Evans Bancorp - Q4 2022

Transcript

Speaker 0

Greetings. Welcome to the Evans Bancorp Fourth Quarter Fiscal Year 2022 Financial Results. 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, Craig Myhali. You may begin.

Speaker 1

Thank you, and good afternoon, everyone. Certainly appreciate you taking the time 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 Connorton, our Chief Financial Officer. David and John are going to review the results for the Q4 and full year of 2022 and provide an update on the company's strategic progress and outlook. After that, we'll open 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 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.

Please find those documents on our website or at the sec.gov. So with that, let me turn it over to David to begin. David?

Speaker 2

Thank you, Craig. Good afternoon, everyone. We appreciate you joining us today. I'll start with a review of the past year and then hand it off to John to discuss our results I'm once again proud to report on the outstanding efforts and responsiveness of our teams in successfully adapting to rapidly shifting Economic conditions and environments during 2022. Evans delivered solid 4th quarter results with $6,000,000 in net income And 14% annualized commercial loan growth, which added to strong performance for the full year of $22,400,000 and 9% commercial loan growth ex PPP loans.

These results approach prior year record earnings We have a significant swing in our provision for loan losses and having to replace nearly $9,000,000 in fee income received in 2021 from extensive participation in the Paycheck Protection Program. As you know, the economy opened 2022 with tremendous liquidity from government stimulus, remaining at financial institutions and very little opportunity to invest this Given inflationary pressures and macroeconomic challenges from ramping supply inputs such as labor, Oil, building supplies and housing as well as the Russian invasion of Ukraine, the Fed embarked on an historic level of interest rate tightening that Raised short term interest rates, 425 basis points in 7 actions taken from March to December. This unprecedented level of tightening resulted in an inverted yield curve, which has historically indicated potential recession. Margins expanded as rates for loans increased and deposit costs stayed modest until late in Q3. At that point, Competitive options mirrored rate increases and money began to flow to alternative investments such as U.

S. Treasuries and higher rate deposits, putting pressure on banks to match or lose funding. On the asset side of the balance sheet, loan yields rose and outstripped levels of deposit increases for a couple of quarters until interest rates reached a level that challenged CRE projects and residential mortgages. Overall, the bank successfully weathered and performed in this environment by delivering record commercial loan originations of $95,000,000 ex PPP At significantly improved rates, driving the yield on earning assets for the portfolio for the loan portfolio to 4.88%. In relation to non interest income, it was a solid year in our insurance business with 6% commercial insurance growth and 2% personal lines growth.

Offsetting the loss of revenue from the discontinued operations of our insurance claims service business, We saw strong account retention, price hardening and a good level of new business attraction. While we continue to make investments in strategic focus areas, we also worked hard throughout the year to pursue efficiencies and deliver disciplined expense management to enhance returns. This included further utilization of technology to refine Back office processes, along with greater customer facing solutions centered on speed, flexibility and efficiency. We completed our branch optimization project in the Q3, which included consolidating 2 branches in the southern area of our footprint, Closing a branch in Rochester and converting a downtown Buffalo location to a loan production office. The anticipated employee savings were realized through normal attrition.

The merger of the 2 branches has been very with excellent morale amongst the team as the combined larger branch is more efficient. Importantly, there has been no material customer defection As a result of these changes, additionally, we have received a purchase offer for the closed location in Derby. The net result of our efforts can be seen in the efficiency ratio, which was 62.9% in the 4th quarter, which is our lowest level in more than 10 years. This past year was also our largest yet $1,000 to the Buffalo Together 514 Community Response Fund, established in collaboration with local funding organizations, 100 local and national foundations and corporations and over 2,000 community members after the mass killing of 10 innocent people in a racist attack in East Buffalo. The fund was created to address systemic and structural issues related to racism and a lack of investment that harmed communities of color.

Of our total contributions last year, nearly 80% was directed towards underserved communities And organizations serving low and moderate income residents. Another area of focus and where strides were made this past year were our efforts Towards inclusion, diversity, equity and awareness. The bank appointed a Chief Diversity, Inclusion and Community Development Officer responsible for driving the overall development, implementation and communication of our inclusive strategic plan. Overall, a 13% increase in ethnic minority associates was realized through concentrated recruitment efforts. As part of our inclusive culture, we continue to achieve pay parity between genders for those who identify as male or female and across race and ethnic backgrounds.

We have also been successful expanding our supplier diversity program to ensure that minority and women owned businesses We're bidding on and securing business from Evans and are ahead of our 5 year goals in all initiatives. The bank has continued to focus on its return of capital to shareholders and total shareholder return. For the year, dividends totaled $1.26 which was up 5% over 2021 and equated to a yield of 3.2%. As we enter 2023, the focus will continue to be on loan growth, customer acquisition and relationship management, along with optimizing operational efficiency and expense management to deliver returns. This will play out against Expected headwinds of margin pressure caused by rising interest rates and pricing competition and potential recessionary effects Impacting the economy and our customers.

We believe our value lies in our community based customer centric model, which allows us to support, And then we'll be happy to take any questions. John?

Speaker 3

Thank you, David, and good afternoon, everyone. For the quarter, we delivered earnings of $6,000,000 or $1.09 per diluted share, which was up 3% from the sequential Q3 and last year's Q4. The increase from the 2022 Q3 was largely due to reduced provision and lower non interest expenses, partially offset by lower non interest income. The change from the prior year reflected lower non interest expenses partially offset by an increase

Speaker 4

in provision.

Speaker 3

Full year net income reached $22,400,000 or $4.04 per diluted share compared with the record level set in 2021. As David mentioned, our annual results were strong considering the higher provision compared with the release of allowance during 2021 along with the significant level of PPP fees during the prior year period. Net interest income was up slightly from the sequential third quarter As higher interest income due to federal funds rate increases of 125 basis points was largely offset by an increase in interest expense given the cost increase of interest bearing liabilities due to competitive pricing on deposits. The decrease in net interest income since last year's Q4 reflected the benefits that impacted the prior year. Those included $2,400,000 of PPP fees, dollars 800,000 of amortization of fair value marks on acquired loans and $700,000 of interest recognized from the payoff of non accrual loans.

The year over year increase in provisions It was largely due to strong loan growth. Also reflected was an increase in criticized loans and an increase in a specific reserve for Smaller commercial loan previously in nonperforming. Our balance sheet benefited from rising interest rates and given recent Fed actions, We saw a 5 basis point lift in net interest margin in the 4th quarter to 3.77%. I will talk to our NIM expectations at the end of my remarks. Non interest income was $4,500,000 in the quarter, down approximately 5% from prior year Q4, primarily due to an insurance claim from BOLI And a reversal of an earn out relating to a small insurance agency acquisition in the other income line, each recognized in the prior year.

Insurance, which is the largest contributor within the category, was up 5% year over year due to higher premiums and new commercial clients. Insurance was down from the linked quarter largely due to typical seasonality in commercial lines insurance commissions. As we mentioned last quarter, the competitive landscape and regulatory environment have brought to the forefront changes to overdraft fees in terms of how they are handled and assessed it and at what levels. We did implement changes during the Q4, which resulted in the reduction in fees of approximately $100,000 The full year impact for 2023 is estimated at $400,000 Total non interest expense decreased 6% or $900,000 From the sequential third quarter, it was down $1,400,000 or 9% from last year's 4th quarter. The primary driver over both comparable periods was lower salaries and employee benefits, which reflects prudent expense management efforts, Our efficiency initiatives and lower incentive accruals.

Our expectation for expenses run rate For the full year, it's between 2% 3%. Turning to the balance sheet and comparing since last year end, investment security balances were up 62,000,000 And total loans increased $100,000,000 or 6%. Excluding the decline in PPP loans, total commercial loans increased $95,000,000 or 9%. PPP loan balances, which are included in commercial and industrial loans, were less than $1,000,000 at the current year end. Looking at the recent Q4, total loans increased $46,000,000 Of that, commercial loans grew 3.6% or $68,000,000 of net originations in the linked quarter, which continues to be higher than last year's average originations.

We have seen a slowdown on 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 $69,000,000 at year end. We expect total commercial loan growth to be between 5% and 7% in 2023. Our Credit metrics remain sound with a slight decrease in non performing loans on a sequential basis and low charge offs in the current quarter. Almost 60% of our hotel portfolio has been upgraded or paid off, leaving $30,000,000 in criticized status at the end of 2022. While trends for this industry have improved, a change in status for the remaining criticized hotel credit is dependent on continued positive payment performance.

Total deposits of $1,770,000,000 decreased $102,000,000 or 5% from the sequential third quarter And on a year over year basis, we're down 9%. Deposit betas began to accelerate during the quarter and some of our more sophisticated commercial and municipal clients with larger balances have moved their excess funds to other investment options. Of the decline in deposits, approximately 60% was due to less than ten Commercial and municipal customers. These customers continue to be operating clients of the bank, but have moved excess funds to treasuries. We have maintained consumer funding balances with the use of competitive pricing of our term products.

We will be proactive with pricing and maintain competitive rates in our We expect these market conditions and pricing pressures will have an impact on our margin for the Q1 and full year period next year. The 4th quarter was a high point in this current interest rate cycle and we expect our NIM to experience approximately 10 basis points of compression in the Q1 of 2023. The bank does have $350,000,000 of variable loan portfolio and expects approximately additional $200,000,000 of maturities and repricing on loans and investments in 2023 to benefit 2 additional 25 basis point increases from the Fed, including the one at yesterday's meeting. These are expected With that operator, we would now like to open the line for questions.

Speaker 0

And our first question comes from the line of Alex Twerdahl with Piper Sandler. Please proceed with your question.

Speaker 5

Good afternoon, guys.

Speaker 2

Good afternoon, Alex.

Speaker 3

Hey, Alex.

Speaker 5

Wanted to start, I guess, kind of where you're ending your comments, John, on funding. And I'm just curious, After the declines that you saw in the Q4 attributed to the larger customers, if you think that that's kind of the extent of your at risk Larger, chunkier customers or

Speaker 0

if you

Speaker 5

can give us some sense for what you're seeing in the Q1, just thoughts around You know the different ways to support the loan growth?

Speaker 3

Yes. That's kind of what we're seeing. We kind of went through more of that larger flow out in the Probably in the latter part of Q4 and for the Q1 we've seen kind of stabilization of that flow out And we're we are obviously, our pricing is keeping the consumer side. On that commercial side, we think the most sensitive have moved away. And we think that as far as there is some seasonality on the municipal side.

We'll see some of that come back in the Q1 as the towns receive their tax receipt. But we've seen the larger again, there was only a very small handful of those customers And we kind of ring fenced them.

Speaker 5

Okay. Would you expect in the Q1 to see your average borrowings or I guess your total borrowings increase?

Speaker 3

Our total borrowing should actually come down a little with the municipal dollars that will come in, Alex, so we would expect it to come down slightly.

Speaker 5

Okay. And can you talk a little bit about the pricing that you're seeing on some of that new C and I paper that is in the pipeline?

Speaker 0

I mean,

Speaker 3

all our yes, most of our C and I paper is coming at our cost of funds plus $2.50 or so. So we're keeping Our spreads, which at this point is anywhere 6.5% and above.

Speaker 5

Okay. And I'm just curious, I guess, in terms of some of the moving parts In fee income, we read about from OER some pretty large snowstorms up in the Buffalo market. I know that historically those types Things have impacted your insurance revenue. I'm just curious if that's something that you think we might see in 2023 or be prepared to see in 2023 or Any other thoughts around whether or not the 5% growth that we saw year over year could continue into the New Year?

Speaker 3

Yes. So you kind of referred to some of the claims adjustment that we had with our claims adjusting company that we Went away from last year. So we don't expect to see any spikes due to kind of the weather related issues. But we still do see that the market is hardening from a premium perspective and we do expect that our new business Growth should be consistent with what we experienced this year.

Speaker 5

Okay, great. And then On the overdraft, I think last quarter you said the total year effect would be around $500,000 So you're now saying that's around $400,000 or is it $400,000 more than

Speaker 3

It's $400,000 for the full year 2023 versus 2022. So Yes, we hit $100,000,000 last year. Yes, we hit $100,000,000 in this quarter. So it's The difference between that, yes.

Speaker 5

Okay. So we're going to be maybe a full quarter's impact if you compare it to a year ago would be around 125 $1,000

Speaker 3

Yes.

Speaker 5

Okay, great. Thank you for taking my questions.

Speaker 3

Thanks, Alex. Thanks, Alex.

Speaker 0

Our next question comes from the line of Chris O'Connell with KBW. Please proceed with your question.

Speaker 4

Hey, good afternoon.

Speaker 3

Hi.

Speaker 4

So wanted to circle back to the margin discussion. It seems like the deposit flows are starting to stabilize in the Q1. Can you talk about what you guys are You're putting out their undeposit pricing in order to keep your current customers and gain new customers And how you see that progressing over the next couple of quarters?

Speaker 3

I think on the term, Chris, So CDs from a consumer perspective, that's anywhere between 3.5% 4%, depending on what market we're in. I do think, then on the savings side where we're talking about commercial savings, we can utilize kind of Our geographic footprint a little bit where we don't have some business can be a little more aggressive and go with some promotions on Business accounts that could be as high as 3.5% to attract new business.

Speaker 4

Got it. And just, I mean, given the margin guidance For down 10 bps in the Q1 and then stable, I mean given where your Deposit costs are now at 51 basis points, and where those new deposits and deposits are repricing Throughout next year, I would think given the variable loan portfolio that the Q1 should be the least amount of impact And then there should be pressure thereafter as the deposits continue to be repriced. So can you just talk about like why that may not Kurt, and I guess like what goes into the margin outlook and the trajectory after the Q1?

Speaker 3

Sure. I mean, I guess I mean the difference between the 4th and the first quarter is to the just the level of borrowings that we had spiked at the end During Q4, but I think and it's the categories of where we had some dollars move out So that the Q4 had some demand deposits move out, in particular some of our larger clients. So that's going to have a kind of an Oversized impact from 4th to 1st quarter, and then we do expect that stabilization. So we've said it in the past, The last cycle we had about a 37 to 39 beta and we still expect that. So if you kind of calculate that through As the year goes through here, we'll get closer to a 2% cost of interest bearing liabilities With an average somewhere between 165 185 during the year.

Speaker 4

Okay. And I guess, but still, Given that the deposits are going to be repricing throughout the year, not just in the Q1, And a variable portfolio is going to stop repricing after the Q1 for the most part. How is that But with the flattening trajectory.

Speaker 3

Well, I mean, we have some Funding that's going to come in, in the Q1 and stick around. So Q4 has a low point and the beginning of the first So we expect our borrowings to shrink and reduce. And so that's kind of the 1st quarter is kind of oversized from that NIM compression.

Speaker 4

Okay, got it. And as far as cash balances, Still pretty low here at like $6,000,000 or so. Is there how do you guys see that progressing over the next couple of quarters.

Speaker 3

I think our cash balances will stay fairly tight Because we're any opportunity we can, we'll pay down on our borrowings, which are more towards the short end at this point.

Speaker 4

Okay, got it. And for the expenses, The outlook is a little bit better, I think than where it was last quarter. Can you just talk about any seasonality that you expect in the Q1 versus the remainder of the year? And maybe where your FDIC costs We'll start off in the Q1 given the higher assessment rate.

Speaker 3

Yes. So that 3% It does include a higher expected FDIC rate. The biggest impact is And on our expenses that are kind of holding down in relation to prior year is our expectation of our in our salaries and our Expected incentive that will pay out just based on the levels of goals that we have and the payout that will were assumed. So, the Q4 is actually kind of a good run rate moving forward. And then with that 2% to 3% kind of impact as the quarters move on quarter from linked quarter to linked quarter.

Speaker 4

Okay, great. And what's a good tax rate for next year?

Speaker 3

24.5 is a good tax rate.

Speaker 4

Great. And then lastly, Credit metrics all around seemed great this quarter. Can you just talk about, Given the move in rates and kind of overall economic activity, what you guys are seeing in your market areas and within your portfolio and Maybe where you're pulling back on or see additional risk as well as What the critical factors are to keep the hotel portfolio criticized coming down over the course of next year?

Speaker 2

I'll answer that one here, Chris. A couple of things. One is in the marketplace, we're still seeing strength And good credit, especially in the manufacturing and the C and I side. Commercial real estate has Slow down with the increase in rates. Mortgage obviously has really tightened up in terms of slowing down.

So from an Activity standpoint, that's kind of what we're seeing. We've offset commercial real estate growth Last year, we've offset that with our C and I expectation. This year, obviously, when you're in industry, whether it's service For manufacturing, if we head into a recession here, there could be impacts there. We're watching that. At this point, Credits are fairly benign.

We're seeing that across the industry and we're feeling the same way. You're hearing that I'm sure across all Your discussions here, we are trying to stay very close to our customers though because If we get into a recessionary environment, demand is going to matter. Most of the people have worked through the supply chain issues that they had, And that actually is resulting at least in the manufacturing side improving. We're not seeing Any deterioration at this moment on the credit side? So I think we're feeling pretty constructively positive In terms of going into this, we're not chasing it.

Certainly, we always Talk about that. We maintained our credit standards. We're not loosening those. John talked about the margins earlier. We are getting paid for the risk We're not shrinking too much on the margin here.

So I think overall, we're feeling okay Going into what we're seeing right now and we're watching it.

Speaker 3

The only thing I would add just Chris just we're going to be On CECL in the upcoming year and the provision will be a little more at risk With forecasts on the economy, so that's something to kind of consider.

Speaker 2

I guess you also asked The question about the hotels, I'll go back to that. 60% of the hotels have come out since we originally criticized them. You have probably $30,000,000 still left. Of those, one of them will stay in there, call it $8,000,000 to $10,000,000 The rest of those, we are continuing to watch for performance at their given cycles, different Prime periods, they are performing. We don't see anything that will preclude them from continuing to repair themselves and come out over the next period of

Speaker 4

Great. And for the CECL impact, do you guys have an estimate for that yet?

Speaker 3

Yes, we'll have some disclosures in our K when it comes out in the beginning of March.

Speaker 4

Okay, got it. Thanks, John. Thanks, Dave. Appreciate you taking my questions.

Speaker 2

Thanks, Chris.

Speaker 0

And we have reached the end of the question and answer session. I'll now turn the call back over to management for closing remarks.

Speaker 2

Thanks, Shamali. I'd like to thank everyone for participating in our teleconference today. We certainly appreciate your Continued interest and support as we go through the years. 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 Q1 2023 results and we hope you have a great day.