Evans Bancorp Inc

AMEX:EVBN

Earnings Call Transcript 2023-Q1

[Operator]

Greetings. Welcome to the Evans Bancorp's First Quarter 2023 Financial Results. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded.

At this time, I'll turn the conference over to Deborah Pawlowski, Investor Relations of Evans Bancorp. Mr. Pawlowski, you may now begin.

[Deborah Pawlowski, Investor Relations]

Good afternoon, everyone and thank you very much for joining us today. We appreciate your interest in Evans Bancorp Inc. Anyway, 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 first quarter of 2023 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 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. 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 & Chief Executive Officer]

Thank you, Deborah. Good afternoon, everyone. We appreciate you joining us today. I will start with a review of the past quarter and we'll then hand it off to John to discuss our results in detail. In light of the recent turmoil in the banking industry and range of negative headlines nationwide about banks and financial institutions, we believe our team has managed to headwinds well and delivered solid results during the quarter.

It's important to note that we are a strong community bank that has been operating for more than 100 years in a consistent and resilient way in the slow and steady market. We work in a range bound market, which does not see high peaks are the resulting deep troughs. With a diversified client base and focus on quality commercial and consumer customers, we have weathered uncertain environments before and continue to do so.

Despite being buffeted by macro factors, including the most rapid ascent of Fed rates in history, bank failures driven by risky activities and negative sentiment on financial industry performance. We have continued to drive our strategy forward and focus on initiatives that we can control.

Our focus remains on cultivating core relationships, managing expenses in delivery of our business, maintaining credit risk discipline, making strategic investments to optimize operations, reduce operational risk and improve our customer interactions. It is the blocking and tackling of traditional community banking with appropriate risk management and making sure we are in a position of strength to capitalize on opportunities as they present themselves.

With that said, during the past quarter, we realigned our leadership teams to provide intense focus on our strategic pillars growth, operational effectiveness, and digital migration, talent, culture and community, financial stewardship, and appropriate risk and controls guardrails. We believe these internal changes better align corporate responsibilities with our strategic plan, while fostering collaboration and accountability.

Highlighting some of the results for the quarter, we delivered $5.8 million in net income, which was up 22% over last year. This result does reflect a provision release, but absent that, we were still pleased with the performance given the margin pressure caused by rising interest rates and pricing competition. Given inflationary pressures and historic Fed increases in rates, the cost of interest bearing liabilities rapidly accelerated during the quarter as competition for deposits intensified and customers look for options with greater returns.

Evans does not have a material concentration of uninsured deposits, and has maintained funding balances with the use of competitive and relationship pricing within our products, as Evans deposit balances decreased only 1% in the quarter and in fact, when looking at spot balances at the end of the period, total deposits were up 4% from the previous quarter. And the asset side of the balance sheet, loan production during the first quarter was solid as we continue to build a diverse portfolio of high quality loans with average balances up 5% year-over-year and up 1% from last quarter.

Equally important credit trends in the first quarter continue to be favorable. The yield on loans improved both sequentially and year-over-year, but the increases are now being outpaced by deposit costs as reflected in NIM contraction. We expect these market conditions and pricing challenges to persist and pressure our margin as John will discuss in more detail.

While focusing on expense management, we have committed to strategic investments in people and technology to better scale the organization, drive future efficiencies, and improve customer facing solutions for better experiences. Some examples include a new digital platform with live customer chat functionality, enhanced capabilities within the commercial loan servicing and processing system and enhancements in credit and portfolio management to reduce risk and create opportunities for efficiencies.

During the quarter, we completed the sale of the two properties in the southern tier market that were part of our branch rationalization initiative completed toward the end of last year. CECL or current expected credit losses methodology was implemented during the quarter, which John will also cover. As we look ahead, we expect to continue to confront headwinds and are doing all that we can to support our clients in the community in a thoughtful, profitable way, while addressing volatility and risk as we've been able to do through many cycles.

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, Chief Financial Officer]

Thank you, David, and good afternoon, everyone. For the quarter we delivered earnings of $5.8 million or $1.06 per diluted share, which was up 22% or 1.1 million from last year's first quarter. The increase reflected higher net interest income in a benefit from the change in provision for credit losses, partially offset by lower non-interest income. The decrease from the sequential fourth quarter was largely due to a reduction in net interest income, partially offset by a release of allowance for credit losses.

Net interest income was down 10% from the fourth quarter at higher interest expense resulted from intense competition pressure on pricing of deposits which accelerated during the quarter. This more than offset the 4% increase in interest income, which was driven by growth in our variable rate portfolios following the Federal Reserve's continued increase in rates of 50 basis points during the quarter.

The 5% growth in net interest income since last year's first quarter reflected an increase due to the interest rate environment and expansion of interest earnings assets over the past 12 months. With increased interest expense as a result of higher deposit costs, we saw a 31 basis point decrease to net interest margin in the first quarter from the fourth quarter to 3.46%. I will talk to our NIM expectations at the end of my remarks.

On January 01, 2023, the Company adopted the current expected loss methodology for estimating and accounting for the provision for credit losses, which is commonly known as CECL. The impact of CECL was $2.7 million addition to allowance for credit losses and a $2 million net of tax was booked to capital as a beginning of period adjustment. The benefit of $654,000 in the provision for the quarter was due to lower loan balances, qualitative factors related to home price moderation, and lower specific reserves on impaired loans.

Non-interest income was $4.1 million in the quarter, down approximately 7% from the prior year's first quarter, primarily due to movements in mortgage servicing rights and lower loan fees. Compared with the 2022 fourth quarter, non-interest income decreased 8% as the sequential quarter included income from a gain-on-sale and rents collected from an ORE property.

Insurance, which is our largest contributor within this category was up 6% year-over-year and 10% from the linked quarter, due to increased profit sharing, higher written premiums and new commercial clients. 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 and at what levels.

We did implement changes during the 2022 fourth quarter, which resulted in a reduction in fees of approximately $70,000 to $80,000 with the deposit service charges line. Total non-interest expense decreased 3% or $400,000 from the sequential fourth quarter and was relatively flat with last year's first quarter. The quarter benefited from lower incentive accruals of $600,000 when compared to both the linked and prior year quarter within the salaries and employee benefits line.

Reflected in this quarter are the annual resets on FICA and unemployment insurance and the annual payment into our HSA accounts, which partially offset the lower incentive accruals when compared to the linked quarter. Compared with the prior year's first quarter, the decrease in salary expense incentive benefit was offset by merit increases awarded in 2022. Our expectation for the full year expense run rate is between 1% and 2%.

Turning to the balance sheet and reviewing movements in the first quarter. Total loans were down $14 million of that commercial loans decreased less than 1% or $9 million. Net originations were $56 million during the quarter and that compares with $71 million of net originations in the fourth quarter. We have seen a slowdown in commercial real estate loans, giving the rising rate environment, whereas commercial and industrial volume has strengthened and made up 80% of our net originations.

These C&I originations consist of lines of credit, which will have future balance impacts. However, they remain unfunded during the quarter and muted any growth in the portfolio. The current pipeline remains active instead of $62 million at quarter end. We expect total commercial loan growth to be approximately 3% in 2023. Our credit metrics remained sound with a slight decrease in non-performing loans on a sequential basis and low charge-offs in the current quarter.

Total deposits of $1.85 billion increased $78 million or 4% from the fourth quarter. Reflected in the deposit increase was seasonal inflow of municipal deposits. While commercial deposits have seen a seasonal outflow, which is typical in the first quarter due to distributionand tax payments that commercial clients make at the beginning of the year. This smaller outflow in the current quarter was similar in size to last year's first quarter, and was offset by growth and consumer deposit balances, as we attracted funding into our CD portfolio, which grew at $7 million during the quarter.

We will be proactive with pricing and maintain competitive rates in our market and expect that our clients as has happened in previous cycles will migrate balances in different products. In particular, we are seeing commercial clients migrate funds out of demand deposit accounts and into sweet products. And we expect consumer clients to continue moving funds from savings accounts to CDs.

These trends and pricing pressures have an accelerated impact on our margin for the first quarter, and if trends continue, we expect it will impact margin on a full year basis. As of now, we expect our NIM to experience approximately 35 basis points of compression in the second quarter of 2023. Beyond the second quarter is hard to forecast given external macro forces such as potential future Fed moves and how competition may play out.

With that operator, we would now like to open the line for question.

[Operator]

Thank you. We'll now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our First question comes in line of Alex Twerdahl with Piper Sandler.

[Alex Twerdahl, Piper Sandler]

First, I wanted to start with a follow-up on that last comment on the NIM, John. What assumptions are you making in terms of the average balance sheet size and a meaningful shift one way or the other?

[John Connerton, Chief Financial Officer]

I think we talked about just the growth in our asset side on the loan side would be about 3% for the full year and correlated deposit growth, so both of them probably in step with each other expectation from now until the end of the year.

[Alex Twerdahl, Piper Sandler]

But in terms of the just NIM guide for down 25 in the second quarter, the assumption there is relatively flat balance sheet or maybe a little bit of that 3% we start to see in the second quarter?

[John Connerton, Chief Financial Officer]

Yes, gradual increase.

[Alex Twerdahl, Piper Sandler]

And then just go into your expense guide. I think you said, expecting 1% to 2% expense growth for the full year. Last quarter, you said 2% to 3% for the full year in '23. Can you talk about some of the things that you've done to bring that guidance down?

[John Connerton, Chief Financial Officer]

Sure. I think, in particular, we mentioned the incentive accrual is a big piece of that as well as we're looking at managing all of our discretionary funds or discretionary spending that we're having this year.

[Alex Twerdahl, Piper Sandler]

And then, I wanted to ask about insurance revenue, the growth of 6%, roughly year-over-year. Is that a reasonable indicator when we think about full year insurance expense over 2022? Is that 6%, is that -- can we extrapolate that?

[John Connerton, Chief Financial Officer]

I think, the each quarter. If we look year-over-year should be on an annual basis of 6%. And I think that has to do in part to the hardening market as well as some of the growth that we had last year that we're now realizing. So, a 6% growth would be reasonable.

[Alex Twerdahl, Piper Sandler]

And then just the final question that I have is just when we think about CECL the adoption and kind of updated outlook for some of you different portfolios and growth, etc. How should we be thinking about the provision expense do you think now that your CECL bank?

[John Connerton, Chief Financial Officer]

I mean, barring volatility in the economy, that could take us up or down, maybe a little more at a little more quicker pace. I think typically, what drives us is the growth or any impact from a criticized asset, meaning going into non-accruals. So, I think a typical provision for each quarter will be consistent as it has been historically.

[Alex Twerdahl, Piper Sandler]

Okay. Well, when you when you did the CECL adjustment, did you have any sort of quantitative overlays on top of the economic forecasts? Just, you know, a lot of people think we're going into recession and other people don't? Just curious kind of what kind of assumptions went into it?

[John Connerton, Chief Financial Officer]

Yes, I mean, we have our quantitative piece, which is locked in on the forecast that we identified that's correlated to our last projection, but we do have we do have an economic qualitative factor that we have moved in the quarter due to what you've suggested is we see a little weakness in the future economy.

[Operator]

[Operator Instructions] The next question is coming from line of Chris O'Connell with KBW. Please proceed with your question.

[Chris O'Connell, KBW]

So follow up on the expense commentary. The full year guide modestly improved, but just given, the starting point to the year, at lower levels then than last year, in the branch closures, how are you thinking about the cadence going into 2Q '23 as a starting point?

[John Connerton, Chief Financial Officer]

So I think this quarter is a little higher on the, I mean, salaries drive most of our expenses, and this was a little higher based on what I suggested with the FICA and the HSA payment. But I think, moving forward, we do have our merit increases that we typically do at the end of the first quarter, that'll move that number, that'll offset some of that benefit that we'll have in second quarter. So, I think, extrapolating, the full year to each of the quarters is a reasonable estimate.

[Chris O'Connell, KBW]

And then on the NIM guide for down 35 basis points next quarter, can you provide us with a little bit of color around what's going into that on the deposit costs and where those might trend towards for the quarter or just the overall IBL costs?

[John Connerton, Chief Financial Officer]

Sure. So, I think, if we look at our beta through the cycle, through the last month of the quarter, we were at 28. If you look at the, if you just take the quarter beta, we're closer down to 22. So, we've taken that 28 kind of extrapolated that through to the first quarter, which is not evident in the quarterly results, but that's where -- that's what's really driving and that'll be impacting the second quarter going through. So, it's kind of already pricing was done through the quarter to the end and we expect that to carry through to second quarter.

[John Connerton, Chief Financial Officer]

So, we'd say rate migration.

[Chris O'Connell, KBW]

Yes. And so that 28, that's the total deposit beta, not the interest bearing?

[John Connerton, Chief Financial Officer]

Yes.

[Chris O'Connell, KBW]

Okay. And as far as the securities portfolio goes, can you just provide us with what the duration is there and how much of the portfolio is floating rate?

[John Connerton, Chief Financial Officer]

Sure. All of the -- whole portfolio, there is we don't have any variable rate in our security portfolio. The duration is just under five years.

[Chris O'Connell, KBW]

Great. And I know there was a couple of items in that were impacting other income on a quarter-over-quarter basis relative to the fourth quarter. Is this a good run rate on a go forward basis or will you guys see a little bit of pickup, given I think it was at higher levels for of the last year?

[John Connerton, Chief Financial Officer]

Yes. I think we had some items, kind of one off items it seemed throughout the quarters last year. This is a good run rate other than just to remind you that, we do have seasonality in our insurance portfolio. Third quarter is typically significantly higher. That seasonality, we expect to be similar, so you can apply that seasonality to any expectations for this year's revenue.

[Chris O'Connell, KBW]

Okay, got it. And then on the tax rate, it came in I think a little bit lower than what you guys were thinking previously. Is 24.5% still a good number, or do you think that'll shake out a little bit lower this year?

[John Connerton, Chief Financial Officer]

I think it will shake out a little lower just based on our expectation for lower income with the margin compression.

[Chris O'Connell, KBW]

Got it. And for the overall credit quality and what you guys are seeing within your markets in the portfolio. Obviously, this quarter was very strong. Is there any pockets of risk or what are you guys looking most closely at in terms of what's most attractive at this point in the cycle, and what you are most excited to put on the balance sheet versus where you might be shying away from?

[David Nasca, President & Chief Executive Officer]

That's a couple of questions here, Chris. Let me start with part of the answer and make sure that I cover down on all yours. Number one, what we are seeing is a migration, which we have tried to do anyway from CRE or commercial mortgages to C&I. We like that. That's good. So, we are happy with that migration to put that on the books. And you talked about credit performance. I'll talk about that at the end.

But we are seeing obviously on the other loan portfolios you are also seeing mortgage slowdown. So on both sides, consumer and commercial rates are impacting the projects and slowing. But as John mentioned, we've seen 80% of our production come out of C&I in the last quarter, which is a good market for us. We believe as we're balancing the portfolio with good earning assets there.

With regard to credit, we feel good about the quality of credit right now. We talked about the take back of the provision here, but remember, part of that was production related in terms of lower levels of production assets in terms of we have less balances, so you didn't need provision there. That's part of the step back on that. But on top of that, we've been talking for a long time about the hotels, those got better, we do not have a concentration in offices.

Our commercial real estate portfolio has generally been in things like owner occupied multifamily, which are still performing very well. So, we're feeling good about credit quality in terms of the diversity of the portfolio and in terms of the focus of the things that we are in. Did I cover the things you want to cover there?

[Chris O'Connell, KBW]

Yes. That's all I had. Thank you. I appreciate you taking my questions.

[Operator]

Thank you. At this time, I have to turn the floor over to management for any further remarks.

[David Nasca, President & Chief Executive Officer]

Thank you, Rob. We'd like to thank everyone for participating in the teleconference today. We certainly appreciate your continued interest in support. Please feel free to reach out to us anytime we look forward to talking with all of you again when we report the second quarter to 2023 results and we hope you have a great day.

Thank you, again.

[Operator]

This will conclude today's conference. You may disconnect your lines at this time. Thank you for your participation.