Evans Bancorp Inc

AMEX:EVBN

Earnings Call Analysis

Earnings Call Transcript 2023-Q4

[Operator]

Greetings, and welcome to the Evans Bancorp Fourth Quarter Fiscal Year 2023 Financial Results.

[Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce you to your host, Deborah Pawlowski, Investor Relations for Evans Bancorp. Thank you, Deborah. You may begin.

[Deborah Pawlowski]

Thank you, Alicia, and good afternoon, everyone. We appreciate your taking the time to join us today as well as your interest in Evans Bancorp. Joining me here are Dave Nasca, our President and CEO; and John Connerton, our Chief Financial Officer. David and John are going to review the results for the fourth 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 the markets closed. And if not, you can't access them on our website at evansbank.com.

As you may be 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 and as well as other factors that could cause actual results to differ materially 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 Nasca, executive]

Thank you, Debbie, and good afternoon, everyone. We appreciate you joining us today. I will start with a review of the highlights from the past year, including the strategic initiatives we completed in the fourth quarter and we'll then hand it off to John to discuss our results in detail. 2023 was a year that can be characterized as one of resilience. With a backdrop of interest rate volatility and economic challenges that accelerated throughout the year, the entire Evans team continued to deliver results. Net income was constrained by margin pressure due to the acceleration of funding costs, which rose faster than asset yields as banks responded to the steepest Federal Reserve increase in rates in decades and thought to maintain liquidity during a time of industry concern. We believe we manage this unique environment well by retaining key relationships, deposits and our liquidity position.

In addition, growth, while difficult to come by, was attained through our commercial business development and lending activity. The bank instituted CECL at the beginning of 2023, and which provided increased allowance for credit losses of $2.7 million. Our credit trends have remained favorable as we experienced continued improvement in criticized assets and low charge-offs this past year. Combined with improved economic conditions, we saw a muted provision impact in 2023. During the year, we continued proactive measures to control costs, deliver efficiencies and scalability and improve the overall customer experience with new technology and process improvements.

Of note, total noninterest expense for the year decreased about $550,000 or 1%, which reflected our branch rationalization earlier in the year as well as other initiatives which was -- which were partially offset by investments in technology and the community. The bank has maintained focus on return of capital to shareholders and total shareholder returns. For the year, dividends totaled $1.32 per share, which was up 5% and equated to a yield of about 4.3%.

Turning to the strategic actions taken during the fourth quarter. For more than 20 years, insurance had been an integral part of Evans Bank. Ultimately, we built a successful business that was highly valued. On November 30, 2023, the company finalized the sale of the Evans Agency to Arthur J. Gallagher & Company for $40 million. A question could be why did we sell? Growth in insurance required additional investments and acquisitions have become increasingly competitive based on how big insurance companies value assets and how they are financing them. We completed a significant amount of research and validated the opportunity that existed for a sale, along with exercising what we felt was a fiduciary responsibility to realize the value created. The decision was also driven in part by a recognition that the Evans Agency could realize greater opportunity for success and sustainability integrated with one of the top insurance and benefits companies in the world. A.J. Gallagher is a growth-focused insurance-first company with broader scope and scale to provide optimal benefits for all stakeholders. Of the objectives for the deal, a key one was to ensure a good home for our associates and clients. There were no job eliminations and current leadership in the 60-plus direct employees of the agency were all offered positions with Gallagher. Clients will have access to a greater breadth of insurance expertise in specialty areas while experiencing the continuity of working with their current talented team of agency associates and leadership. In the end, we believe the combination provides the best opportunity to elevate our customers' experience and provide our associates significant opportunities for career growth and to flourish with enhanced resources. Gallagher will remain an insurance partner with Evans providing commercial employee benefits and personal insurance products to our existing and prospective commercial, municipal, public entity and retail clients. From a shareholder perspective, we believe the rationale was compelling. This was a unique opportunity to monetize the strategic investments made in insurance services and allows us to optimize our capital and unlock value that we do not believe was being recognized in our stock. The sale of price represented a substantial premium for the agency at almost 20 years of earnings. It eliminates about $12 million of goodwill and other intangible assets, resulting in approximately $4.55 per share tangible book value improvement. The after-tax gain was approximately $13 million, which provides us with the flexibility to strategically redeploy capital back into our core banking franchise.

Given the current environment, we will continue to review a broad range of options to determine the best uses for this capital. Ultimately, we believe there are ample opportunities to grow and create shareholder value. This includes the balance sheet restructuring that we completed in the fourth quarter, which consisted of selling $78 million of available-for-sale investment securities, predominantly U.S. treasuries and government-sponsored agency securities. Proceeds realized from the restructuring totaled $73 million, which were used to pay down short-term borrowings and a $5 million loss was recognized on the sale. This transaction reduces a portion of the bank's liability sensitivity and is expected to improve returns in 2024 by enhancing our net interest margin. John will give you more details on that in a moment.

Looking forward, headwinds are expected to continue for community and regional banks with likely pressures on margins, growth and funding until interest rates recede. We are seeing signs of moderation in deposit cost increases, and John will talk to our NIM expectations during his remarks. Although we do not have control over economic conditions, we are focused on what we can impact, which is growth in our core banking model and controlling costs to optimize our efficiency.

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

[John Connerton, executive]

Thank you, David, and good afternoon, everyone. For the quarter, we delivered earnings of $10.2 million or $1.85 per diluted share, which was up from last year's fourth quarter and the sequential third quarter largely due to the gain from the sale of the Evans Insurance Agency. Offsetting these increases was the loss from the sale of investment securities and a decrease in net interest 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 Federal Reserve series of rate increases. As was discussed in our third quarter earnings call in October, the sequential third quarter net interest margin was impacted by 8 basis points from the reversal of approximately $400,000 of interest income primarily resulting from 1 large commercial loan that was put on nonaccrual.

Adjusting for this impact, NIM for the sequential third quarter was 2.87%. Therefore, on an adjusted basis, we saw a 12 basis point decrease in the quarter to 2.75%, which although at a reduced pace from recent quarters, continues to be driven by increased interest expense from higher deposit costs I will talk to our net NIM expectations at the end of my remarks. The $282,000 in the provision for credit losses was predominantly due to the loan portfolio growth and higher reserves on individually analyzed loans partially offset by peer group metrics and economic factors.

Noninterest income was up from both the linked quarter and the previous year's fourth quarter as a result of the gain on the sale of our insurance agency, which David discussed in length. The gain was offset by a loss of $5 million from the sale, of the $78 million in securities, which were yielding 2.12% and were used to reduce wholesale borrowings with a weighted average cost of 5.30%. The balance sheet restructure has an earn-back of 2.2 years and is expected to have a $2.3 million positive impact to net interest income in 2024. Noninterest income was $3.4 million after removing onetime transactions relating to the gain on sale of the insurance agency and the loss on the sale of securities, which is down approximately 30% over last year's fourth quarter and down 62% sequentially. Insurance, which typically is the largest contributor within this category had income of $1.6 million, which reflects after the sale of the insurance agency on November 30, only 2 months of revenue earned by the agency. This accounted for approximately $600,000 decrease from the prior year's fourth quarter. The reduction from the sequential third quarter was also impacted by the abbreviated months of operation and the third quarter had higher seasonal commissions earned from institutional clients.

Other income decreased $200,000 from the third quarter of 2023 due to movements in mortgage servicing rights. The decrease from last year's fourth quarter was primarily due to a $200,000 gain on sale of asset that was acquired in foreclosure and sold in the fourth quarter of 2022 and included $200,000 of revenue recognized relating to rents received from the acquired asset prior to the sale. Total noninterest expense increased $1.9 million from the sequential third quarter and was up $1.4 million from last year's fourth quarter. The driver of these increases was largely within the salaries and employee benefits line due to greater incentive accruals. As a result of the execution of the strategic sale of Evans Insurance Agency, the company reached performance levels and recognized a corresponding incentive in the fourth quarter. The incentive increased from the sequential third quarter by $2.2 million and increased $1.6 million from the prior year's fourth quarter. Offsetting both increases from prior periods was the partial quarter of salary activity due to former insurance employees. 2023 full year expenses attributable to the insurance agency was $6.8 million. Adjusting for the reduction of the expenses related to the insurance agency, the company expects expenses to decrease 1.5% in 2024 from 2023.

Turning to the balance sheet and reviewing movements in the fourth quarter. Total loans were up approximately $17 million. Of that, commercial loans increased 2% or $13 million. Net commercial originations were $58 million during the quarter compared with $62 million of net originations in the third quarter. We are being selective in our underwriting decisions, but are seeing opportunities in commercial real estate, including multifamily and warehouse 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 is strong and stands at $75 million at quarter end. We expect total commercial loan growth to be approximately 4% in 2024.

Credit metrics remained sound with nonperforming loans remaining flat for the quarter. Criticized loans decreased slightly by $5 million from $76 million at September 30 to $71 million as of the end of the fourth quarter. This is a $21 million decrease from last year's fourth quarter of $92 million. Average total deposit balances decreased to $1.65 billion during the quarter when compared to $1.87 billion in the third quarter, reflected in the deposit decrease was the seasonal outflow of municipal deposits and commercial deposits, which is typical this time of the year. 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 the demand deposit accounts and the sweep accounts and we expect consumer clients to continue moving funds from saving accounts to CDs. At December 31, the percentage of uninsured and uncollateralize deposits was at 15%.

As with many banks, we will continue to fight for deposits by being proactive with pricing and maintaining competitive rates in our markets. Market deposit rates have stabilized during the fourth quarter due to expectations of decreases in Fed funds during 2024. The bank is managing its deposit pricing strategy to include balancing liquidity with profitability. Our actions in the market include offering shorter terms on CD products and reserving preferred pricing for core clients. We expect that continued competition for deposits will mute growth for the full year 2024 to a low single-digit increase. These trends and pricing pressures continue to impact our margin for the fourth quarter, our expectation is deposit betas, although deaccelerating will continue to increase cost of funds. However, with the impact of the balance sheet restructure, we expect our NIM to be flat in the first quarter of 2024. Beyond the first quarter, it's difficult to forecast given external macro forces such as timing of potential future Fed break moves and how competition may play out. But our current expectation is that NIM pressure moderates further during the rest of the 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]

I appreciate the commentary on the near-term NIM outlook for flatness in the first quarter and then moderating pressure afterwards. If we start to get Fed cuts in the middle of the year, are you set to benefit substantially?

[John Connerton, executive]

I mean I won't really quantify it, Nick. But yes, breaks down from the Fed, we would begin to -- would be able to benefit, especially on our cost of funds. But I don't think it's not going to be a sea change, but it should stem the tide and moderate our NIM compression even further. And hopefully, as our assets reprice, we'll start to benefit and see some increase in our NIM.

[Nicholas Cucharale, analyst]

Okay. And then in light of the capital generated from the sale of the insurance operation and what sounds like another year of moderate loan growth. Are there other capital actions you're looking at? Are there additional restructurings or buybacks on the table?

[David Nasca, executive]

Buybacks are on the table. We have looked at those. We've talked before, it's difficult for us to get bulk in that, but we're that is on the table, and we continue to pursue all our revenues. That's 1 of them. We've made other investments in things like our Rochester growth, but certainly, that's on the table.

[Nicholas Cucharale, analyst]

Okay. And then on the securities portfolio, are the sales this quarter -- or after the sales this quarter, you're down to 13% of assets. Are we at the point where you're beginning to add to the investment portfolio? Or is that book still in run-off mode?

[John Connerton, executive]

Still in runoff mode, Nick.

[Nicholas Cucharale, analyst]

Okay. And then as it relates to the tax rate, you saw the commentary regarding the nondeductible goodwill in the quarter. What's your forecast for the effective tax rate going forward?

[John Connerton, executive]

That should be around 22%.

[Operator]

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

[Alexander Roberts Twerdahl, analyst]

So it seems like the securities transaction you did basically offset the lost earnings from the insurance business basically completely. Is that kind of how you thought about doing sort of the size of what you did? Or maybe talk a little bit more about, I guess, exactly how you decide what to the restructure on the securities portfolio?

[John Connerton, executive]

Well, I think we -- when we looked at the size of the capital that we wanted to utilize, I think we looked at our capital levels and where we like to be probably, Alex, probably was the biggest priority, like we knew that we would be taking in this capital from the insurance gain, but we want to utilize somewhere for the restructure, but I think what mostly drove it was we like where our capital ratios are currently to do the things that David just discussed as far as give us the flexibility to do buybacks to continue to invest in our business.

[David Nasca, executive]

I think the one thing I'd say also, Alex, is we looked at this thing when we sold the insurance agency and I've been saying it all along, we fast-forwarded like 20 years' worth earnings. I know people want the current earnings that way. But we're looking at this as a chance to bring in capital and redeploy that we calibrated the loss that we wanted to take based on where we wanted our capital position, as John just said. So I'd just reemphasize that.

[Alexander Roberts Twerdahl, analyst]

Yes. When you guys think about sort of where you want the capital position, are you looking at TCE ratio? Are you looking at that Tier 1 leverage ratio? I guess, like what's the metric that you would point towards as being a limiting metric?

[John Connerton, executive]

Our Tier 1 leverage ratio is kind of what we're looking at.

[Alexander Roberts Twerdahl, analyst]

Okay. And would be the goal to keep that sort of above 10%?

[John Connerton, executive]

Well, close to 10% in that range.

[Alexander Roberts Twerdahl, analyst]

Okay. And then as we think about loan growth coming on today, maybe talk a little bit about the types of opportunities you're seeing in terms of the yields relative to the book yield. And I guess the lower the 4% growth, which is a little bit lower than maybe you've guided in years past. Is that driven more about by the appetite in your balance sheet or more about the opportunities you're seeing in the market?

[John Connerton, executive]

I think we're still seeing a little -- as I mentioned, we're seeing a little challenge on our C&I side from our customers drawing on their lines, and that draw percentages down significantly, and we haven't seen that move. So that does temper some of our growth. The areas that we see in the growth, we do have a good pipeline, a lot of that pipeline is C&I. But I think we're seeing it in both C&I and commercial real estate, and it's kind of across our regular typical stuff that we do within our portfolio. Back to the rates, I mean, the rates that we're getting on lines is north of 8%, and term is north of 6.5%, 7%

[David Nasca, executive]

But let me say additively, we are being considerate of our credit quality at this moment. We're making sure that we're living to our credit quality and getting the returns we want out of these deals, one, and 2 is your question directly is we're seeing a little less activity in the marketplace right now. But we're pretty open for business right now. If the market heats up, that number could move a little bit. But we do have a good pipeline, as John said, but we're making sure that we're doing deals that fit our credit quality.

[Alexander Roberts Twerdahl, analyst]

Okay. And as you're thinking about -- I guess, back to the capital question and sort of the uses of capital, -- are there -- would you consider M&A as one of those uses of capital? I know there's not a lot in the way of sort of the [indiscernible] bank out there maybe. But if you kind of look a little bit more and think about branches or other things like that, is that something that you'd consider?

[David Nasca, executive]

Yes. I think we consider -- we're considering all opportunities. So short answer is yes. As you said, there's not a lot of opportunities to do operate this second, but we'd consider those things. But we also think that there's growth on our horizon, and that capital helps us get there to our native growth too.

[Operator]

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

[Christopher O'Connell, analyst]

Just wanted to start it off on the expenses. I appreciate the guide and hoping to just get a little bit of color as to the starting point, particularly in the comp line, given the insurance falloff in the incentive accruals in the fourth quarter. Where do you think that line item kind of starts off the year?

[John Connerton, executive]

Yes. So probably in the first quarter, our expectations of our salary line item would be around $7.3 million, that if you take -- if you normalize our fourth -- any of the quarters, insurance was about $1.5 million on that salary line.

[Christopher O'Connell, analyst]

Great. And does the 2024 guidance, does the OpEx guide assume like that percent of accruals are being hit at 100%?

[John Connerton, executive]

They'll be reduced from this year just based on our expectation of where our performance is going to be.

[Christopher O'Connell, analyst]

Okay. Great. And then can you talk about the deposit base? And how much of the outflows this quarter were muni related? And how much of those you think come back in the first quarter and if you think they'll be coming back into the same product?

[John Connerton, executive]

Sure. So in the fourth quarter, we can have variability on a day-to-day basis. So spot balances are sometimes a little misleading. So that's why I talked to the average balance. And if you look at the average balance, it's down close to $20 million, and almost all of that is the muni portfolio. And as far as we do expect -- we have -- we expect to get that back and more. The first quarter is when our municipals get their tax collections and and they come in and sit there through the first quarter quite a bit and then trail off and get utilized through the rest of the year until the schools get it back in the fall. So our expectation is we will get that back as well as NIM and more.

[Christopher O'Connell, analyst]

Do you think I mean, it looks like much of that came out of noninterest expense -- or noninterest-bearing deposit line. Do you think it comes back within that line or into different interest-bearing products?

[John Connerton, executive]

Yes. I think within those line items, the aggregate story is municipal the line item stories is our commercial accounts are continuing to move to some of our -- our interest-bearing transactional accounts like our NOW accounts. It is at a low point, but we don't expect it to fully come back on the demand deposit line. A lot of those customers have rotated into interest-earning transactional lines like our shift.

[Christopher O'Connell, analyst]

Okay. Great. And just thinking about the NIM on a go-forward basis. I appreciate the flat guide for the first quarter. I mean, how do you guys think even, I guess, just assuming no Fed cuts or any movement on that side, just stable rates. How far into 2024, do you think the NIM can bottom?

[John Connerton, executive]

I guess what I would say is, as our assets reprice, right, through principal paydowns or renewals. We expect a good chunk of the continued beta to be offset by that. So if we look forward, our expectation, our hope is that even after fourth quarter, our balance sheet reprices itself. But we do think there is a potential, again, based on where the market goes, that betas can pick up here or there, without any Fed movement and that there could be some continued pressure. And most likely, that pressure will be in the second quarter. But then as we move out and the Fed takes their movements, we would expect that third and fourth quarter see a minimum stabilization and maybe some expansion.

[David Nasca, executive]

The vagary, if you will, Chris, is the competitive environment, and we see a little bit of moderation there.

[Christopher O'Connell, analyst]

Great. And do you guys have how much of the assets are set to reprice in 2024?

[John Connerton, executive]

So I've shared that. I mean between our investment principal runoff, our loan runoff, renewals, it's around $300 million.

[Operator]

Thank you. There are no further questions at this time. I'd like to turn the floor back over to Mr. Nasca for closing comments.

[David Nasca, executive]

Thank you, Alicia. I'd like to thank everybody for participating in the teleconference today. We certainly appreciate your continued interest and support and your questions. Please feel free to reach out at us any time. And we look forward to talking with all of you again when we report the first quarter 2024 results. So we hope you have a great day, and thank you again for your interest.

[Operator]

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.