Evans Bancorp, Inc. (NYSE:EVBN) Q3 2022 Earnings Conference Call October 26, 2022 4:45 PM ET
Company Participants
Deborah Pawlowski – Investor Relations
David Nasca – President & Chief Executive Officer
John Connerton – Chief Financial Officer
Conference Call Participants
Alex Twerdahl – Piper Sandler
Chris O’Connell – KBW
Erik Zwick – Hovde Group
Operator
Greetings and welcome to the Evans Bancorp Third Quarter Fiscal Year 2022 Financial Results. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.
I’d now like to introduce your host Deborah Pawlowski. Please proceed, ma’am.
Deborah Pawlowski
Good afternoon, everyone. We certainly appreciate, you taking the time today to join us as well as your interest in Evans Bancorp. On the call, I have with me here, David Nasca, our President and CEO; and John Connerton, our Chief Financial Officer. David and John are going to review the results for the third quarter of 2022 and provide an update on the Company’s strategic progress and outlook. After that, we will open the call for questions.
You should have a copy of the financial results that were released today after markets closed. And if not, you can access them on our website at www.evansbank.com. As you are aware, we may make some forward-looking statements during the formal discussion as well as during the Q&A. These statements apply to future events that are subject to risks and uncertainties as well as other factors that could cause actual results to differ from what is stated on today’s call.
These risks and uncertainties and other factors are provided in the earnings release as well as with other documents filed by the company with the Securities and Exchange Commission. You can find those documents on our website or at sec.gov.
So with that, let me turn it over to David to begin. David?
David Nasca
Thank you, Debbie. Good afternoon, everyone. We appreciate you joining us for disclosure of our results today. I will start with an overview of the past quarter and then hand it off to John to discuss the details.
Our third quarter results were solid with $25 million of revenue, a strength in net interest margin, lower efficiency ratio and further improvement within our hotel portfolio. We delivered quarterly earnings of $5.9 million, which was up from the second quarter.
On a year-over-year basis, earnings reflected the impact of a single charge-off credit from a declination on a government guaranteed loan that resulted in a higher than typical provision during the quarter. We believe that credit was unique and not indicative of our portfolio, other government-guaranteed loans or our long-standing credit discipline. John will provide more detail.
In October, we continued to increase returns to shareholders with a semi-annual cash dividend of $0.64 per common share or a 3.5% annualized return. For the year, dividends totaled $1.26, which was up 5% over 2021.
Overall, lending performance has been somewhat encouraging considering current headwinds and higher rates that have slowed commercial real estate activity. Importantly, commercial and industrial lending has been more robust and resilient in these challenging economic conditions and is responsible for a strong pipeline.
As we have discussed for several quarters, due to the impacts of the pandemic during 2020, the bank classified the entire hotel portfolio as criticized in recognition of increased risk. We have been working with and supporting these clients and closely monitoring their progress. As of the end of the most recent quarter, we have now had more than half of the portfolio upgraded or paid off, leaving just $38 million in criticized status.
While trends for this industry have improved given released travel restrictions and improvements in tourism and business travel, the bank is looking to assure sustained performance on these remaining credits before upgrading.
On the community front, we are working in a public-private partnership with the City of Buffalo, the Buffalo Erie Niagara Land Improvement Corporation a.k.a. the Land bank, a local developer and a minority and women-owned realtor firm to rebuild a neighborhood by constructing and marketing up to 10 single-family homes in an underserved area within the City of Buffalo.
Evans is providing the financing for the construction of the homes and will assist with mortgages for prospective new owners. The infill housing initiative is located in an area near the Westminster Commons where Evans has a new branch and invested over $30 million in affordable housing units, a homeless shelter, a charter school and a fresh food grocery store. This innovative initiative is one that we hope will be a model to be replicated elsewhere within underserved neighborhoods in the City of Buffalo.
Internally, as part of our operational effectiveness strategy, we have spent a good deal of effort focused on refining initiatives to build out more back office and customer-facing solutions, centered on speed, flexibility and efficiency.
We recently completed an upgrade to our core operating system, to provide new security features and processing efficiencies in the branches. We also kicked off a large commercial efficiency project which will touch all areas of commercial lending, including loan application underwriting booking and servicing.
We plan to utilize enhanced current loan origination systems and are bringing in some new technology solutions with enhanced work streams in order to facilitate commercial production and documentation in a scalable, integrated, digital and streamlined workflow with better controls and an enhanced client experience.
In total we expect to invest about $1 million in the project over a 12-month period with savings to be recognized in later 2023 and beyond. We believe that driving greater operational efficiency and improvement around client engagement can help us enhance and scale returns over the long-term.
Another area of focus for 2023 is within our non-interest income categories. The competitive landscape and regulatory environment have brought to the forefront changes to overdraft fees in terms of how they are handled and assessed and at what levels.
We estimate these efforts while favorable for consumers will have a negative impact to our service charge income of approximately $500,000 annually. There are a number of efforts to help counter and bolster our fee income the most important of which is our insurance business.
While we are entering a hardening market with higher premiums that equate to higher commissions, we are also winning new business especially within public entity clients such as government services and in particular school districts.
You can see the early success of our efforts in the growth of our insurance business this past quarter. While we remain positive on our local economy, we believe our strong and diversified portfolio positions us well to continue to serve our clients and communities through a range of economic environments, such as we prospectively face.
With that, I’ll turn it over to John to run through our results, and then we’ll be happy to take any questions. John?
John Connerton
Thank you, David and good afternoon everyone. Net income was $5.9 million or $1.06 per diluted share compared with $7 million or $1.27 per diluted share, in last year’s third quarter and $5.7 million or $1.03 per diluted share in the trailing second quarter of 2022.
The increase from the sequential second quarter was largely due to higher net interest income. The change from prior year largely reflected lower paycheck protection plan or PPP fees and a sizable credit and provision that, was taken in last year’s period.
Net interest income was up $1.1 million or 6% from the sequential second quarter. Driving the change were loan rates rising above the prior quarter due to the Fed’s 300 basis point rate increase since the beginning of the year.
The increase in net interest income of 6% since last year’s third quarter largely reflected the higher income from investment securities, and higher average loan balances and loan rates which more than offset the decrease in PPP fees.
During the quarter we realized $83,000 in deferred PPP fees compared to $224,000 in the second quarter of 2022 and $2.1 million in the third quarter of 2021. All the fees related to PPP have been booked to income.
The increase in provision was primarily due to the charge-off of a single commercial loan. The loan was within our non-performing category since late-2019 and was originally underwritten with a government agency guarantee.
The pandemic extended the time in which the guarantee was reviewed by the government agency. In the current quarter the government denied the guarantee and we subsequently charged the loan off.
The loan was to a local startup company that was producing a new product. For loans with this risk profile, an integral part of the bank’s underwriting decision would be the requirement to include a government guarantee.
Although we are disappointed with the agency’s decision concerning the guarantee, the characteristics of this particular loan were unique and are not indicative of other commercial credits in our portfolio or specifically other loans with a government guarantee.
Our balance sheet is well positioned for rising interest rates. And as expected, given the recent Fed actions we saw a 27 basis point lift to net interest margin in the second quarter to 3.72%. I will talk to our NIM expectations at the end of my remarks.
Non-interest income was $5.8 million in the quarter up approximately 12% over last year, and up 25% on a sequential basis. Insurance, which is the main driver within this category, was up from the linked quarter due to seasonally higher commercial lines insurance commissions and profit-sharing revenue.
On a year-over-year basis, insurance revenue was up $200,000 primarily due to higher premiums, and new commercial clients, which more than offset the loss of income from discontinued operations of our insurance claims service business. Changes in the other income line from the sequential and prior year period was due to movements in the fair value of mortgage servicing rights, as well as the receipt of $200,000 final payment in connection with a past historic tax credit investment.
Deposit service charges have seen a steady rise over the last year, mostly due to higher debit card usage. Total non-interest expense increased 7% or $1 million from the sequential second quarter. Salaries and employee benefits drove that increase and comprised 66% of the total non-interest expenses during the quarter.
About $700,000 was due to an increase in bonus accruals. On a year-over-year basis, non-interest expense was up 3%, as we have continued to balance our investments around strategic focus areas and are utilizing technology to supplement our efficiency efforts. We also are seeing the initial benefits of the branch rationalization initiated earlier this year. The company’s efficiency ratio was 63.3% in the third quarter, and an improvement of 270 basis points since last year’s similar period.
Turning to the balance sheet. We continue to deploy excess liquidity into investments, with those balances up $118 million since last year’s third quarter. We’re also using liquidity to fund loan growth over the last year, as commercial loans increased $55 million, which contributed about two-thirds to our total loan growth of $87 million, or 5.3%, when excluding the impact of PPP loan forgiveness. The remainder of the growth was largely in residential mortgages.
In terms of PPP loans, we had just $1 million left at quarter end from the approximately $300 million that was originated. This compared with $3.5 million at June 30, 2022 and $76 million at the end of last year’s third quarter.
During the current quarter, total loans grew $13 million; of that commercial loans grew $7.5 million in the quarter net of PPP and net originations were $68 million. Payoffs are still running a bit higher than typical due to opportunistic sales of clients’ businesses as asset prices remain high, that compares with $87 million of net originations in the linked quarter, which continues to be higher than last year’s average originations.
We have seen a slowdown on the commercial real estate side given the rising rate environment, whereas commercial and industrial has strengthened and is making up the bulk of our pipeline, which stood at $84 million at quarter end.
We expect to continue to generate commercial loan growth as payoffs and refinances continue to normalize. Our credit metrics remain sound despite a modest increase in nonperforming loans, which reflected the addition of one commercial real estate loan that is well collateralized.
Total deposits of $1.87 billion decreased $95 million, or 5% from the sequential second quarter, due to the seasonality in municipal client balances and outflows of interest rate-sensitive clients that the bank is determined to be non-core having just one bank product.
On a year-over-year basis, total deposits were down less than 1%. Deposit betas did not accelerate for much of the quarter, but the competitive landscape began to change toward the end of the period. We will be proactive with pricing, where it is warranted, but will also be prudent and disciplined.
At this point assuming another Fed rate hike of 75 basis points in November, we expect to see further expansion in our NIM of approximately 10 basis points in the fourth quarter. Any further increases by the Fed would have a positive impact. As a reminder 25 basis point move from the Fed all other things held constant would increase net interest income by $1 million annually or four basis points in total margin, due to our variable rate portfolio.
With that, operator, we would now like to open the line for questions.
Question-and-Answer Session
Operator
Thank you very much, sir. We will now be conducting a question-and-answer session. [Operator Instructions] The first question comes from Alex Twerdahl from Piper Sandler. Please proceed with your question, Alex.
Alex Twerdahl
Hey, good afternoon guys.
David Nasca
Good afternoon, Alex.
John Connerton
Hi, Alex.
Alex Twerdahl
First off I wanted to ask about — it looks like your cash balances dropped pretty — down to $7 million at the end of the quarter. So can you talk a little bit about the liquidity that you have right now sort of the cash flows from the securities portfolios that you’re expecting to see over the next couple of months?
John Connerton
Yeah. So I mean we — part of that liquidity decreases the seasonality in the municipal book Alex and we’ll see some increase in our liquidity mostly during the quarter because of inflows from the municipal deposits. And as far as the investment portfolio, we see about — we’ll only see about $12 million a quarter in cash flow from that.
Alex Twerdahl
Okay. And in your NIM guide, the 10 basis points of the fourth quarter, what does that assume in terms of average size of the balance sheet in terms of how much liquidity you’re expecting to come back from those municipals?
John Connerton
So typically, you can see just historically that we bring in about another — probably about $30 million into the quarter due to that seasonality.
Alex Twerdahl
Okay. And that — so the expectation is that liquidity goes up by about $30 million, obviously give or take depending on loan growth and other deposit flows do. Can you talk a little bit about maybe the pressures you’re seeing on other deposit costs and sort of some of the successes that you’ve been able to have recently and possibly trying to bring in some more deposits?
David Nasca
Yeah. I think just to kind of revisit where we were at the second quarter, we were expecting eventually here as the rates started to rise and we would utilize that excess liquidity. So we have been disciplined and we’ve had opportunity to keep some of that liquidity, but we decided not to as from an expense perspective. But as far as growth going forward, we do have — we are competitive in our CD side. And CDs are our main product that we’re attracting deposits and liquidity. And also on the municipal side, we can be selective on that product line and with specific customers. So those are kind of where we’re going to have the opportunities to grow in each of those product lines over the next couple of quarters.
John Connerton
Although if you look at the past couple of quarters Alex, while we’re flat quarter over prior quarter, if you look quarter-over-quarter, third quarter to third quarter, we did have good success in core deposits with demand checking. So we have grown our liquidity with core deposits over the last year. But it appears that consumer sentiment has changed to wanting some rate.
Alex Twerdahl
The $1 million that you talked about investing in technology et cetera, do you have an expected earn back on that investment, or when would we actually start to see some of the savings show up on the P&L? Is that kind of a tail end of 2023 event?
David Nasca
Yes. It is a tail end of 2023 event and there’s going to be several places that we’ll see the return. Number one, we’ll see it in savings related to labor cost. We’ll see it in savings related to throughput. So we’re looking at a return on that over the next couple of years, but it will start coming back to us we hope by the end of the 2023.
Alex Twerdahl
Okay. And then the overdraft the $500,000, when does that start hitting fees?
David Nasca
So we’ll be changing some of those parameters within our system at the end of this quarter. So really, a small impact for this particular quarter, but we’ll have a full year impact next year.
Alex Twerdahl
Okay. I think that’s all my questions for now. Thanks for taking the questions.
David Nasca
Thank you. Thanks for your questions Alex.
Operator
Thank you. The next question comes from Chris O’Connell from KBW. Please proceed with your question, Chris.
Chris O’Connell
Yeah. As far as the expense commentary, I know you guys have a couple of moving parts here over the next couple of quarters. But I think the commentary on the last call was for a relatively flat run rate going into the fourth quarter of this year. Can you maybe just talk about an updated outlook here for the near term and how you guys think that will kind of progress as we move into ’23?
David Nasca
Sure, Chris. So, I think just to recall, third quarter is when we do assess our accrual for our bonus. So that $700,000 was aggregating the first three quarters. So that was three quarters of our bonus — additional bonus that we would have had. So, $1 million in total. So we would expect that our salaries, which drives most of our non-interest income will be down in the fourth quarter compared to the third quarter, just because — mostly because of that accrual difference. And then going forward into next year, it will be elevated and we’ve had good success this year at around 3% and we would expect that for the full year. And then next year though, it’s going to be elevated a little bit probably closer to 5%.
Chris O’Connell
Got it. That’s helpful. And then, can you talk a little bit about what you’re seeing in the loan demand and the loan pipeline? It sounds like there’s been a pretty good shift towards C&I here but the pipeline seems to be up at quarter end relative to last quarter I believe on the total. And so, just how you’re thinking about the CRE book and whether that shows any of that growth over the next couple of quarters here and there will be downward pressure there and how that pipeline kind of flows into the total loan growth for the next few quarters?
David Nasca
I’ll give you the top-level answer, if John wants to add to that, he can add to this. The pipeline has been building. We have seen good activity headed into the quarter. So you have seen a growth in the pipeline as you mentioned. That growth has been predominantly — probably two-thirds or more of that has been C&I lending. We are still seeing commercial real estate activity. There is some refinance activity in that. So, that wouldn’t count as necessarily growth, but we also did a fair amount of construction over the past year and you will see draws on that start to happen, where you may not have seen that money come out prior to this point.
So, we expect — I don’t think you’ll see — that churns a little bit, but I don’t think you’ll see a decrease in portfolio as a result of not getting a lot more CRE or getting more C&I than CRE at this point. The C&I portfolio tends to put the money out immediately as opposed to sometimes some of the construction and real estate portfolio is over a period of time with draws as you know. So, I hope that answers your question a little bit.
Chris O’Connell
Yes, definitely. That helps. And on the muni side, I thought that last quarter was a seasonal outflow quarter and that usually starts to come in towards the end of 3Q here and this is a seasonal inflow quarter. Maybe just a little bit of color around the quarterly seasonality of that book?
David Nasca
Yes, the end of third quarter Chris is kind of a low point taxes are collected for the townships mostly in October. So, fourth quarter is an inflow, whereas third quarter is an outflow, as school districts use their dollars and then we — then what comes in fourth quarter are the townships. And it’s a smaller level, but it’s the same way for school districts at the beginning of the year first and second quarter not to the magnitude you see at the end of the year obviously.
Chris O’Connell
Okay. Got it. That’s helpful. And then just on the credit side. It sounds like the guaranteed loan is unique, but you had a little bit of a comment on the NPLs and the CRE. Maybe just a little bit of color around that credit and what you’re seeing from the strength of the consumer base within your markets and overall credit going forward? And I think that the hotel book was going to be assessed at some point around now and just the timing and kind of how you’re looking at that assessment and when that might come back on?
David Nasca
Sure. So the NPL increase and the hotels have a common shared event. So the loan that went in NPL is one of our hotel portfolio – out of our hotel portfolio. So as we’ve said from the start out of the $80 million that originally went in the criticized, we would continually assess the performance and we had different levels of operators that were in good – better shape than others and worse shape than others. But the one that actually went into non-performing this quarter we’re very positive on this particular property. The borrower had a management team in there that was not performing and they swapped that out to make sure that they’re getting the best efficient productive use out of that property. And we feel that based on the LTV, especially it’s very low it’s under 50% LTV and the position that place is from a geographic perspective we’re very comfortable on that particular piece of property.
But as far as what’s remaining out of the $38 million, that’s obviously – that’s around $8 million of what’s in the hotel book. But the rest of it we’re continually – some are going to perform. We’re going to have better assessment quicker and we did upgrade some this quarter to the tune of around $12 million. And our expectation is we’ll continue to improve in fourth quarter, the remainder of the $30 million that aren’t in non-performing. And we think some of that will happen in fourth quarter and probably a little more in the first quarter. As we get a full – some need a full year look at and we’ll have that at the end of the year.
Chris O’Connell
Got it. And then just any update as to the CECL impact for the start of next year?
David Nasca
We’re still determining the impact of that and we’ll have further communication and disclosure in the first quarter.
Chris O’Connell
Got it. That’s all I had. Thank you.
David Nasca
Thanks, Chris.
Operator
Thank you. [Operator Instructions] The next question comes from Erik Zwick from Hovde Group. Please proceed with your question, Erik.
Erik Zwick
Good evening, guys.
David Nasca
Hello, Erik.
Erik Zwick
Just one question for me today. It’s been a couple of years since you completed your last whole bank acquisition. Just curious how you view the opportunities today, if there’s anything out there to continue to review deals? Is there anything from either strategic or geographic standpoint that looks attractive? And maybe remind me kind of what the potential target size range would be of deals you’d consider undertaking?
David Nasca
I’ll answer that. That question is – so I go back a ways in this market. And I would say as we’ve talked about as many of your counterparts in the investment bank would tell you, this market in contiguous areas are kind of devoid of a lot of opportunities. This market is consolidated over a period of time with people like M&T and First Niagara and to a lesser extent in this market, Community Bank systems.
And there is really not a lot of opportunity to do meaningful things. We were opportunistic and we will be opportunistic if something were to come along that strategically made sense. The smaller organizations $200 million, $300 million, while they might add a little heft and maybe a little bit of strategic benefit if they were available, generally legacy banks, they are generally family-owned or things like that, where they’re not really motivated to do anything and they really wouldn’t do much for us. So there’s not a lot of real big opportunity in this marketplace to do that.
That said, if there was an opportunity and we’d go, I don’t know anywhere up towards Albany for example if there were opportunities. We know this market is very similar. But we would say, we try to do something – we’re a $2 billion bank. We try to do something in the $500 million, maybe up to $750 million range where you’re really mitigating your risk of a whole bank acquisition, but there aren’t a real lot of opportunities to do that, is what the bottom line is.
Erik Zwick
Thanks. I appreciate the color on that. And just kind of just reading through the lines there, it sounds like you would then prefer to focus on organic growth in your existing markets, as opposed to jump into something further away, if there are not contiguous opportunities. Is that correct?
David Nasca
That’s certainly true. That’s been our MO from the beginning. We have been an organic grower. We continue to grow at a pace that we think is pretty reasonable and significant comparatively. The last couple of years, have been interesting years, but we line up against people like M&T and KeyCorp in this market and we have been growing over time.
We have a different I’ll say, a different approach to the market in terms of, relationship status and a commercial driver as we’ve talked about. But I’d also say that, we would look at an opportunity if it added and was accretive to our shareholders in terms of, strategically, but we don’t see a lot of those opportunities to do that. So we’re going to do it the franchise value, accretive way which is organic.
Erik Zwick
Makes sense. And actually, I have one other. Just curious, in terms of the tax rate any changes to the outlook for the tax rate either in 4Q or into 2023 or still pretty much around, the call it 24.5% 25% range plus or minus a little bit?
John Connerton
That will be a stable rate, for the rest of the — for this quarter or the coming up quarter in 2023.
Erik Zwick
Great. Thanks for taking y questions, there.
David Nasca
You’re welcome. Thank you.
Operator
Thank you. At this time, there are no further questions. I would like to turn the call over back to David Nasca for closing remarks. Thank you, sir.
End of Q&A
David Nasca
Thank you, Claudia. Thank you all for participating in the teleconference today and for your questions. We certainly appreciate your continued interest and support. Please feel free to reach out to John and myself at any time. We look forward to talking with all of you again, when we report our fourth quarter 2022 results, and we are making some trips to some investor conferences. So we look forward to talking to people at those conferences as well. So we hope you have a great day, and thank you for joining us again.
Operator
Thank you. This concludes today’s teleconference. Thank you very much for joining us. You may now disconnect your lines.
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