Evans Bancorp - Q2 2023
July 27, 2023
Transcript
Operator (participant)
Welcome to Evans Bancorp's Second Quarter Fiscal Year, 2023 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Craig Mychajluk, Investor Relations, Evans Bancorp. Thank you, Mr. Mychajluk. You may begin.
Craig Mychajluk (Investor Relations)
Yeah, 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 second quarter of 2023 and provide an update on the company's strategic progress and outlook. After that, we'll open up the call for questions. You should have a copy of the financial results that were released today after markets closed.
If not, you can access them on our website at 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. Please find those documents on our website or at sec.gov. With that, let me turn it over to David to begin. David?
David Nasca (President and CEO)
Thank you, Craig. Good afternoon, everyone. We appreciate your joining us today. I'll start with a review of the key themes that played out during the quarter. We'll then hand it off to John to discuss our results in detail. Things have somewhat settled in the banking sector this quarter as the focus has returned from fears of bank failures to execution. However, external market forces, in particular, the interest rate environment, continue to have an effect on our results.
While loan yields have improved both sequentially and year-over-year, the increases are being outpaced by deposit costs, as reflected in net interest margin contraction. We expect these market conditions and pricing pressures to persist and negatively impact our margin at a decreasing rate in the third quarter, as John will discuss in more detail. Addressing these headwinds, we are focusing our efforts on areas that are important for short-term stability and to deliver us in a position of strength when the cycle turns and these conditions change.
This includes maintaining and growing deposits, prudent asset growth, expense management, maintaining our credit standards, and strengthening capital. The shared tool for all these objectives remains a laser focus on client engagement and providing broad solutions through continued collaborative communication by our associates. Our deposit base is solid and stable and remains backed by a diversified product portfolio, which is a focus of our efforts to grow. Along with deposits, we have a robust availability of alternative funding sources.
Second quarter and year-to-date performance has reflected balance fluctuations that are mostly seasonal, which predominantly includes normal municipal flows. Overall, we believe we are executing well against stiff competition as our team has continued to retain key deposits while accumulating net new customers and accounts. Staying close to our clients and cultivating prospective relationships remains paramount as we look for opportunities to drive growth and loan production.
While growth has been somewhat muted this quarter and for the year, we continue to focus on building a diverse portfolio of high-quality loans and have a robust pipeline, which stood at $87 million at quarter end. Credit trends in the second quarter continue to be favorable, and while we have historically experienced higher non-performing assets than our peers due to relative size and commercial focus, we have and expect to successfully manage these credits and as a result, continue to see low actual charge-offs.
Investing in technology and talent is also critical as we look to scale the organization, enhance client experience, and more effectively manage risk while creating opportunities for efficiencies. We have completed phase one of the multi-year commercial efficiency and customer experience initiative, embarked upon late last year with integrated loan applications, streamlined, more efficient loan origination workflows, and consistent product handling. Other highlights from the quarter included changes to our board.
In May, as part of our annual meeting of shareholders' activities, longtime director James E. Biddle, Jr. retired, and we added two new highly experienced and accomplished leaders. Dawn DePerrior, who brings vast knowledge and experience in information technology, cybersecurity, finance, strategy, and digitization, and Robert James, a corporate attorney, who adds expertise in corporate governance, diversity, equity, and inclusion.
Additionally, during the quarter, the company was re-added to the Russell 2000 Index as part of its annual reconstitution. We believe this can provide additional demand and liquidity to our stock trading. Lastly, on the community front, the bank made a $1 million investment with Launch New York, a nonprofit venture development organization and CDFI, providing high growth potential startups with mentorship and access to seed funding, with a goal to fuel the startup ecosystem in Western New York. This is the second round of investing the bank has participated in with this organization.
As we look to the second half of the year, we expect to continue to confront headwinds, but we'll maintain focus on those areas that support short-term progress and sustainability of our business model and position us strongly coming through this unusual business climate for the successful execution of our long-term strategic goals. With that, I'll turn it over to John to run through our results in detail, and then we'll be happy to take any questions. John?
John Connerton (CFO)
Thank you, David. Good afternoon, everyone. For the quarter, we delivered earnings of $4.9 million, or $0.90 per diluted share, which was down from last year's second quarter, largely due to reduced net interest income. Helping offset this reduction were lower expenses and a benefit from the change in provision for credit losses. The decrease in earnings from the sequential first quarter also reflected a reduction in net interest income, as well as a smaller release of allowance for credit losses, partially offset by higher non-interest income and lower non-interest expense.
Net interest income was impacted over both comparable periods by higher interest expense, given intense competitive pressure on deposit pricing, which began to accelerate last quarter. This more than offset increases in interest income, which was driven by growth in our variable rate portfolios, following the Federal Reserve's series of rate increases.
With increased interest expense from higher deposit costs, we saw a 36 basis point decrease to net interest margin in the quarter to 3.10%. I will talk to our NIM expectations at the end of my remarks. The benefit of $116,000 in provision for credit losses during the quarter was largely due to lower criticized loan balances and lower specific reserves on impaired loans, partially offset by loan growth.
Non-interest income was $4.7 million in the quarter, up approximately 2% over last year's second quarter and up 14% sequentially. Insurance, which is the largest contributor within this category, was up 6% year-over-year and 12% from the linked quarter. The increase from the first quarter of 2023 reflects seasonal higher policy renewals for institutional clients, while the year-over-year increase was due to commissions from new commercial lines insurance sales and higher premiums.
As mentioned previously, 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 level. We did implement changes at the end of last year, which resulted in a reduction in fees within the deposit service charges line when compared with last year. The other income line increased $300,000 from the sequential first quarter, primarily due to movements in mortgage servicing rates and higher loan fees. Total non-interest expense decreased 2% from the sequential first quarter and was down 4% from last year's second quarter.
The driver of this improvement was largely within the salaries and employees benefit line, which was down 8% over both comparative periods. Reflected in the linked first quarter was the annual reset on FICA and unemployment insurance and the annual payment into our HSA accounts. When compared with last year's second quarter, the decrease was primarily due to lower incentive accruals of $1.2 million, partially offset by merit increases in strategic hires. Our expectation for the full-year expense run rate is a decrease of 1%.
Turning to the balance sheet and reviewing movements in the second quarter, total loans were up approximately $12 million. Of that, commercial loans increased 1% or $11 million. Net originations were $54 million during the quarter, compared with $56 million of net originations in the first quarter. We've seen a slowdown in commercial real estate loans given the rising rate environment, and C&I originations remain unfunded to date, muting growth in the portfolio. The current pipeline remains active and stands at $87 million at the quarter end.
We expect total commercial loan growth to be approximately 3% in 2023. Our credit metrics remain sound despite the rise, the rise in nonperforming loans, which reflects just a single commercial credit of $6.5 million that is still accruing, and then we expect that loan to come current in the third quarter. Criticized loans decreased during the quarter by $19 million from $93 million at March 31st to $74 million as of the end of second quarter.
Total deposits of $1.79 billion decreased $63 million, or 3% from the first quarter, $48 million of which consisted of typical seasonal municipal outflows. An additional $11 million transferred to our securities under agreement to repurchase account, which provides collateralization for those deposits, but is not classified as a deposit. It is, however, still a customer account and a source of funding. Overall, our core deposit levels have been solid given external market forces and current headwinds.
At June 30th, the percentage of uninsured and uncollateralized deposits was steady at 19%. Average total deposit balances were stable at $1.82 billion during the quarter when compared to the linked first quarter. As has occurred in previous cycles, balances have and are expected to continue to migrate into different products. Specifically, we are seeing commercial clients migrate funds from demand deposit accounts into sweep accounts, and we expect consumer clients to continue moving funds from saving accounts to CDs.
As mentioned earlier, these trends and pricing pressures have an accelerated impact on our margin for the second quarter and are expected to impact the margin on a full-year basis. As with many banks, we will continue to fight for deposits by being proactive with pricing and maintaining competitive rates in our markets. Currently, we expect our NIM to experience approximately 20 basis points of compression in the third quarter of 2023.
Beyond the third quarter, it's difficult to forecast given the external macro forces, such as potential future Fed rate moves and how competition may play out, but our current expectation is that NIM pressure could moderate toward the end of the year. With that, operator, we would now like to open the line for questions.
Operator (participant)
Thank you. We will now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your questions from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment please, while we poll for questions. First question comes from the line of Nick Cucharale with Hovde Group. Please go ahead.
Nick Cucharale (Director and Senior Equity Research Analyst)
Good afternoon, everyone. How are you today?
David Nasca (President and CEO)
Good, Nick. How are you?
John Connerton (CFO)
Good. I'm doing well, Nick.
Nick Cucharale (Director and Senior Equity Research Analyst)
Good. Good. On the loan growth side, I heard your commentary for 3% commercial growth in 2023. Can you help us think about your full year expectation for the overall portfolio?
John Connerton (CFO)
For the overall on the lo, can you just clarify a little bit, Nick? You mean just the, the total growth or.
Nick Cucharale (Director and Senior Equity Research Analyst)
Yes. Yes, exactly. Just including the residential and, the, the residential component as well.
John Connerton (CFO)
Yeah, our residential portfolio, probably we're not going to see much lift from that. Most of the growth will be in our commercial portfolio, and that'll be, you know, the, the 3% growth that we're seeing from here to the end of the year, the end of the year.
Nick Cucharale (Director and Senior Equity Research Analyst)
Okay, great. Just to, just to follow up on the expense guide, you know, clearly a great job of controlling costs so far and finding efficiencies. Just to get to that, that minus 1% rate by the end of the year, it kind of assumes a sizable pickup in the back half of the year. Is that pretty ratable across the, the last two quarters, or, is there, you know, a pickup in the third quarter that kind of gets you there?
John Connerton (CFO)
No, I'd say both, both quarters, would be equally sized from the, from the total gross expense.
Nick Cucharale (Director and Senior Equity Research Analyst)
That's very helpful. Then just on the loan pricing side, can you just help us think about what rates you're getting on your CORE Commercial Real Estate product?
John Connerton (CFO)
Yeah. We're, we're, we're probably getting high 6s, anywhere from 6.5%-7%. You know, depending obviously on, on term and maturity, but that's probably where it's falling in. That's anywhere between 2.25% and 2.50% off of our-
David Nasca (President and CEO)
Over
John Connerton (CFO)
Current, over our current funding source.
Nick Cucharale (Director and Senior Equity Research Analyst)
Wonderful. Thank you for taking my questions.
John Connerton (CFO)
Thank you, Nick.
Operator (participant)
Thank you. Next question comes from the line of Alex Twerdahl with Piper Sandler. Please go ahead.
Alexander Twerdahl (Managing Director)
Hey, good afternoon.
David Nasca (President and CEO)
Good afternoon, Alex.
John Connerton (CFO)
Hello, Alex.
Alexander Twerdahl (Managing Director)
All right, I wanted to ask about loan asset sensitivity and kind of what kind of lifts may still be to come on the loan portfolio. I, I seem to remember you guys have a pretty good chunk of variable rate loans out there. I'm just curious if they've reached ceilings or if we still expect some some lifts in that portfolio as the year continues to progress?
John Connerton (CFO)
Yeah, there's about $320 million in variable, we haven't reached any ceilings on those, we would expect. I mean, there are some resets across the month, so there's some going 30 days or 60 days from, from a change in prime. You know, just looking at a full year, we expect a 25 basis point lift, we'd get that on the 300, you know, 300 and something million dollars.
Alexander Twerdahl (Managing Director)
Okay. I guess, you know, sort of bigger picture when you think about asset sensitivity and as, you know, we may be later this year, transition from a rising rate environment to a potential lower rate environment, how would you say you're positioned these days? I mean, it seems like the cost of deposits is obviously moving higher pretty, pretty quickly, but would you say that you, you've kind of moved from an asset sensitivity position to a liability sensitive position, or, or how are the models coming out?
John Connerton (CFO)
Yeah, I'd, I'd, I'd say that we have moved, from an asset sensitivity to a liability sensitivity. I think in a down 200, you know, we'll, we'll come out in our two, but it's not, it's not significantly material from, you know, less than 5%, on a down 200.
Alexander Twerdahl (Managing Director)
Okay. I guess as you think about obviously managing through a pretty tough rate environment and revenue environment, and, you know, I think you alluded to sort of phase one of the expense initiatives being now completed, you know, is it, is it time to be looking at phase two, or and, and sort of what kinds of things could that include?
John Connerton (CFO)
I think we're, I think we're constantly looking, you know, for, for efficiencies. I do think our David, we went through, we're still through the project, so we're actually a little elevated on our expenses because we're incurring some expenses when we, when we're putting the project in. The, the cost efficiencies will be at the end of this year and into 2024.
Alexander Twerdahl (Managing Director)
Okay. I guess where-- I mean, if the expense level ticks back up above $15 million, $15.1 million or so in the third and fourth quarter, as you mentioned earlier, in your response to the last questions, you know, where do you, where do you see expenses starting, I guess, starting the year with those efficiencies in place starting in 2024?
David Nasca (President and CEO)
Well, I, I think, I think we expect the efficiencies, as John said, we're going to run at kind of this level here till the end of the year. We expect that some of the efficiencies coming out of the commercial project will play into next year. You know, there's some, some positions that will be worked through there. I mean, I'm, I... Do you want to-
John Connerton (CFO)
Yeah. Alex, I would say that our, the efficiencies that we're going to get in 2024 are going to offset some of the increases that we typically have, merit and stuff. I'd say it's kind of a, a flat, at least for the first quarter of next year, is, is kind of what our expectation is, and we, we still have a lot to look at, you know, for looking through and budgeting out the remainder of 2024.
David Nasca (President and CEO)
I think there's also an ongoing requirement, Alex, looking forward as we've tried to digitize more to get some of these efficiencies, that there will be some investment in there that'll balance those saves off, too. 'Cause we're going to reinvest in continuing to migrate towards some digitization that will help us at least be competitive with some of these bigger people, that are spending a lot more than we're spending on it.
Alexander Twerdahl (Managing Director)
Okay. Great. Thanks for taking my questions.
David Nasca (President and CEO)
You're welcome.
John Connerton (CFO)
Thanks, Alex.
Operator (participant)
Thank you. A reminder to all the participants that you may press star and one to ask a question. Next question comes from the line of Chris O'Connell with KBW. Please go ahead.
Christopher O'Connell (VP for Equity Research)
Hi. Yeah, good afternoon.
John Connerton (CFO)
Hi, Chris.
Christopher O'Connell (VP for Equity Research)
You guys talked, talked about, I think a $1 million investment, charitable investment in the quarter, and I think it came through in other expenses. Did that all come through this quarter in other expenses, or was that spread out over the course of the expense base?
John Connerton (CFO)
Yeah. Chris, I'm sorry. Yeah, That wasn't a direct expense investment. It was actually an investment that we hold on the balance sheet. That, that actually earns a return. We, we've only made, I think, in this quarter, we had about a $50,000 charitable contribution, was the limit of our total contributions for this particular quarter.
David Nasca (President and CEO)
Yeah, that's not a charitable investment, Chris. That is a community investment, but it does have a return to it. It. You mentioned, it's a CDFI. It's also a seed capital for venture startups, and they are throwing off a return on the fund.
Christopher O'Connell (VP for Equity Research)
Okay. Got it. Got it. You guys talked about, you know, the, the non-interest bearing deposit mix shift and, you know, perhaps some continued pressure, into the back half of the year. I know that there is some seasonal muni flows as well this quarter. Can you just, you know, talk through, you know, what you're seeing, how much, you know, mix shift might be remaining, and where things can kind of settle out from here and just overall, you know, the, the municipal kind of seasonal impact into the back half of the year?
John Connerton (CFO)
Yeah. I think the high-- you know, our, our balances... I'll talk municipal flow first. Our balances are probably high at the, you know, the end of the end of the first quarter and then again at the end of third and the beginning of fourth quarter. Those flows that you saw, so a decrease of $63, and I think we had a similar increase in first quarter, that's kind of the, the high and the low points there. High at the end of March and then, then low at, in June, and then high again, high again into the third quarter and then low by the end of the year. That's kind of how that ebbs and flows. It's material, obviously, but it's, it's pretty predictable.
As far as, as far as movement from, from transactional accounts or savings accounts, you know, I think that's all reflective in our expectation of the margin. The 20 basis points, you know, that's kind of our, you know, that's, that's, that's reflecting the movement there. Then we have seen some, some slowdown of that. A lot of that margin compression we've seen through June and, and some moderation of that, and that's why we're, for the fourth quarter and the rest of the year, we're, we're hopeful that we're going to see that 20 basis points could be a stabilization point.
Christopher O'Connell (VP for Equity Research)
Okay, great. Do you, do you guys have any updated, you know, deposit beta expectations, you know, for this full tightening cycle?
John Connerton (CFO)
Yeah, I think, you know, we're, we're looking for a little more data through the third quarter really to kind of predict to see that exactly what your question was as far as movement out of transactional accounts into the interest-bearing accounts. I think we're still seeing some, some volatility there, and, you know, we really haven't -- to predict where that's going, we don't have the, the, the data at this point.
Christopher O'Connell (VP for Equity Research)
Okay. Got it. On the credit side, I think you mentioned in your prepared comments that we expect the one nonaccrual that was moved over this quarter to become current in 3Q. Just any, any color you can provide around that relationship?
John Connerton (CFO)
Sure. It's, it's not a nonaccrual. It's 90 days and still accruing, Chris. It's just, it has, it's a senior living center that has some funding issues through the state, and our expectation is delay, that that will that'll come around in third quarter. We haven't classified it as a nonaccrual at this point, based on our expectation of it, upcoming current.
Christopher O'Connell (VP for Equity Research)
Okay. Got it. And as far as just the overall credit, you know, outlook, obviously not, you know, too much movement here and, you know, net charge-offs, you know, have been great so far. I mean, how, how are you thinking about the reserve levels going forward? And if you could, you know, remind us on some of the reserve levels related to kind of the hotel portfolio and how you're seeing, you know, how that might progress into the back half of the year?
John Connerton (CFO)
Yeah, I think our, I think our hotel portfolio, we, we now we currently, you know, it's a small amount that's, that's kind of in our criticized, in our portfolio. I'd say in general, we've seen this quarter, we've seen our criticized assets, which really is, is one of our more solid metrics as to where our credit is trending. We've, again, as I mentioned earlier, we saw a $19 million reduction in that. Most of that was in our C&I portfolio, operating portfolio or operating company portfolios. Our hotels, we do. We have one
in non-performing that's pretty big, $7 million, and then two other that are still just criticized. We see progress in each of those, and that's where if we do have additional, reduction in benefit, that's where we'll see it. Now, under CECL, a lot of our, a lot of our, amounts that are driven by the, the where the economy is. So as the economy goes, the CECL will go. So predicting that, at least as long as things stay stable, we see, we see our provision kind of staying, it'll be represented by the growth that we have in the, in the portfolio.
Christopher O'Connell (VP for Equity Research)
Okay, great. On the, on, on the fee side, insurance fees are strong. I know, you know, a lot of it's seasonal, but also year-over-year, I mean, is, is that, you know, strength expect to continue into, you know, the back half of the year?
John Connerton (CFO)
Yes, we do. I mean, a lot of that strength is, is really in the industry. You know, they use the term hardening of the market. I think insurance companies have brought up their premiums, and we're benefiting on our commissions, due to that. There is just a general increase in our commissions based on the amount of premium that our customers are paying because of, because of the increase in the industry.
Christopher O'Connell (VP for Equity Research)
Okay, great. Is that other, other income line just on MSR benefit in this quarter, is that straight back down to 1Q levels or more similar to what was seen in 2022?
John Connerton (CFO)
Well, there's, there's loan, there is loan, fees in there too. They're the two of them together, it does pop around a little bit just based on volatility and interest rate, markets, and, you know, it's hard to be predictable on that.
Christopher O'Connell (VP for Equity Research)
Got it. Appreciate the time. Thanks for taking my question.
John Connerton (CFO)
Okay, Chris.
Operator (participant)
Thank you. There are no further questions at this time. I would like to turn the floor back over to David Nasca for closing comments.
David Nasca (President and CEO)
Thank you. I'd like to thank everybody for participating in the teleconference today. We certainly appreciate your continued interest and support. We ask that you please feel free to reach out to us at any time. We look forward to talking with all of you again when we report our third quarter 2023 results. We hope you have a great day. Thank you very much.
Operator (participant)
Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.