Evans Bancorp - Q2 2022

Transcript

Speaker 0

Welcome to the Evans Bancorp Second Quarter 2022 Financial Results Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. Please note this conference is being recorded. I'll now turn the conference over to your host, Deborah Pawlowski, Investor Relations for Evans Bancorp.

You may begin.

Speaker 1

Thank you, Shamali, and good afternoon, everyone. We certainly appreciate you taking the time today to join us and your interest in Evans Bancorp. Here with me on the call today, I have David Nasca, our President and Chief Executive Officer and John Connorton, our Chief Financial Officer. David and John are going to review our results for the Q2 of 2022 and provide an update on the company's strategic progress and outlook, after which we will then open it up for Q and A. You should have a copy of the financial results that were released today after 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 and 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 atsec.gov. So with that, let me turn it over to David to begin.

Speaker 2

Thank you, Debbie. Good afternoon, everyone. We appreciate you joining us for the call today, and I'm going to start with a review of the past quarter and then hand it off to John to discuss the results in detail. Results for the Q2 were very solid, Driven by continued growth in commercial business lending, core deposit attraction, especially checking and savings, Strengthening margins and a diligent focus on expense management, despite the rapidly changing market dynamics all financial institutions operate in currently. The team continues to execute our strategy, resulting in the attraction of new business and market share growth with a consistent community and relationship driven focus that centers on the customer.

It is our expectation that a rising interest rate environment We'll drive higher net interest income and margins going forward. During the Q2, net income was particularly encouraging as we were up 9% from the first And comparatively, although down slightly to last year's Q2, we effectively covered $2,500,000 in PPP fees Received in last year's period. We experienced another quarter of significant production performance by hitting 1 $105,000,000 in loan closings, which was led by robust commercial real estate demand and strong progress in commercial and industrial loans. And while net loan growth was not substantial during the quarter, we are pleased with the positive trend we see in the number of new commitments and loan closings As our teams across the footprint have been performing well in this current market. We also continue to focus on deposit growth.

And while there was a slight dip in this past quarter due to seasonality of municipal deposits, our core deposit balances continue to trend positively. We have exceeded our expectations with core consumer checking balances and commercial deposit acquisition continues to be strong. An area of highlight during the quarter was continued performance in managing expenses, while simultaneously maintaining targeted technology investments To enhance the customer experience and engagement with digital offerings as well as drive operational efficiency and effectiveness, Notable achievements include an upgrade to our core operating system to provide new security features and processing Including a new teller system that was implemented throughout the branch and the kickoff of a commercial efficiency project, which will touch all areas of commercial lending from data collection to underwriting, booking and portfolio management. Our expectation is that we can facilitate commercial production and documentation in an integrated, digital, accountable and streamlined workflow With better controls and an enhanced customer experience, we expect components of the new project to be in rollout in the late 3rd or early 4th quarter. We discussed on our last earnings call embarking on a branch network efficiency initiative, which resulted in the closure or repurposing of 3 locations.

To date, the transition of these branches has been smooth with positive feedback. The expected run rate of annual non interest cost savings from these changes is approximately $750,000 And we are already starting to see the initial benefits in this past quarter. Another critical pillar of our strategy, We like all businesses continue to be challenged by the market for associates, Competition for top performers and rapid labor cost inflation. We've had success in recruitment and key associate retention We are continuously working to drive a culture that is inviting in a place where top talent wants to work. A culture pulse survey was recently completed Focusing on fairness, collaboration and communication to determine recommendations and suggestions that we can apply to continue to enhance the employee We are also excited about a recent promotion during the quarter that will help us continue our cultural momentum Toward inclusion, diversity, equity and awareness.

Bryce Woods, who previously served as Vice President of Community Development in Commercial Banking, Was promoted to the newly created position of Chief Diversity, Inclusion and Community Development Officer. He is responsible for collaborating and influencing The overall development, implementation and communication of the organization's inclusive strategic plan. Royce has deep ties throughout the market, coming from work with the City of Buffalo and a WMBE Advisory and Development Organization, as well as interfacing with several local nonprofit boards. His passion for community development work, diversity and cultural evolution will be an asset as he takes on this all important role at Evans. There are 2 other areas we are taking a focused approach to, The intersection of associates' career desires and the company's needs.

First, our insurance account executive development program was recently enhanced with formalized sales process for new and existing account executives focusing on sourcing leads, building centers of influence, Winning at cold calling and utilization of existing technologies to assist with sales processes and data. We also completed the initial phase of our commercial banking talent development program, which consisted of detailed multi month onboarding courses and training built within our online learning management system. Phase 2 of the project will utilize development toolkits to prepare internal candidates for promotion, thus building an internal commercial banking talent pipeline. Lastly, as a community financial institution, the organization and our associates try to be positioned to play a part and assist in the community in a multitude of ways. As you may know, on May 14, our community was rocked to its core as a racially motivated mass shooting occurred in East Buffalo Within the most prominent and important grocery store in the area, taking 10 lives and injuring 3 others.

The Buffalo community showed its resolve and resilience By coming together in response to this unspeakable tragedy as the true city of good neighbors that it is. As a community steward, Evans is, along with many other community institutions, actively assisting to help make a difference and be a positive influence for Equity and Justice, whether it be providing platforms for our associates to assist, Expanding already significant associate community involvement, working in a public private partnership with the city to develop infill housing Or donating money to the recovery fund to support systemic change aligning with our values and commitment to assure that everyone in our community is 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?

Speaker 3

Thank you, David, and good afternoon, everyone. Net income was $5,700,000 or $1.03 per diluted share Compared with $6,300,000 or $1.15 per diluted share in last year's Q2 and $4,700,000 or $0.86 per diluted share in the trailing Q1 of 2022. The increase from the sequential Q1 was largely due to higher net interest income. The change from prior year largely reflected lower PPP And a sizable credit and provision for loan losses that was taken in last year's period. Net interest income increased $1,600,000 or 9% The sequential Q1 driving the change is both higher average loan balances and loan offering rates being above the prior quarter due to the Fed's 150 basis point rate Increase since March.

Positive betas have not accelerated to this point as the competitive landscape has not been challenging as of yet. The slight decrease in net interest income since last year's Q2 largely reflected the decrease in PPP fees given the deceleration The rate of remaining loan forgiveness as the program nears its conclusion. During the quarter, we realized $224,000 in deferred PPP fees compared $500,000 in the Q1 of 2022 $2,500,000 in the Q2 of 2021. Nearly all the original $7,400,000 in fees from the 1st round of PPP have been booked to income. The 2nd round of PPP originations produced $4,900,000 of additional fees, of which $4,800,000 has been recognized in income, Leaving approximately $83,000 of fees to be booked.

The $267,000 provision for loan losses in the current quarter was driven by economic qualitative As GDP is showing some weakness, the sequential first quarter provision reflected strong loan growth, While last year's Q2 had a credit due to the benefit of unwinding the pandemic effect of the economy, our balance sheet is well positioned for rising rates Rising interest rates and as expected given recent Fed actions, we saw a 27 basis point lift to net interest margin in the 2nd quarter to 3 point 4% or 5%. I will talk to our net interest margin expectations at the end of my remarks. Non interest income was $4,600,000 in the quarter, up about $200,000 over each comparable period. Insurance, which is the main driver within this category, was up from the linked quarter due to Seasonally higher policy renewals for institutional clients. On a year over year basis, insurance revenue was down less than $100,000 primarily due to discontinued operations of our insurance claims services business.

The changes in the other income line from the sequential and prior year period was largely due to movements in the fair value of mortgage servicing rights. Deposit service charges have seen a steady rise over the last year, mostly due to higher debit card usage. Total non interest expense increased 2% from the sequential Q1 and on a year over year basis was down 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 beginning to see the initial benefits of the branch rationalization. Salaries and employee benefits, which comprise 64% of total non interest expenses remain largely unchanged from the Q1 of 2022 Q2 of 2021.

Advertising expense increased $259,000 from the sequential quarter due to seasonal marketing campaigns. The company's efficiency ratio was 65.2 percent in the 2nd quarter, an improvement of 150 basis points since last year's period. Turning to the balance sheet. We continue to deploy excess liquidity into investment securities with those balances up $169,000,000 since last year's Q2. We're also using liquidity to fund loan growth over the last year as total loans increased $53,000,000 excluding the impact of PPP loan forgiveness.

Of the approximately $300,000,000 of PPP loans originated, we had just $3,500,000 left at quarter end. This compared with $10,000,000 At March 31 and 146 at the end of last year's Q2. Looking at the Q2 specifically, commercial loans grew 7,000,000 But net originations were $87,000,000 That compares well with the $94,000,000 of net originations in the linked quarter and continuing much higher than last year's average originations. The lack of growth during the quarter largely reflects the $37,000,000 or 42% of originations that were from unfunded commercial real estate construction loans, which will fund as construction ramps up. Payoffs are also still running a bit higher than typical due to some sales of customer businesses as asset prices remain high.

We still have a healthy commercial loan pipeline of $73,000,000 and we expect that 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 1 commercial real estate loan that is well Total deposits of $1,970,000,000 decreased 1% from the sequential Q1 due to the seasonality in municipal client balances. Excluding municipal deposits, total deposits were up $18,000,000 during the quarter, mostly in demand deposits. On a year over year basis, total deposits were up $85,000,000 or 4% and reflected growth across all deposit categories with the exception of time deposits. At this point, assuming no further Fed rate hikes, we expect to see further expansion in our net interest margin of approximately 20 basis points in the 3rd quarter.

We have not seen competition for deposit rates begin to rise, but expect some movement in late Q3. Any further increases by the Fed, including today's increase, would have a positive impact. As a reminder, a 25 basis point move from the Fed, All other things held constant will increase net interest income by $1,000,000 annually or 4 basis points in total margin due to our variable rate portfolio. With that, operator, we would now like to open the line for questions.

Speaker 0

And at this time, we will be conducting a question and answer session. One moment please while we poll for questions. And our first question comes from the line of Alexander Twerdahl with Piper Sandler, please proceed with your question.

Speaker 4

Good afternoon.

Speaker 2

Good afternoon, Alex. Good afternoon, Alex.

Speaker 4

Just wanted to keep you going

Speaker 5

on that last set of comments on the NIM, John. I think you said 20 basis points is expected in the 3rd quarter And that does not include the 75 basis point hike from today?

Speaker 3

That's correct.

Speaker 5

And the What kind of expectation for average earning assets would that take into account? I mean, now that cash is kind of Gotten closer to normalized levels, it looks like, in the second quarter. Is there still some sort of asset transitioning that's

Speaker 3

So I think there'll be some movement in our cash into Interest earning assets, I think what's going to drive it is we do expect loan growth to still for the whole year to still be in the higher single digits Between 7% 9%. So, that would grow that's really where we're looking to grow our interest earning assets.

Speaker 4

Okay. But to fund the

Speaker 5

loan growth, would you need to actually expand the balance sheet, just given sort of the liquidity position today? Or can it be done with cash and cash flows from securities?

Speaker 3

It can be done with cash. We're Still sitting in on approximately $80,000,000 in excess liquidity and we plan on driving those putting that into use.

Speaker 5

Great. And then the $1,000,000 annually from each 25 basis points, is that do you think that's Does that take into account deposit betas or do you think that kind of the million

Speaker 6

that we've seen

Speaker 3

Yes, sorry Alex. Yes, that's everything held constant. We haven't seen our betas move. We expect betas to start to move. So that would bring that $1,000,000 down for every 25 basis points If and when beta well, when betas start to move up.

Speaker 0

Okay.

Speaker 3

We talked about it last time I think we talked about it Our betas in our last cycle moved around between 30 40 basis points for the whole cycle. We expect with the excess liquidity that we have here, Our strategy is going to be proactive with our core customers and adjust our rates to those particular customers. And with the excess liquidity that we do have, as well as our deposit gathering that We've had recently, we feel we'll be able to most likely do better than that or there should be some probability that we do better than that from the last cycle.

Speaker 6

Okay.

Speaker 5

That's good color on that. And then just Switching gears to the efficiency, the commercial efficiency process that you're talking about, David, in your prepared remarks. Is the I guess, is the goal to that to reduce or to create operating leverage and reduce expenses or is it to drive more loan growth or kind of maybe talk to a little bit more sort of the higher level rationale for putting this in place? Is it Is it catch up on just getting the systems up to the 21st century or what's I mean, what's kind of the higher level thought process behind it?

Speaker 2

Okay. I'll do that. You asked about 3 questions here. And I'm laughing, Alex, because it's sort of all of those things. We're not we're up to the 21st century.

I mean, we've got good loan processes and systems, but We have been growing above trend for a long period of time. There is a need to address The continued scaling of that operation, it will provide efficiencies to the organization, but it will also allow us To effectively create some scale for the organization to grow and continue growing faster Because it affects all areas. It affects underwriting, operating, booking, portfolio management. And on top of that, What it will do is it will position us with maybe what you'd say is it will enhance our controls as well And making sure that with this kind of volume, we're diligent around our control. So I think it's all three of those things.

It's efficiency, it's Scalability and its control environment. So we're going to be making we're making investments to get better and stronger and bigger.

Speaker 5

Great. And then just can you just remind us with the branch efficiency program, the 750,000, We started to see that. And I think you mentioned that you started to see the very beginning of that in the Q2, but when does that really start impacting the expense

Speaker 3

It's really occurring. The largest component of that is salaries, Alex, and that is already begun. But By the beginning of Q4, all those expense saves should start to be there from an annual perspective.

Speaker 5

Great. Thanks for taking my questions.

Speaker 2

Thanks, Alex. Thanks,

Speaker 0

Next question comes from the line of Chris O'Connell with KBW, please proceed with your question.

Speaker 4

Hey, good afternoon. Good afternoon. Wanted to start off with the origination yields coming on the books. I heard the pipeline numbers, but I may have missed But if you guys could just go through what the loan yields coming on are, that'd be great?

Speaker 3

Sure. The yields, we usually get anywhere between $200,000,000 $250,000,000 off of our funding source, Which is yields anywhere between 5.5% and 6% at this point.

Speaker 4

And that's blended on the whole portfolio?

Speaker 3

Yes. No, I mean, 5.5, that's on the new originations going forward.

Speaker 4

Yes, yes. Sorry.

Speaker 2

Got you.

Speaker 4

Okay, great. And then for the efficiency Initiatives as well as kind of the branch savings, in putting it all together, how are you seeing Bottom line kind of operating expense numbers flowing through into the back half of the year here?

Speaker 3

So Chris, I think the only I think the current run rate is a good run rate With the exception of as we move through the quarters here towards the end of the year, we do look at our What our bottom line is going to be and then how that's going to impact our incentive, which we won't we usually don't know until into the Q3. So if you look at prior year's 3rd quarters, you can see if we are doing well, we'll adjust the incentive calculation then, so that would be an impact to kind of bring up the current run rate going forward. But we haven't really got to that point In the year yet, we're comfortable booking that additional incentive if the performance the full year performance warrants it.

Speaker 4

Got it. And to these the technology and the outside of the branch Plan, do these investments create a little bit of a higher expense Growth run rate headed into 2023, or are there offsets there?

Speaker 2

I think the answer to that is, we'll have some expense run rate into 2023, We're also managing other sides of that expense, whether it's personnel, some other things. So we think The run rate that you've seen is appropriate going forward. You're not going to see big bumps up or down. We think we're at a Good level here. So there's going to be puts and takes there.

Speaker 4

Okay, got it. And for the deposit flows this quarter, most of it being driven by the muni decline, How much of that do you think will come back in the Q3?

Speaker 3

It's going to follow the seasonality that we've had in prior years. And usually, probably a good chunk of that. So we our high point is somewhere in the Q1 And then again, it kind of meets that same high point, at the end of Q3, beginning of Q4. So we would expect that We haven't been we're not losing any customers, so we expect that those balances should come back on those high points in the period.

Speaker 2

Yes. Let me just add on to that, Chris, what you have here is, obviously, in New York State, taxes, school and property taxes FebruaryMarch and then they're kind of October for the school taxes. So they build, They get paid by the municipalities. They come out of their accounts kind of in that March, April timeframe and they come out of the accounts in the October, November timeframe, but up to that point they build back to those levels.

Speaker 4

Okay. That makes sense. And then I know you guys were eventually looking to Hold back TCE back to the 8% range, obviously difficult with the AOC Mark, this quarter, how are you guys thinking about capital levels in terms of regulatory versus TC, and is there a goal or a timeline that you guys want to get back Towards the high 7% or 8%, yes.

Speaker 3

Well, I think with the AOCI impact there, we are kind of adjusting for that and we think that where our capital ratios are at This point are sufficient and we'll manage, if you adjust kind of excluding the AOCI at this point, We're cognizant of it, but we based on the makeup of our portfolio, our investment portfolio, we're not Significantly concerned around the impact from AOCI and where our capital levels are, we're pretty good From the perspective of where we want to be.

Speaker 4

Got it. And looking ahead, kind of piggybacking on Alex's questions, you guys grew the investment portfolio Just to touch this quarter again, do you think that you'll be keeping that more flat or moving The flows into loans as they come off going forward or do you expect that to continue to grow?

Speaker 3

We think from here, we're probably at a level that's going to stay pretty consistent. We'll utilize our excess cash that we do have, as Alex suggested, for loan growth and Any impacts from funding flowing out because we're staying disciplined on our deposit pricing.

Speaker 4

Okay, great. And then lastly, I know it's been There for a while and you guys have the $54,000,000 left on the criticized Hospitality book, any updates there on how you see that progressing over the course of the tail end of this year?

Speaker 3

Yes. It's kind of consistent with what we've been saying for the last couple of quarters. It's a Seasonal business up here. Most of our properties are around in our geographic area and we'll be we're going to look at it At the end of Q3, which will be kind of the end of the season to make the assessment on those assets. And so far, our understanding of the activity and their performance is headed in a positive

Speaker 2

Improving. Yes.

Speaker 4

Great. All right. Nice quarter. Thanks for taking my questions.

Speaker 2

Thank you, Chris.

Speaker 0

Our next question comes from the line of Eric Zwick with Holt Group. Please proceed with your question.

Speaker 6

Thanks. Good evening, guys.

Speaker 2

Good evening, Derek.

Speaker 6

Just a question, I guess, on your Commercial borrowers with variable rate loans and just trying to understand the potential impact to them. We've got, I I guess, 225 basis points of hikes under our belt now and future scrub would suggest maybe another 75 by the end of the year. As you underwrite these loans and then continue to monitor them ongoing, certainly a lot of these borrowers still have a lot So cash on hand maybe more than they did pre pandemic, but as their debt service goes up, Does it get to a point, are there any borrowers that start to become a little bit more stressed? Or do you build in enough cushion that they can withstand this? And I guess how often are cash flows for those borrowers updated?

Are they seeing uptake in those cash flows that could help offset? Or just curious about Potential, kind of like your credit developments that could result from the interest rate hiking cycle?

Speaker 2

Okay. I'll answer that first, Eric. This is Dave Nasca. A couple of things that you asked there that I'd like One is, we when we're underwriting these borrowers, we stress them for increased levels. So we have several stressors that we put the loans through in underwriting.

So from a perspective of Do we see them being damaged by the rates up my terms, not yours? In In terms of that, we see the industry challenged by the rising level of inflation certainly, But we have underwritten these loans to be able to stomach this. So you asked is there a little bit of a cushion in there. I don't know if I'd call it a cushion, but we certainly understand where they are with respect to stress. Secondly, We do get and we look at these loans at regular intervals.

And where we are concerned, we will Certainly make sure that we get cash flow statements and we're in relationship with these borrowers, so we understand their businesses and where they are. I think that is the difference with us as a community institution that's really relationship focused. We are working with them. If they do experience difficulties, we're usually first to know and sort of working on that. So we have not In that level of, I'll call it, damage yet, But there's significant impactors here certainly, but we don't expect it to we hope that it's not a tremendous Continuing burden, and we've written strong collateral.

We have guarantees. We have Debt service coverage ratios that are on the reasonable, if not conservative side. So I think the question Do you have cushions there? We believe we do.

Speaker 6

That's great. Thanks, Dave. I appreciate the detailed answer there. That's all I had today. Thank you.

Speaker 3

Awesome. Thanks, Aaron.

Speaker 2

All right. Are there any other questions there, Shamali?

Speaker 0

No. That is all the questions for today.

Speaker 2

All right. Well, I'd like to thank everybody for participating in the teleconference today. We really appreciate your continued interest and support. And please feel free to reach out to us at any time. We look forward to talking with all of you again when we report the Q3 2022 results.

And we hope you have a great day.

Speaker 0

And this concludes today's conference and you may disconnect your lines at this time. Thank you for