Good morning, and welcome to the Financial Institutions, Inc. Third Quarter 2019 Earnings Conference Call and Webcast. All participants will be in listen-only mode. [Operator Instructions] Please note, this event is being recorded.I would now like to turn the conference over to Ms. Shelly Doran, Director of Investor and External Relations, Executive Vice President and General Counsel. Please go ahead, ma'am.

Good morning. Thank you for joining us for today's call. Providing prepared comments will be President and Chief Executive Officer, Marty Birmingham; and Chief Financial Officer, Justin Bigham.During the question-and-answer portion of the call, they will be joined by Chief Banking and Revenue Officer, Bill Kreienberg; and Director of Financial Planning and Analysis, Mike Grover.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 historical SEC filings, which are available on our website for a 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 that are intended to supplement and not substitute for comparable GAAP measures. Reconciliations of these non-GAAP measures to GAAP measures were provided in the earnings release, which was filed as an exhibit to the Form 8-K. Please note that this call includes information that is accurate only as of today's date, October 30, 2019.I'll now turn the call over to Marty.

Thank you very much, Shelly. Good morning, and welcome to our third quarter earnings call. We are pleased to report another strong quarter with net income of $12.8 million or $0.78 per share. Pretax pre-provision income was $19 million, 13.6% higher than the second quarter of 2019 and 24.7% higher than the third quarter of 2018. Both net income and pretax pre-provision income were the highest in company history.Our results reflect the hard work of our teammates, resulting in effective execution of strategies intended to drive long-term shareholder value. Outcomes this quarter reflect the continued focus on balance sheet optimization, including the conversion of securities to relationship-based loans, downscaling the consumer indirect portfolio and building tangible capital, while remaining disciplined with the management of expenses, growth in noninterest revenues and maintenance of a robust credit culture.Meaningful progress was achieved in the third quarter related to realizing positive operating leverage and higher return on average assets and return on average equity. During the quarter, in addition to including the redeployment of securities, we took advantage of a market opportunity to convert unrealized gains by selling $65 million of investment securities generating a $1.6 million gain. Proceeds of $65 million were immediately reinvested into investment securities with intermediate durations. This repositioning was completed without materially impacting portfolio yield.We expect to continue to take advantage of these opportunities when they become available to us. Growth in total loans was relatively flat during the quarter due to 2 factors. First, we experienced a higher than typical level of loan payoffs in the quarter following 2 quarters of very low payoffs. A portion of this activity was transactional. For example, one customer was sold, resulting in the repayment of a $5.3 million loan. Another was a sizable C&I relationship that we strategically participated to another…

Thanks, Marty. Good morning, everyone. I'll be providing commentary on a few key items with comparisons to the second quarter of 2019.Net interest income was $32.5 million, flat compared to the linked quarter. This was the result of lower average interest-earning assets in the quarter, offset by the impact of net interest margin expansion. During the third quarter, as Marty discussed, we sold and immediately reinvested $65 million of securities, realizing a gain of $1.6 million. That transaction had an immaterial impact on our NIM. Additionally, and in line with guidance, this quarter, we concluded our balance sheet strategy of redeploying investment securities into higher yielding loans.Going forward, we expect the securities portfolio to float within a range of $780 million to $800 million depending on the level of municipal deposits. The decrease in securities was greater than the increase in loans during the quarter, resulting in lower average interest-earning assets for the period. The timing of loan growth in the third quarter of 2019 resulted in a temporary deployment of a portion of investment security proceeds for other purposes.NIM for the quarter was 3.29%, up 1 basis point from the linked quarter. Margin expansion was positively impacted by the repositioning of the balance sheet as loans became a higher percentage of earning assets. Our average yield on loans was 4.77% in the quarter, down 5 basis points from the second quarter. The average yield on interest-earning assets was 4.29%, unchanged from the linked quarter. Our cost of funds decreased by 1 basis point as compared to the second quarter [technical difficulty] 100 basis points.Total loans increased by 0.2% from the end of the second quarter as a result in growth in commercial mortgage and residential real estate of 2.5% and 2.3%, respectively, offset by decreases in commercial business and…

Thank you, Justin. Before we open the call for questions, a few concluding comments, during last quarter's call, I commented that we were about to deploy improvement initiatives to identify and take advantage of opportunities to improve efficiency while enhancing customer experience and employee experiences. We continue to pursue opportunities to maintain expense discipline, improve operational efficiency and automate low-value repetitive activities using robotic process automation.Our executive management team and senior leadership supported by capable improvement advisers, who specialize in near term self-funding business process improvement, have initiated a program to improve company operations across the enterprise, also to deliver enhanced customer experience and improve operational efficiency to create incremental capacity and more effectively leverage our costs.With regard to 2020 guidance, we will -- that will be communicated during the call at year-end, in January, we intend to provide more details on the costs and benefits of the substantive strategic opportunity.Ilene, this concludes our prepared comments.

Thank you, sir. We will now begin the question-and-answer session. [Operator Instructions] Our first question is from Damon DelMonte of KBW.

So just first question, if you could just kind of talk a little bit about the margin. I think, Justin, you said that you look for a little bit of modest expansion here in the fourth quarter. Could you just talk a little bit about your rate expectations by the Fed as far as cuts coming this year or into next year? And kind of how that plays into your outlook?

Yes, sure, Damon. So that outlook has a cut today and does not assume anything more than the cut that's going to happen -- that we anticipate will happen today.

And if there were to be another cut in December or one in March, how is the margin positioned to handle that?

Well, we continue to be very slightly liability-sensitive. And so my -- I would anticipate that a rate cut in December would have only marginal impact on our margin.

Got it. Okay. All right, great. And then with regard to the outlook for loan growth, could you guys just give a little bit of color on what you're seeing throughout your footprint and where the best opportunities are for that growth? And kind of what you're targeting over the next handful of quarters?

Well, I think, Damon, this is Bill Kreienberg. We've -- given our guidance as to where we think we'll end up overall from the indirect portfolio, we've commented on our conscious efforts to reduce the size of the portfolio. But from a commercial point of view, our pipelines remain pretty full. We are seeing a lot of very good opportunities and going through our normal process. So we haven't seen any, what we would call, economic weakening in our footprint, and we remain confident about our ability on the commercial side to deliver the loan growth.

Okay. Great. And then just one final question on expenses. The FDIC credit that you guys received this quarter, are you expecting to begin to accrue again next quarter? Or how should we model that out?

We will be able -- we will have enough credits to see FDIC costs similar to this quarter, next quarter as well.

Our next question is from Alex Twerdahl of Sandler O'Neill.

First off, I just wanted to ask a follow up on the expense initiatives that you were talking about a minute ago, Marty. Is there a specific objective or target that you have in mind in terms of efficiency ratio or ROA or anything like that, that you kind of have in the back of your mind as you look at these expense initiatives?

So I anticipate that we will be much more definitive in January with you. But I think we have a material opportunity to think constructively and critically about the operations of the company. And as I said, Alex, it's an enterprise-wide initiative. We are being supported by capable consultants who are going to support our ability to execute a project in a very definitive and timely manner.

Okay. And it's going to -- is it mostly going to be targeting expenses or is it going to be looking to spend more in order to make a lot more?

Right now, we're looking at process improvement and efficiency. If there are ideas relative to revenues, we'll be open to those. But as I said, we will communicate the cost and our anticipated benefits of the program. I think reengineering has gone through general business. Certainly, it has gone through the banking industry over the course of the last 20 or so years. And we have that opportunity available to us, and we're going to take advantage of it.

Great. And then just kind of to elaborate on the margin commentary, given that you guys are kind of a little bit on the liability-sensitive side and now with a 2, probably 3 later today cuts, it doesn't look like we're going to get any increases anytime soon. I mean, would it be fair to say that the margin at kind of 3.29%, that's kind of like sort of a low end for where the margin will be over the next, call it, 4 to 5 quarters?

Alex, that's a great question. It's very difficult to sort of project out that far. As you can imagine, it depends a lot on the shape of the curve, not just overall Fed funds target rates. And if the shape of the curve was to change materially, it could have a material impact on the margin. I guess the way that I would think about it is our slightly liability-sensitive commentary is really more of a 1-year kind of view.And as you get to year 2 and year 3 and year 4, obviously, at some point, if rates continue to decline, you're not able to continue to reprice your liability side as low as your asset side can continue to come down. So it's just not as simple of an answer of that. But I can tell you that we will provide very specific ranges for 2020 in our call at the end of the -- in January.

Okay. And then just kind of as I sort of think, and I haven't done the exact math on this, but just based on the securities kind of reaching the end of the transformation and the loan growth being a little bit lighter this quarter and average earning assets being a little bit lighter, does that imply that there should be a little bit more margin impact as loans -- as some of the loans come on in the fourth quarter?

I think that's a fair way to think about it. And I guess the other thing I'd point out too, Alex, is we talked about a pretty significant reduction in our CD portfolio. And one of the things that we also saw this quarter was a significant increase in our retail and commercial deposit portfolio excluding CDs. And so we are generating and doing a really nice job generating strong deposit growth and it's primarily on the commercial side where we've seen that growth. So from my perspective, that's also sort of a good guide, if you will, relative to how we think about the margin going forward. And I think your commentary about the asset side is also accurate.

Great. And then just one final question for me. Saw a little bit of M&A in your backyard announced last week that you guys have talked about it during [technical difficulty]. Maybe you can kind of update us [technical Difficulty] criteria [technical difficulty].Can you hear me?

Go over, again, that would be good. We couldn't catch all of it.

Sorry, I'm not sure [technical Difficulty] what's going on here. But I was just asking about M&A, had a deal announced in your backyard last week, and I was just kind of curious if M&A is still something that's a consideration for you guys? Or -- and if it is, what the criteria, if you could remind us what that might be?

So Alex, we're -- we obviously saw the same thing you saw relative to a small bank based in the Southern Tier in Upstate New York. From our perspective, we are focusing on the continued execution of our strategic plan, which is driving organic growth, which we continue to build on our track record there.To the extent opportunities are available, we're ready and willing to consider them. But at this point, we want to make sure we remain very disciplined in terms of the execution of our plan as well as with the increased volatility in the world, whether it's political or the international pressures, the economic outlook, we want to make very sure that we're not stretching on both the execution of our plan as well as on strategic opportunities.

[Operator Instructions]

So Ilene, it looks like there's no further questions and we also experienced a little technical difficulty there. So at this point, hearing no further questions, I think we're ready to conclude the call, and we'll look forward to reconnecting in January with our investors.

Thank you, sir. We do not have any further questions. Do you have any other closing remarks?

No. Thank you very much, Ilene. We're ready to conclude the call.

Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.