Upstate New York footprint to 15 counties throughout Western New York, the Southern tier, and the Finger Lakes region. The Syracuse office will be home to a three person commercial and industrial team, and a commercial real estate banker. In accordance with our strategic plan, we've expanded beyond our historic rural Upstate New York footprint, to serve metros like Buffalo Rochester, and now Syracuse. This most recent expansion supports our focus on driving credit disciplined loan growth, and growing deposits by bringing our style of community banking, with local leadership and local decision-making to businesses of all sizes throughout Central New York. In closing, I would like to thank my fellow teammates for their ongoing dedication and commitment. Their efforts are instrumental to our achievements and ongoing success. Operator, please open the call for questions.

[Operator Instructions] Our first question is from Alex Twerdahl from Piper Sandler. Alex, your line is now open. Please go ahead.

Hey, good morning, guys.

Hey, good morning, Alex.

First off Jack, I was hoping you could give us a little bit more on the $1 billion of cash flow from the securities and loans. I guess first off, how much of that would you need just to keep the loan portfolio flat? I'm just trying to figure out how much might be excess after the loan growth guidance that you gave us.

So if we're bifurcating that guidance between the two portfolios, we're currently modeling $180 million in cash flow from the securities portfolio and then about $900 million in cash flow off the loan portfolio.

Okay. And is that going to be – should we expect those cash flows to be pretty consistent throughout the year, or are there any big chunks in there that we should be aware of?

It modeled to be a little fairly consistent. There is lumpiness in the commercial portfolio. But from a timing standpoint we would expect that to be relatively flat over the year.

Okay. And then when we think about the reinvestments of that into new loans. Can you give us a little bit of sense for what kind of rates you're getting? What kind of yields you're getting on new production? And if that is different across the different portfolios as well as the different geographies that you're in?

Yes I can comment on the total portfolio. Just as recently as December, we were seeing new origination rates in the commercial portfolio come on around 7% and a little bit better in the indirect portfolio.

Okay. And the last question that I had is on the $150 million of deposits from the Banking as a Service relationships. Would those typically be time deposits or transactional deposits, or what kind of – I guess what kind of rate would you need to pay on the types of deposits that those relationships would generate?

Those are generally non-maturity deposits and the rate that we would have there is favorable to what we're seeing in the time deposit space. So I'm not going to comment purely on what we're paying but it does benefit margin.

Great. Thanks for taking my questions.

Thank you, Alex.

Thank you, Alex. Our next question is from Damon DelMonte from KBW. Damon, your line is now open. Please go ahead.

Good morning, guys. Thanks for taking my questions today. With respect to the deposit betas, I think Marty you made a comment that cycle to date you see about 22% deposit beta. What is like the full cycle expectation from you guys on your end?

I think Jack made that comment 22% all-in and – in maturity. Go ahead, Jack.

Hey, Damon. Yes, so cycle to date through the end of the year we were at 22% for total deposits. As we look at our expectations for rate increases in 2023 and then go back and consider that full cycle which would essentially be two years, right? We're looking at 25% to 30% cycle to date betas.

Okay. So you feel like you got the majority of it pushed through already if you're already at 22%, right?

Yes from what we observed in the fourth quarter.

Got it. Okay. And then with respect to the growth you guys have been getting in the Mid-Atlantic, could you just give a little bit more color on the size and the type of industries that these loans are for? I know they're predominantly office space but what kind of businesses are these supporting?

So it's really kind of been across the board. We've seen some very nice health care-related opportunities related to tenants related to the federal government and others in between.

Got it. Okay. And what about like the average size of these credits?

It was $7 million to $12 million – summer have been larger. But on the whole it's been fairly granular.

All right. Great. And then lastly the guidance calls for 35 to 40 basis points of net charge-offs. So when we think about loan growth, when we think about that level of charge-offs, the reserve was around I think 112 in this last quarter. Is your goal to hold that? Is your goal to grow that a little bit kind of just given growing uncertainty trying to kind of triangulate to figure out how we should think about actual provision each quarter.

Yes. Damon, I think, you're spot on there. The coverage ratio of 112 basis points is consistent with where we were from our day one CECL modeling, and there are moving parts of the CECL model related to unemployment forecast, which is our quantitative driver, but that coverage ratio makes me comfortable when I look at the credit quality of our portfolio. So holding that against loan growth and modeling 35 to 40 basis points of charge-offs should get you to the number you need from a provisioning standpoint.

Perfect. Great. That's all that I had. Thank you very much.

Thanks, Damon.

[Operator Instructions] Our next question is from Erik Zwick from Hovde Group. Erik, your line is now open.

Good morning guys.

Good morning, Erik.

First just wanted to start, make sure I've got something right, Jack. In terms of the outlook for non-interest income to be relatively flat in 2023 versus kind of that adjusted 2022 number -- sorry, if I missed this. Can you just refresh me on what that kind of adjusted 2022 base number should be?

Yes. We stripped out $2 million of gains that we had from or additional income we had from a bank-owned life insurance enhancement realized in the third quarter when we surrendered and redeployed part of that portfolio. So we consider that to be non-recurring.

Okay. Just that $2 million?

Yes.

Great. Thank you. And then in terms of -- you talked a little bit about the cash flow coming off of the securities portfolio. That book has shrunk over the last year or so in terms of percentage of total assets down to about 20% now. What would be the optimal size relative to total assets for the securities portfolio in your mind?

Yes, if we get down to the 18% range, I think, that would be comfortable.

Got it. And then in terms of the $350,000 of restructuring charges related to the branch closures, I think, you mentioned there are write-down in the real estate assets to fair market values based on current market conditions. Curious if those fair value marks are kind of something specific related to those branches, or if there's anything larger you're seeing in terms of real estate values in your markets, or any kind of broader view or read through we could take from those marks?

Those were five branches that were located in our rural banking footprint. Two of those are under sale agreements at this stage of the game. And the other three were written down to recent broker opinion of value as of year-end. So it's just reflective of market conditions for older abandoned bank space in that area.

I think it's specific to these buildings, these facilities versus a larger issue in the marketplace. These are kind of single-use type of facilities, some are older. And they're in markets where demand is pretty modest.

Correct.

That's helpful. That's what I expected, but I just wanted to make sure. And then last one just thinking about the Banking-as-a-Service initiative. Just curious if you can kind of update us on from a bigger picture perspective where you are in the entire process? And what goals or milestones you hope to reach in 2023 you mentioned the deposits that you expect about $150 million of deposits, but just curious what else you're kind of targeting and looking for this year?

Well, the way, we're thinking about that first and foremost is to make sure that we have a curate -- a series of opportunities that end up being a reasonable risk and really in alignment working with companies that are in alignment with our own approach to our risk appetite statement. As we indicated in our investor deck, we've got five opportunities that we're in various stages of. One is live, and two are in integration onboarding, and two are in testing right now. So we are emphasizing commercial business versus consumer, because we think that that's a more sustainable opportunity over the longer-term. And we can -- from a budgeting standpoint, it's inject's guidance that in the next 12 months what we're investing is and what will the benefits and the costs will end up offsetting each other and be neutral to our budget. But over time we see large opportunity, substantive opportunity in terms of driving non-interest revenues contributing to our deposit portfolio and a modest amount of utilization of the balance sheet relative to lending.

Great. That was very helpful. That’s it from me. Thanks for taking my questions today.

Thanks, Erik.

Our next question is again from Alex Twerdahl from Piper Sandler. Alex, your line is now open. Please go ahead.

I just want to follow up quickly on the announcement you guys made earlier this week on Syracuse. And I was hoping Marty maybe you could talk a little bit more about the overall strategy in that market. I know there's been a major investment announced by Micron. And I'm just curious, if this is kind of the start of an overall longer-term strategy to kind of be a little bit more active in that market or how you're thinking about it?

So thanks for circling back, Alex. We've been active really in that market servicing it at the end of our geographic footprint, which is halfway between Rochester and Syracuse out of our Auburn market, but we've had significant participation through seasoned relationship management. Our regional president is a long-term commercial banking professional that's really helped us drive some very nice opportunities full commercial relationships. And so based on that experience, we've been working together to build out a loan production office including importantly our human capital that would help us lead that initiative. The Micron announcement really is indicative of what we've been talking to investors about for a number of years and that on a regional basis New York State has been encouraging regions to work together to develop strategic economic development plans that are grounded in the assets, the technology, the human capital that is in the regions, the industries that are there and to pursue it and to leverage the collaborative opportunity for investment that comes through the public sector private sector and other sources. So the Micron deal obviously was turbocharged through the Senate majority leader and others and we see that as very significant upside relative to that region. But I would just point out that as you go down the true way there are very bright opportunities in every kind of so-called major city Buffalo, Rochester, Syracuse, Utica and Albany as a result of that collaborative regional economic development process.

Great. That’s really helpful. Thanks for taking my follow-up.

Thanks.

We currently have no further questions. I will now hand back to our speaker Mr. Birmingham. Mr. Birmingham, please go ahead.

Thanks so much for your assistance operator this morning. Thanks to all who participated. We look forward to continuing to build on our communication with you at the conclusion of our first quarter results. Thank you.

Ladies and gentlemen, this concludes today's call. Thank you for joining. You may now disconnect your lines. Have a good day.