Evans Bancorp, Inc.
Q4 2021 Earnings Call Transcript

Published: 3 Feb 2022

[Operator:]

Greetings. Welcome to the Evans Bancorp Fourth Quarter Fiscal Year 2021 Financial Results. Please note, this conference is being recorded. I will now turn the conference over to your host, Deborah Pawlowski of Investor Relations for Evans Bancorp. You may begin.

[Deborah Pawlowski:]

Thank you, Shamali, and good afternoon, everyone. We certainly appreciate you taking the time today to join us and for your interest in Evans Bancorp. On the call today, we have David Nasca, our President and Chief Executive Officer; and John Connerton, our Chief Financial Officer. David and John will review our results for the fourth quarter and full year of 2021 and provide an update on the Company’s strategic progress and outlook, after which we will then open it up for Q&A. You should have a copy of the financial results that were released today after the markets closed. And if not, you can access them on our website at www.evansbank.com. On the website, you’ll also find slides that accompany today’s discussion. So, if you are reviewing those slides, if you would please turn to slide 2 for the safe harbor statement. 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. You can find those documents on our website or at sec.gov. So with that, let me turn it over to David to begin. David?

[David Nasca:]

Thank you, Debbie. Good afternoon, everyone. We appreciate you joining us for the call today. I will start with a review of the past year and hand off to John to discuss the quarterly results in detail and then come back for closing comments around our refined strategy and expectations. The past year, while very much late 2020 in challenges, delivered a very different result. Business was still being largely conducted in a remote environment, and there was significant uncertainty as to when some sense of normalcy might return. I’m incredibly proud of the resilience and selfless work of the entire Evans team as we fought through compressed margins and challenging asset returns, abnormal levels of liquidity, historic prepayment and repayment activity, credit challenges for some businesses and a difficult environment for our core strength of relationship building. Against this backdrop, we delivered exceptional results in 2021, culminating in record net income of $24 million, more than double the prior year. There were a number of highlights, some of which I will touch on now. In the commercial banking segment, significant experience and talent were added to the commercial real estate and commercial and industrial teams in both Buffalo and Rochester, which helped deepen our penetration in those markets and introduce new contacts and clients to Evans. This helped enable record commercial loan production exceeding $312 million, which was critical to offsetting commercial loan payoffs, which ran at double average rates. Payoffs were the result of historically low interest rates, intensified commercial real estate demand due to strong valuations and increased sales of commercial businesses. Though detrimental to balances, these payoffs provided $1.2 million in fees to the bank. In addition to record commercial loan production, we participated in the second round of the Paycheck Protection Program and generated $94 million of loans, largely at the beginning of 2021, with approximately three quarters of those loans forgiven by year-end. These loans, together with approximately $200 million from the first round of PPP, which were forgiven during the year, resulted in a significant contribution to income. John will provide more details on current PPP balances, fees received and fees remaining, and we have this scheduled out in our deck, which Deb mentioned earlier. Credit quality improved during 2021, especially related to our efforts and assistance around the hotel portfolio. Of those loans, approximately a third were upgraded during the year, and the remainder of the portfolio is positioned for upgrades as we move through 2022. While Evans’ primary focus is meeting the needs of businesses and commercial clients, the addition of Fairport Savings Bank’s residential mortgage operation, combined with Evans’ recent modernization and growth of our consumer lending products and platform, allowed us to drive profits in a scalable and efficient manner with a superior client experience while meeting the surging demand for home financing. The combined organization produced a record $119 million in mortgages in 2021. In addition to other key initiatives, on the digital front, Evans has adapted as client preferences have evolved. While associates continue to serve customers as they always have, clients are finding self-service tools available through mobile and online banking to be convenient and efficient as digital channel usage to open accounts, deposit checks, pay bills, manage commercial balances and other functions continue to increase. During the year, upgrades were made to our account opening platform to support digital client acquisition as well as our consumer loan platform, which improved our ability to sell, process, underwrite and close consumer mortgages in a scalable and compliant way. With that, I’ll turn it over to John to run through our quarterly results, and then we’ll be happy to take questions. John?

[John Connerton:]

Good afternoon, everyone. Net income was $5.9 million or $1.06 per diluted share in the fourth quarter of 2021, down slightly from the prior year period, which benefited from a lower tax rate due to a historic tax credit transaction. On a pretax basis, income for the 2021 fourth quarter was up $0.9 million or 12%. The decline in net income when compared with the sequential third quarter largely reflected the change in provision. As David mentioned earlier, full year net income reached a record $24 million or $4.37 per diluted share, up from $11.2 million or $2.13 per diluted share in 2020. Net interest income increased $3.2 million or 20% from the prior year fourth quarter and $1.5 million or 8% when compared with the sequential third quarter as a result of increased interest recognized on nonaccrual loans that paid off during the quarter, higher amortization of fair value marks on acquired loans due to faster-than-anticipated loan payoffs and an increase in PPP fees. As PPP loans are forgiven, the Company is accelerating the recognition of fees that were being amortized over the original life of the loan. During the quarter, we realized $2.4 million in deferred PPP fees compared with $2.1 million in the third quarter of 2021 and $1.4 million in the fourth quarter of 2020. Nearly all of the original $7.4 million in fees from the first round of PPP have been booked to income. The second round of PPP originations produced $4.9 million of additional fees, of which $4.2 million has been recognized in income, leaving approximately $0.8 million of fees to be booked. The $400,000 provision for loan losses in the current quarter was due to loan growth of performing assets, offset by a reduction in specific reserves. Fourth quarter net interest margin of 3.74% increased 26 basis points from the third quarter, reflecting higher loan yields and lower interest-bearing liabilities. The 36 basis-point growth from last year’s fourth quarter reflects higher loan yields, PPP fee amortization and reduced interest expense as the Company continued to effectively manage rates on deposits. Excluding PPP fees, non-accrued interest recognized and the acceleration of the loan mark impacts, the net interest margin was 3.06%. I will talk to our NIM expectations at the end of my remarks. Noninterest income was $4.7 million in the quarter. Insurance, which is the main driver within this category, was down from the linked quarter due to the seasonal decrease in commercial lines insurance commissions. On a year-over-year basis, insurance revenues were also down due to a decrease in profit sharing revenue resulting from higher loss ratios experienced by the insurance carriers. There were some smaller atypical items that impacted the BOLI and other income line as noted in our press release. While total noninterest expense increased from the third quarter of 2021, we believe expenses, which are our focus areas, are being prudently managed. Salaries and employee benefits costs increased $343,000 or 4% from the sequential third quarter and $1.2 million or 13% from last year’s fourth quarter. A large driver of the change was accrual for incentives related to our record performance. These accruals were up $0.7 million compared to the fourth quarter of 2020. Additionally, we, like many businesses, are contending with labor inflation and have made a number of strategic hires in support of our continued growth. Adjusting for our normalized incentives, salaries would have a run rate closer to $9.7 million a quarter. The other expense line was up about $600,000, largely reflecting philanthropic contributions made during the quarter as we took the opportunity provided by our performance to enhance our commitment to the community. The effective tax rate for the quarter was 23.4% compared with 25.6% in the third quarter of 2021 and 12% in last year’s fourth quarter. Excluding the impact of historic tax credit transaction, the effective tax rate was 22.1% in the fourth quarter of 2020. Turning to the balance sheet and specifically loans. As David highlighted, we generated record loan production this year, but PPP forgiveness and higher-than-typical payoffs in this historically low rate environment, along with reduced commercial line usage, continue to provide headwinds to our overall loan growth. As a result, total loans decreased $42 million from the third quarter of 2021 and were down $122 million from last year’s fourth quarter. Helping offset were higher residential mortgage and commercial real estate loans. The balance of PPP loans forgiven in the fourth quarter of 2021 was $51 million, bringing the total of loans forgiven to date to $273 million. The remaining balance of all PPP loans as of December 31st was $24.9 million or about 8% of the approximately $300 million originated. Excluding PPP, commercial loans were flat from the third quarter. The bank’s net originations of new commercial loans, which excludes refinances of existing loans, was $270 million for all of 2021, including $77 million in the fourth quarter. This compares with an average net origination of $235 million for the previous four years. We have great momentum entering this New Year, which is backed by a commercial loan pipeline exceeding $90 million. We expect solid commercial loan growth as payoffs and refinances begin to normalize. Evans remains disciplined in not relaxing its credit standards to chase the terms of other funding sources, and that approach is reflected in our asset quality metrics. Nonperforming loans showed a marked decline during the quarter as approximately $7 million of those loans were fully repaid, which included one hotel credit. Total deposits of $1.9 billion grew 3% sequentially and were up 9% since last year’s period, which was driven by heightened liquidity levels of commercial and consumer clients. We’ve deployed some of our excess liquidity during the fourth quarter into additional investment securities, which were up $51 million, and interest-bearing deposits at banks, which were up $55 million since the linked quarter. We believe we are in a strong position as we look to 2022. We will utilize excess liquidity to fund strong loan growth and deploy into investments, which will assist the overall margin in coming quarters. As these funds are deployed, it is expected the core net interest margin will improve to a level of 15 to 20 basis points higher than the current quarter. While we do not project our net interest margin performance with rate hikes assumed, our balance sheet is well positioned for rising rates. The impact of a 25 basis-point move from the Fed, all other things held constant, increases net interest income by $1 million annually. Our more robust model to measure the bank sensitivity and an immediate change in rates of 100 basis points indicates an increase in annual net interest income of approximately 5.2%. With that, I will turn it back to David to review our refined strategy and performance goals. Dave?

[David Nasca:]

Thanks, John. Given the changes in the financial services industry, we would like to level set on how we expect to create value and deliver for all our stakeholders, including shareholders, community, clients and associates. Looking out over the next two years, we have refined our strategy that is aimed at delivering results in the top quartile of banks our size, i.e., our peer group. For Evans, it starts with commercial banking. As noted at the beginning of our remarks, the commercial banking team delivered record production levels by meeting increased demand for commercial real estate, expanding market coverage with the addition of top-tier talent, and being present for commercial businesses that needed financial assistance to grow or weather the challenges of the environment they faced. We believe our relationship-based approach and a strong commercial pipeline is geared to drive organic commercial loan growth in the mid-single digits. We have significantly expanded the residential mortgage team and plan to continue that expansion in 2022 and going forward as we believe a more substantial mortgage program adds diversity to our revenue stream and complements our insurance agency and large and successful commercial banking business. Insurance remains an important line of business that drives the bulk of our noninterest income and contributes approximately $10 million to that line. This industry is facing headwinds of an aging sales talent demographic and has experienced attrition and a lack of fresh talent over the last several years. To counter, we have launched detailed onboarding programs for new associates and identified and successfully hired four new account executives over the course of 2021. As we move forward, we have initiated a formal career development program to support newly hired mid-career sales professionals from outside of insurance to develop into functioning insurance producers. And we have revamped internal processes to drive more referrals between our various business lines. Another area of attention is in technology, where our strategy has several points of focus

[Operator:]

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

[Alex Twerdahl:]

I wanted to start on your -- on the slide 7, which lays out your goals, which I think is the first time I’ve seen this slide. I was just wondering if you could just walk us through how you came up with these ranges. And is the presumption that these should be dynamic, if rates go higher and banks generally do better, that these ranges will evolve with that changing landscape?

[David Nasca:]

The short answer is I believe they are dynamic. That’s why we put a range in there. We expect them to trend higher if the opportunity for rate increase is hit. But we came up with these return levels based on looking forward with the business that we think we can do, the challenges that we’ve experienced and the returns that we’re driving. There’s still a lot of vagaries in the market. There’s still payoffs there, but we think we can drive to these levels. And they’re based on us looking at things like where our pipeline is, what the production levels are, the talent we’ve added to the organization. So, there are several inputs that drive to these numbers.

[Alex Twerdahl:]

Great. And they’re basically good run rate levels that don’t assume any interest recoveries or reserve releases or anything like that, correct?

[David Nasca:]

Correct.

[Alex Twerdahl:]

Okay. And then, on the expense guide, John, you made a comment about salaries having -- would have been $9.7 million run rate. Is that -- can you just clarify that? Is that where you expect salaries to go back to next quarter, or what is the kind of the right run rate for that expense line going into next year?

[John Connerton:]

So I mean, because we had a really good performance year, we did pay a much higher incentive, which is impactful to the quarter. And so, the $9.7 million is what a more typical run rate would have been for the fourth quarter. And then coming off of that $9.7 million from fourth quarter forward, we wouldn’t expect much of a jump from there.

[Alex Twerdahl:]

Okay. So, that should reset down to sort of the $9.7 million range early next year and then, I guess, that’s the right starting point?

[John Connerton:]

Yes.

[Alex Twerdahl:]

Okay. And then, when I look at the reserve, it looks like the reserve went up a bit, even though your NPLs got better. You didn’t have any charge-offs, and you made some comments in the prepared remarks about the remainder of the hotel portfolio being positioned for upgrades in the coming years. So, I was just kind of wondering if you could walk us through why that went higher.

[John Connerton:]

So, I mean a big part of -- I mean, we were flat on a commercial -- on the balances. But if you look at performing loans, we were actually up. So, that we actually did have growth in our performing assets because a lot of our payoffs this quarter were from our non-accrued loans. So, we actually took provision this quarter, and that’s really what drove it. As far as the hotel portfolio, there was really no impact from that this quarter. Obviously, going forward, I think we’ve said in previous earnings calls that as those -- the remainder of that portfolio comes out of criticized, that will be beneficial to the provision.

[Alex Twerdahl:]

Okay, great. And then just a final question for me. The purchase accounting accretion that you saw in the fourth quarter, how much of that is left on the balance sheet? And kind of what’s the expectation for that in the margin over the next couple of quarters?

[John Connerton:]

Yes. We expect that that won’t be very impactful for the next couple of quarters. We had significant prepayment in particular around the commercial portfolio that we purchased at the FSB acquisition. And that portfolio has since kind of played out. So we don’t -- and there was a lot of the amortization that came from there. So, we would just expect normal amortization going forward.

[Operator:]

Our next question comes from the line of Chris O’Connell with KBW.

[Chris O’Connell:]

I just wanted to start with the excess liquidity in the balance sheet. I think you mentioned 15% to 20% of core NIM expansion expected to come through that. Wondering if you could walk through maybe the cadence or how you guys are thinking about deploying that excess liquidity into the securities book, which is added to this quarter, versus the loan portfolio, and maybe how that will come through over the course of 2022.

[John Connerton:]

Sure. I think, David mentioned our total balance growth on the loan portfolio will be mid to upper single digit. And that expectation will kind of drive a lot of when and how we put the investment portfolio or the additional excess funds through into the investment portfolio. But we plan, just sitting on, obviously, quite a bit, that a lot of that will go out in the first two quarters here such that we’ll utilize most of the excess liquidity by the end of June.

[Chris O’Connell:]

Okay, great. And what is the rate that you guys are putting on new securities at?

[John Connerton:]

We’re -- looking at the yield curve, we see most of the value probably in the 4 to 5-year duration. And currently, that’s somewhere around $160 million to $170 million.

[Chris O’Connell:]

Okay, great. And I appreciate all the color around compensation and kind of the overall expense base. Given the loan growth outlook and the revenue expectations, I was wondering if you guys could comment as to how you’re thinking about the overall wage pressures on compensation over the course of 2022.

[David Nasca:]

You want me to go on that?

[John Connerton:]

Yes. Go ahead.

[David Nasca:]

I’ll give you an overview on that, Chris. I think our thought is the wages moving up is going to be related to the labor. It’s not going to necessarily be just related to production growth. So, we think even if we have big production and the commercial portfolio, which we expect some good opportunity there. As John mentioned, we have a robust portfolio. We think that we’ll have pretty normal incentive compensation there. Where our pressure is really coming from right now is talent and the competition and the fight for that and retaining that. And we did, last year, make sure that we looked at all compensation and made sure people were being compensated appropriately, competitively. We have several competitors in this market that are driving to that, and we’re looked at as having good talent. So, we’re just making sure that we’re aligned. That’s kind of a broad question, but you asked where do we think the pressure will come from? The pressure will come from labor inflation in terms of retention as opposed to incentive growth.

[Chris O’Connell:]

Got it. Yes. That’s helpful color. And then, just one last touch-up question. What do you guys think the effective tax rate will shake out for next year?

[John Connerton:]

So, I think the effective tax rate for the fourth quarter is emblematic pretty much of what I would -- that we’re expecting going through 2022.

[Operator:]

And we have reached the end of the question-and-answer session. I’ll now turn the call back over to CEO, David Nasca, for closing remarks.

[David Nasca:]

Thank you, Shamali. Thank you again for participating in the teleconference today. We certainly appreciate your continued interest and support. 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 first quarter 2022 results. We hope you have a great day and stay warm.

[Operator:]

And we have reached the end of the question-and-answer -- I’m sorry. This concludes today’s conference, and you may disconnect your lines at this time. Thank you for your participation.

[David Nasca:]

Thank you.