Evans Bancorp Inc

AMEX:EVBN

Earnings Call Transcript 2023-Q3

[Operator]

Greetings and welcome to Evans Bancorp Third Quarter Fiscal Year 2023 Financial Results. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce Deborah Pawlowski, Investor Relations for Evans Bancorp. Thank you. You may begin.

[Deborah Pawlowski]

Thank you, Doug, and good afternoon, everyone. We appreciate you taking the time today to join us as well as your interest in Evans Bancorp. On the call, I have with me Dave Nasca, our President and CEO; and John Connerton, our Chief Financial Officer. David and John are going to review the results for the third quarter of 2023 and provide an update on the company's strategic progress and outlook. After that, we will 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.

So with that, let me turn it over to David to begin. Dave?

[David Nasca, executive]

Thank you, Debbie. Good afternoon, everyone. We appreciate you joining us today. I will start with a review of the key themes that played out during the quarter and will then hand it off to John to discuss our results in detail.

Third quarter results were mixed but positive overall from a growth and operating performance standpoint, positioning the company solidly in a difficult business environment. Industry headwinds related to the cost of deposits drove further compression in the net interest margin, which was anticipated. Our margin was further impacted by the reversal of interest income on one large long-time credit client that has experienced government reimbursement challenges.

Despite this unique circumstance, as we review and analyze credit, we see strength and resilience in our portfolio. Credit trends remain favorable, and actual charge-offs continue to be low. Absent the reversal of net income, our margin was in line with projections. We expect market conditions and pricing pressures to generally persist but are seeing signs of moderation in deposit cost increases as we round out this year. John will provide more detail on our NIM expectations during his report.

Our deposit base and liquidity continue to be solid and stable, backed by a diversified product portfolio. In addition, our associates have performed well in lending and business development given today's market dynamics and are making inroads with new clients and cementing existing relationships as evidenced by our 8% annualized loan growth in the quarter.

We are taking proactive measures to control costs and expenditures by focusing on operating efficiency and providing exceptional experience to our valued clients. Overall, we continue to block and tackle on our core business as we grind out results within our risk and return parameters in an inhospitable banking environment.

With that, I will turn it over to John to run through our results in greater detail, and then we will be happy to take any questions.

[John Connerton, executive]

Thank you, David, and good afternoon, everyone. For the quarter, we delivered earnings of $3.6 million or $0.60 per diluted share, which was down from last year's third quarter largely due to reduced net interest income. Helping offset this reduction was increased insurance service and fee revenue, while overall expenses decreased. The reduction in earnings from the sequential second quarter also reflected a lower net interest income and an increase in provision for credit losses, partially offset by seasonally higher noninterest income.

Net interest income was impacted over both comparable periods by higher interest expense given intense competitive pressure on deposit pricing, which began to accelerate at the start of the year. This more than offset increases in interest income driven by growth in our variable rate portfolios following the Fed Reserve series of rate increases. With increased interest expense from higher deposit costs, we saw a 31 basis point decrease in net interest margin in the quarter to 2.79%.

As David indicated, impacting net interest margin by 8 basis points was the reversal of approximately $400,000 of interest income primarily resulting from one large commercial loan that was put on nonaccrual status during the quarter. I will talk to our NIM expectations at the end of my remarks.

The increase of $506,000 in provision for credit losses was predominantly due to loan portfolio growth. Noninterest income was $5.6 million, down approximately 4% over last year's second quarter and up 15% sequentially. Insurance, which is the largest contributor within this category, was up 3% year-over-year and 22% from the linked quarter. The increase from the second quarter of 2023 reflects seasonally 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.

Other income decreased $0.3 million from last year's third quarter primarily due to a $0.2 million final payment received in connection with an historic credit investment during the third quarter of 2022. Total noninterest expense increased 2% from the sequential second quarter and was down 10% from last year's second quarter.

The driver of this change was largely within the salaries and employees benefits line, which is flat quarter-over-quarter and down 20% from the previous year. When compared with last year's second quarter, the decrease was primarily due to lower incentive accruals of $1.3 million and reduced staff expenses through consolidation of branches and back-office operations. Our expectation for full year expense run rate is a decrease of 3%.

Turning to the balance sheet and reviewing movements in the third quarter. Total loans were up approximately $34 million. Of that, commercial loans increased 3% or $31 million. Net commercial originations were $62 million during the quarter compared with $54 million of net originations in the second quarter. We are being selective in our underwriting decisions but are seeing opportunities in commercial real estate, including multi-family and warehousing facilities that are meeting our credit parameters.

The C&I funding rates remain muted and continue to impact growth in that portfolio. The current pipeline remains active and stands at $67 million at quarter end. We expect total commercial loan growth to be approximately 3% in 2023.

Credit metrics remained sound with a 2% decrease in nonperforming loans. Criticized loans increased slightly by $2 million from $74 million at June 30 to $76 million as of the end of the third quarter. This is an $11 million decrease from last year's third quarter from $89 million.

Total deposits of $1.81 billion increased $18 million or 1% from the second quarter. At September 30, the percent of uninsured and uncollateralized deposits was steady at 18%. Average total deposits decreased slightly to $1.79 billion during the quarter when compared to $1.82 billion in the second 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 from savings accounts to CDs.

As mentioned earlier, these trends and pricing pressures have an accelerated impact on our margins for the third 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.

Deposit rates have continued to increase because of strong competition in the time deposit marketplace and as I commented above, have caused the continued shift of customer funds from noninterest-bearing to interest-bearing accounts. Chances of a late 2023 decrease in Fed funds rate have been replaced by expectations that interest rates will stay higher longer, and this has affected customer and competitive behavior.

Currently, we expect our NIM to experience approximately between 15 and 20 basis points of compression in the fourth quarter of 2023. Beyond the fourth quarter, it's difficult to forecast given 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 beginning of next year.

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

[Operator]

[Operator Instructions] Our first question comes from the line of Nick Cucharale with Hovde Group.

[Nicholas Cucharale, analyst]

So just to clarify the NIM guidance, John, are you suggesting 15 to 20 basis points of compression from the reported level of 2 79 or the adjusted level of 2 87, which excludes the interest reversal?

[John Connerton, executive]

The 2 87 million adjusted, Nick. Thank you.

[Nicholas Cucharale, analyst]

And then a nice acceleration of loan growth relative to the prior quarter. You mentioned strong growth in commercial real estate. Are you seeing any sort of pullback from the competition just given the funding challenges in the industry?

[David Nasca, executive]

We are. We're seeing a bit of a pullback in certain quarters. Some people grew quickly and have stepped out. Others are taking their CRE balances and selling them into the secondary market to get them off their balance sheet. So we are seeing some pullback.

But we're also seeing projects slow a little bit as well. We've been doing pretty well to capture our share, but it's been -- the higher rates have been a little bit frosty in terms of some of these projects in terms of their pace.

[Nicholas Cucharale, analyst]

That's very helpful. You've done a great job of controlling expenses this year. As we start thinking about 2024, are there any particular investments to be made that may cause an outsized impact next year?

[John Connerton, executive]

No, Nick. We -- I think the run rate that we have projected for next year is low single digits. So that would just more of the typical inflationary increases that we typically see in any particular year. Most of the -- most of our investments have been made previously, and we're not expecting any large changes to that.

[Nicholas Cucharale, analyst]

Excellent. And then maybe just one final one on the tax rate. It was just a little higher this quarter relative to prior periods. Any sense of where that shakes out going forward?

[John Connerton, executive]

Yes. At 23% for the full year, and that should be typical.

[David Nasca, executive]

Yes. Nick, one thing I also wanted to say just because this is being recorded, John, when he was talking earlier, he talked about -- and it's in our press release, he talked about earnings of $3.6 million, and he stated that we had $0.60 per diluted share. It's actually $0.66 per diluted share. So I just want to get that on the recording, but it is in our press release. So...

[Operator]

Our next question comes from the line of Alex Twerdahl with Piper Sandler.

[Alexander Roberts Twerdahl, analyst]

I wanted to spend a little bit of time chatting about the NIM here. It looks like loan yields increased by about 10 basis points this quarter and last quarter. As you kind of look out and sort of maybe talk a little bit about new origination yields and sort of what kind of pricing you're getting and -- is 10 basis points of higher per quarter kind of what you're thinking, John, in your guidance for the NIM and your outlook for the NIM?

[John Connerton, executive]

So off the top of my head, I haven't recalculated that. If that's a quick calculation off of our reports, that do include the adjustment for that $400,000, Alex. I would say it's slightly higher than that. And I know we've talked about this in the past. We have around $300 million come back to us a year in principal and renewals, securities pay down, payoffs and the like. So that's kind of the repricing portfolio that comes back to us that is kind of driving our expectation on the loan side.

But I guess the short answer would be that our expectation for this quarter's increase in yields would be a good expectation for the continued expectation for next year adjusted for that $400,000.

[Alexander Roberts Twerdahl, analyst]

Yes. My calculation was adjusted for the $400,000 on the nose. So I guess, I think you said some moderation potentially expected early in 2024. I mean, when -- I guess, when and where do you think the NIM could wind up bottoming?

[John Connerton, executive]

Well, I mean, it's -- as I suggested in my comments, it's going to depend on competitive pressure. We did see kind of the competitive pressure moderate to some degree at the end of the second quarter, the beginning of the third quarter. But based on the environment that we're in and the long end pulling up and the response that the competition did, that was not expected. So we had a little bit more compression than we thought. We expected 20 basis points. We came in around 23. And the beginning of fourth quarter here is again probably unexpected. But we would still stick with that moderation in the late second quarter for second quarter of next year based on current run rates in the current environment that we're in.

[Alexander Roberts Twerdahl, analyst]

Okay. Have you guys been considering doing any restructuring in the securities portfolio or adding on any swaps? We've seen some of your competitors do that kind of stuff recently. That's been received well by the market. I'm just curious if you have any appetite for some products that could potentially help that NIM reverse sooner?

[John Connerton, executive]

So we're always looking at our balance sheet and the asset liability management of that, and we're open to -- we're continually looking at it. We're also balancing any type of capital levels that we have and putting those things all together. So yes -- the answer is, yes, we're always looking at those things. Nothing planned immediately.

[Alexander Roberts Twerdahl, analyst]

Got it. And then can you just go through the credit metrics again? And it seems like you guys reversed some noninterest income -- or some interest income as a result of a credit deteriorating what that was. It didn't look like it hit the NPL number, the charge-off number. So just help us figure out exactly what's going on underneath the surface.

[John Connerton, executive]

Sure. So that -- we talked about that last quarter, Alex. That was one of our credits that had gone -- it was in nonperforming, but it was 90 days and still accruing. It was -- as David's comments suggested, they're dependent on government rate reimbursement. Typically, those can go long. This has gone unexpectedly long. We still think that, that credit has matured well, and it has -- it's going to come back around. It's just it was too long from a time perspective. So we did put it into nonaccrual, and we had to unwind that accrued interest that was sitting in our receivable account.

But it was already adjusted for in our nonperforming because it was 90-plus at the end of last quarter, so you wouldn't have seen any increases. And it's well secured so we haven't really needed to reserve anymore, and we haven't charged fading off, if that makes sense to you.

[Operator]

[Operator Instructions] Our next question comes from the line of Chris O'Connell with KBW.

[Christopher O'Connell, analyst]

So just following up on the NIM commentary, you mentioned a little bit more pressure at the start of the fourth quarter. Did you guys have what the spot margin was for September?

[John Connerton, executive]

I don't know that off the top of my head, Chris, I apologize.

[Christopher O'Connell, analyst]

Okay. And then in terms of the restructuring and that question regarding NIM improvement and things of that nature, you've seen a few peer insurance sale transactions and joint restructurings in the market for the past quarter or 2. Is that something that you have considered at all? And just any color on your thoughts there?

[David Nasca, executive]

I think the answer that John was talking about, about the asset liability, we're considering all options to create value for the shareholders. We're looking at all long-term options strategically. So that's sort of the answer. We look at everything.

[Christopher O'Connell, analyst]

Got it. Any chance -- if you could just expand on if you guys have taken a look at that, how you guys lay the pros and cons in that type of transaction?

[David Nasca, executive]

Well, on any transaction that we look at, we look at long-term return to shareholders and what happens to capital, where -- how we redeploy, all those things. It is a full business case for any opportunities we look at, but we look at everything.

[Christopher O'Connell, analyst]

Great. And I apologize if I missed it earlier, but I know you guys gave the loan pipeline at $67 million. Any thoughts on just overall net loan growth going forward and what the oncoming yields are?

[David Nasca, executive]

Well, I think what we're looking at is we think -- the run rate that we talked about was sort of low single digits, the 2% to 3% level. The oncoming rates that we're looking at is generally, we're getting -- our general yield spread is 2 50 over the comparable term. We're getting a little more in some cases right now. We're able to get that because it's a more challenging environment. We're making sure we're being paid for the risk. But you're seeing we're generally holding our spreads a little plus.

[John Connerton, executive]

So just the yields are typically, Chris, are somewhere 7.5% and above.

[Operator]

There are no further questions in the queue. I'd like to hand the call back to management for closing remarks.

[David Nasca, executive]

Thank you. Real quickly, I'd like to thank everybody for participating in our teleconference today. We certainly appreciate your continued interest and support. Please feel free to reach out to us at any time, and we look forward to talking with all of you again when we report our fourth quarter results for 2023. We hope you have a great day. Thank you very much.

[Operator]

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day