Evans Bancorp Inc
AMEX:EVBN
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Greetings. And welcome to the Evans Bancorp's Second Quarter 2023 Financial Results. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded.
At this time, I'll turn the conference over to Craig Mychajluk, Investor Relations, Evans Bancorp. Thank you. Ms. Mychajluk, you may now begin.
Good afternoon, everyone. We certainly appreciate you taking the time today to join us as well as your interest in Evans Bancorp Inc. 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 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.
So, with that, let me turn it over to David to begin. David?
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 and we'll then hand it off to John to discuss our results in detail. Things have somewhat settled in the banking sector this quarter is the focus has returned from fears of bank failures to execution. However, external market forces in particular, the interest rate environment continued 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 emerging 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 in these conditions change. This includes maintaining and growing deposits, proven 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 fire 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 balanced 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 long 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 in 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 D. Biddle Jr, retired and we added two new highly experienced and accomplished leaders, don de Perrier who brings vast knowledge and experience in information technology, cybersecurity, finance strategy and digitization. And Robert James, a corporate attorney, who has expertise in governance and 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 members mentorship and access to seed funding, with a goal to fuel the startup ecosystem in Western New York. This is a 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 are 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.
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 and 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, proven 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 balanced 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 in 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, our corporate attorney, who has expertise in corporate governance, diversity, equity and inclusion.
Additionally, during the quarter, the company was readded 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 a 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?
Thank you, David. And 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 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 a 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 rights 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 and 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 today, 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 in non-performing loans, which reflects just a single commercial credit of $6.5 million that is still accruing, and 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 31 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 30, 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. However, 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 in 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 Instructions]. First question comes from the line of Nick Cucharale with Hovde Group.
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?
Can you just clarify a little bit, Nick? You mean just the total growth or…?
Yes, exactly. Just including the residential and the residential component as well.
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 will be the 3% growth that we're seeing from here to the end of the year.
Just a follow-up on the expense guide. Clearly, a great job of controlling costs so far and finding efficiencies. Just to get to 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 last two quarters? Or is there a pickup in the third quarter that kind of gets you there.
No, I'd say both quarters would be equally sized from the total gross expense.
On the loan pricing side, can you just help us think about what rates you're getting on your core commercial real estate product?
We're probably getting high 6s, anywhere from 6.5% to 7%. Depending obviously on term and maturity, but that's probably where it's falling in. So that's anywhere between 2.25% and 2.50% off of our – over our current funding source. .
Next question comes from the line of Alex Twerdahl with Piper Sandler.
I wanted to ask about loan asset sensitivity and kind of what kind of lift may still be to come on the loan portfolio. 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 lift in that portfolio as the year continues to progress?
There's about $320 million in variable and there are – we haven't reached any ceilings on those. There are some resets across the months, but – so there's some going 30 days or 60 days from a change in prime. But just looking at a full year, if it's a 25 basis point lift, we'd get that on the 300-and-something million dollars.
I guess sort of bigger picture when you think about asset sensitivity and as 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? It seems like the cost of deposits is obviously moving higher pretty quickly. But would you say that you've kind of moved from an asset sensitivity position to a liability-sensitive position? Or how are the models coming out?
I'd say that we have moved from an asset sensitivity to a liability sensitivity. I think in a down 200, we'll come out in our Q, but it's not significantly material from less than 5% on a down 200.
I guess as you think about obviously managing through a pretty tough rate environment and revenue environment and I think you alluded to sort of phase one of the expense initiatives being now completed, is it time to be looking at phase two and sort of what kinds of things could that include?
I think we're constantly looking for efficiencies. I do think – 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're putting the project in, but the cost efficiencies will be at the end of this year and into 2024.
If the expense level ticks back up above 15%, 15.1% or so in the third and fourth quarter, as you mentioned earlier in your response to the last questions, where do you see expenses, I guess, starting the year with those efficiencies in place starting 2024?
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. So there's some positions that will be worked through there. Do you want to…?
Alex, I would say that 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. So I'd say kind of a flat, at least for the first quarter of next year is kind of what our expectation is. And we still have a lot to look at for looking through and budgeting out the remainder of 2024.
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 will balance those saves off too because 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.
[Operator Instructions]. Next question comes from the line of Chris O'Connell with KBW.
You guys talked about, I think, $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?
Chris, I'm sorry. Yeah, that wasn't a direct expense investment. It was actually an investment that we hold on the balance sheet. So that actually earns a return. So 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.
Yeah. That's not a charitable investment, Chris. That is a community investment, but it does have a return to it. You mentioned it's a CDFI. It's also seed capital for venture startups, and they are throwing off a return on a fund.
You guys talked about the non-interest-bearing deposit mix shift and perhaps some continued pressure into the back half of the year. And I know that there is some seasonal muni flows as well this quarter. Can you just talk through what you're seeing, how much mix shift might be remaining and where things could kind of settle out from here and just, overall, the municipal kind of seasonal impact into the back half of the year?
I'll talk municipal flow first. So our balances are probably high at the end of the first quarter and then again at the end of third and the beginning of fourth quarter. And 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 high and the low points there. So high at the end of March and then low in June and then again into the third quarter and then low by the end of the year. So that's kind of how that ebbs and flows. It's material, obviously, but it's pretty predictable.
As far as movement from transactional accounts or savings accounts, I think that's all reflective in our expectation of the margin. The 20 basis points, that's reflecting the movement there. And then we have seen some slowdown of that and a lot of that margin compression we've seen through June and some moderation of that. And that's why, for the fourth quarter and the rest of the year, we're hopeful that we're going to see some – that 20 basis points could be a stabilization point.
Do you guys have any updated deposit beta expectations for this full tightening cycle?
Yeah. I think 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 account, I think we're still seeing some volatility there and we really haven't – to predict where that's going, we don't have the data at this point.
On the credit side, I think you mentioned in your prepared comments that we expect the one non-accrual that was moved over this quarter to become current in 3Q. Just any color you can provide around that relationship?
It's not a non-accrual. It's 90 days and still accruing, Chris. It's a senior living center that has some funding issues through the state and our expectation is delay, that that will come around in third quarter. So we haven't classified it as a non-accrual at this point based on our expectation of it coming current.
As far as just the overall credit outlook, obviously, not too much movement here and net charge-offs have been great so far. How are you thinking about the reserve levels going forward? And if you could remind us on some of the reserve levels related to kind of the hotel portfolio and how that might progress into the back half of the year?
I think our hotel portfolio – it's a small amount 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 one of our more solid metrics as to where our credit is trending. And as I mentioned earlier, we saw a $19 million reduction in that. Most of that was in our C&I portfolio – operating company portfolios.
But our hotels, we have one in non-performing that's pretty big, $7 million, and then a couple of others that are still just criticized. We see progress in each of those. And if we do have additional reduction and benefit, that's where we'll see it.
Now under CECL, a lot of our amounts that are driven by the – where the economy is, and so as the economy goes, the CECL will go. So predicting that, at least as long as things stay stable, we see our provision kind of staying – it will be represented by the growth that we have in the portfolio.
On the fee side, insurance fees are strong. I know a lot of it's seasonal, but also year-over-year. Is that strength expected to continue into the back half of the year?
Yes, we do. A lot of that strength is really in the industry. 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. So there is just a general increase in our commissions based on the amount of premium that our customers are paying because of the increase in the industry.
Is that other income line just on – I think MSR benefit in this quarter, does that shape back down to 1Q levels or is it more similar to what we're seeing in 2022?
Well, there is loan fees in there, too. So the two of them together, it does pop around a little bit just based on volatility in interest rate markets. And it's hard to be predictable on that.
There are no further questions at this time. I would like to turn the floor back over to David Nasca for closing comments.
Thank you. I'd like to thank everybody for participating in the teleconference today. We certainly appreciate your continued interest and support and 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. And we hope you have a great day. Thank you very much.
Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.