Evans Bancorp, Inc.
Q2 2020 Earnings Call Transcript

Published: 2 Aug 2020

[Operator:]

Hello and welcome to the Evans Bancorp Second Quarter Fiscal Year 2020 Financial Results Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Craig Mychajluk, Investor Relations. Please go ahead, sir.

[Craig Mychajluk:]

Yes. Thank you and good afternoon, everyone. We certainly appreciate you taking the time today to join us and your interest in Evans Bancorp. On the call today, we have David Nasca, President and Chief Executive Officer; and John Connerton, our Chief Financial Officer. David and John will review our results for the second quarter of 2020, and then 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 at our website at evansbank.com. On the website, you will also find slides that accompany today's discussion. If you are reviewing those slides, please turn to Slide 2 for the safe harbor. 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, Craig. Good afternoon, everyone. We appreciate you joining us for the call today and hope you and your families are doing well during this most unusual period. Before we get to the details of the presentation, I'd like to take this opportunity to thank our almost 400 associates for their outstanding efforts and ongoing commitment to maintaining our operations under these challenging conditions, working tirelessly to support and meet the needs of our clients and communities. I couldn't be prouder of their drive and resilience. The second quarter presented a unique set of opportunities and challenges for Evans and for all financial institutions. We believe our performance was solid and demonstrated the effectiveness of our community commitment and relationship-centric focus. Despite the bottom line being impacted by elevated credit costs and merger-related expenses, we strengthened an already solid balance sheet, measurably grew our deposit base and are on track with the integration of Fairport Savings Bank after closing the acquisition. As previously announced, we successfully closed on the FSB acquisition on May 1 despite dealing with this incredibly demanding environment and the associated changes -- challenges of the pandemic. We felt it was important to continue closing of the transaction for our new associates to remove any uncertainty at a most volatile and unusual time. This acquisition added 5 branches in the contiguous and strategically prioritized metropolitan area of Rochester, New York along with $271 million of loans and $245 million of deposits to our portfolio. Our current focus is to deliver our combined strategy, leveraging Evans' commercial banking platform and strength in conjunction with FSB's solid retail and consumer lending presence in addition to expanding capabilities across the combined platform in areas such as municipal banking, insurance, employee benefits and cash management. Our initial expectations related to operating performance are being realized in these early stages, and we are ahead of schedule in terms of commercial loan talent acquisition in the market. As we discussed last quarter, we have been supporting our clients and communities during this pandemic through various programs. Our commitment was evident in our meaningful participation in the Paycheck Protection Program or PPP. We are proactive in staying abreast of and communicating off changing guidance on the program as it was rolled out, and we were able to process and secure funding for more than 600 loan requests in Phase 1 of the PPP program amounting to approximately $140 million. That level of activity equated to approximately 2 years of growth completed in just 13 days. Phase 2, which was continued into July, saw us handle another 1,000-plus applications. To date, we have produced more than 1,750 PPP loans totaling approximately $198 million, the vast majority of which were produced in the second quarter. We estimate our work helped the businesses that received these loans protect approximately 28,000 jobs in the communities we serve. Noteworthy is that while we helped many existing clients navigate and secure funding for the program, more than half of those served represented new loan relationships, some of which had previously not been serviced or had been turned away by other banks. Strategically, we believe that this could be an important platform and opportunity to build and add relationships and offer our other products and services. We provide further details on our PPP accomplishments on Slide 5 of the associated handout. We've also been working diligently with clients who qualify for payment deferrals as a result of COVID-19 impacts. John will provide more detail on the level and categories of these requests and our expectations during his remarks. I'm pleased to report that our portfolio continues to perform well, and we expect to see a significant decrease in the number of deferrals in the third quarter. Lastly, given the uncertainty related to the pandemic and its impact on the economy, we felt it prudent to protect and fortify our balance sheet by raising additional capital in early July after the quarter ended. We announced the private placement of $20 million of subordinated notes that added to our regulatory capital position and will act as a source of ongoing strength to our bank. We believe our ability to raise additional capital at this time at reasonable levels is a testament to the strength of our franchise and strategy for growth. While the duration of the pandemic and resulting impacts continue to be unknown, our more diversified platform and sufficient liquidity put us in a strengthened position and well situated for future challenges and opportunities. Evans has been a consistent and stable source for financial services for our clients and communities for over 100 years. Our strong relationships and core values have guided the organization through many challenging times and economic cycles during our history and will continue to lead us forward. With that, I'll hand it over to John to run through the results in more detail and then we'll be happy to take questions. John?

[John Connerton:]

Thank you, David, and good afternoon, everyone. As reported today, second quarter net income was $0.5 million or $0.09 per diluted share compared with $4.4 million or $0.88 per diluted share in last year's period and $0.2 million or $0.04 per diluted share in the linked first quarter. The variance from the last year's period largely reflects $5 million of onetime merger-related costs and an elevated loan loss provision, which reflects the continued economic impact of the COVID-19 pandemic. Net interest income increased 14% year-over-year and 70% sequentially due to the FSB acquisition and higher interest income and recognized fees as a result of PPP lending. FSB contributed $271 million in total loans, and PPP lending added $195 million of loan growth during the second quarter. The total fees paid to Evans by the Small Business Administration for originating and servicing these PPP loans were approximately $7 million or an average of 3.5% of the total PPP balances. These fees will be amortized over the current 24-month loan duration. And as a result, we recognized approximately $600,000 in fees in the quarter. This amortization may be extended or shortened depending on whether the PPP loans are extended to 60 months or forgiven as allowed by the legislation. The net interest margin of 3.36% percent was down 28 and 51 basis points from the linked first quarter and 2019 second quarter, respectively. The current margin reflects the significant lowering of the Fed funds rate in the first quarter, a lower margin on PPP loans, the impact of the FSB acquisition and its relative lower margin and finally, the significant liquidity the bank is experiencing through deposit growth. The impact from the linked quarter included 4 basis points of compression from both PPP and FSB and 20 basis points due to the excess Fed funds from the growth in deposits. We are continually looking to improve our asset mix and focus our pricing discipline on areas where we have the ability to reprice while limiting any loss to core relationships. As we have discussed previously, we expect to take advantage of repricing our certificate of deposit portfolio, which has a duration of under 1 year. Our margin has been mostly impacted by the inflow of the liquidity in the market, largely from government stimulus and reduced consumer spending. Client behavior in utilizing these funds will drive our margin performance. Based on our expectations of continued elevated deposit levels as a result of the speed of the economy opening and potential further government actions, we expect our margin to compress between 5 and 8 basis points. Keep in mind, there could be impact from the PPP portfolio, which is still a variable given the potential amounts and timing that may or may not be forgiven by the federal government. The $597,000 provision reflects reserve build given changes in credit quality standards due to the continued impact of the COVID-19 pandemic on the economy. While this provision is still elevated, it is a significant improvement from the sequential first quarter. In a moment, I will touch on the details around loan modifications and our expectations. Noninterest income decreased due to a decline in deposit service charges resulting from weaker consumer spending and the temporary suspension of certain fees to assess clients affected by COVID-19. The other driver of the year-over-year change was lower insurance service and fee revenue, which saw a reduction in contingent profit sharing and claims revenue. Noninterest expenses were up over the prior year period in the linked first quarter, largely due to the addition of FSB and related merger costs. The effective tax rate for the quarter was 16.7%, which reflects the historic tax credit transaction completed last quarter. Absent the tax credit, the rate was 25.9%. At this time, we do not anticipate additional historic tax transactions this year. Turning to the balance sheet. The loan portfolio increased $473 million or 39% since the end of last year's second quarter, largely reflecting growth in commercial and industrial loans, commercial real estate, PPP activity and the FSB acquisition. Commercial loans were down in the quarter when excluding PPP and FSB. Originations were lower than typical as a result of the economic environment, and these balances were further diminished by pay downs in the payoff of $20 million in commercial real estate loans precipitated by low interest rates. The bank made the determination not to meet the terms on these refinance opportunities as they were outside our risk appetite. Although lower than typical, our loan pipeline is building again and we expect growth to return in the third quarter to an annualized rate in the low single digits. During the second quarter, we implemented a client payment deferred program to assist both consumer and business owner -- business borrowers who indicated they may be experiencing financial hardship due to COVID-19-related challenges. These deferrals had 90-day durations, which will expire in the third quarter. The vast majority of the deferral requests were processed in April and May, and at our peak, we had a total commercial loan deferrals of approximately $372 million or 37% of the total commercial portfolio. Our bankers and credit risk management teams have been completing extensive portfolio reviews of these relationships, focusing on a number of metrics like liquidity, business assumptions and collateral coverage to name a few. This heightened level of review will continue as we evaluate repayment risk. With those initial deferrals set to expire in the third quarter and given ongoing conversations with clients, we expect the percentage of the commercial portfolio that will be granted a second deferment to fall by 2/3 to around $120 million or 12% of the total commercial portfolio with the majority centered on our hotel portfolio. We are monitoring this group closely and see occupancy beginning to improve with the opening of the economy locally, but it is expected to take longer than other industries. For further detail on our commercial loan portfolio and deferrals, please refer to Slides 6 and 7. While FSB did add $245 million of deposits, we also saw significant growth due to proceeds from PPP loans and our clients maintaining greater liquidity. Total deposits were up 36% or $482 million in the quarter and were up 41% or $526 million since the end of last year's second quarter. Growth was realized in all major product lines. Total average demand deposits were $400 million for the 2020 second quarter, an increase of 64% year-over-year. Looking forward, we are confident that we have taken the appropriate actions to remain in a solid position with a high level of capitalization to navigate this ever-changing environment and are well positioned to fund future balance sheet growth. That concludes my comments. So we now would like to open the line for questions.

[Operator:]

[Operator Instructions]. Our first question today is coming from Alex Twerdahl from Piper Sandler.

[Alex Twerdahl:]

First off, just wanted to go back, John, to your margin commentary. I think you said the breakdown was 4 basis points from PPP, 4 from FSB and 20 from enhanced liquidity and the drop in, I guess, the full quarter's impact of the drop of rates in the first quarter. And then I think you said 5 to 8 basis points of compression expected in the third quarter. For the guidance for the third quarter, does that assume similar levels of liquidity that you currently have on the balance sheet today?

[John Connerton:]

Yes. I think as I suggested, we think that, that liquidity will continue to be maintained, and it will be slightly higher than actually our average liquidity in the second quarter, and that will be -- that's really the driver of the additional compression. So we'll have -- our average actual cash that we'll have on hand is going to be slightly higher just due to where our spot balances ended at second quarter. We think that liquidity will continue through third quarter. It'll put those -- it will compress that margin additionally between 5 and 8 basis points.

[Alex Twerdahl:]

Okay. And then with the higher average earning assets and the lower margin, does NII come in up just a little bit in the third quarter? Or is it flattish? Or how do you think about the NII piece of it?

[John Connerton:]

The NII will be slightly up from where we were in second quarter.

[Alex Twerdahl:]

Okay. And then how should we be thinking about -- or maybe help us understand the insurance service revenues that, obviously, there's a lot of volatility or a lot of seasonality, I should say, throughout the years and -- throughout the year. That was down a little bit year-over-year. Is that directly related to COVID? Or is there -- I guess how should we be thinking of the third quarter for that specifically in the fourth quarter? And how do you expect that line to trend going forward?

[John Connerton:]

Yes. I think our -- the large impact there is we have a small claims division that just -- we haven't had the activity because that's usually variable based on whether or not there's events, weather events mostly that drive that business. Another big impactor is the profit sharing. So most of the profit sharing expectations that we had are going to come through in the first two quarters if there was adjustments to that. So going forward, our expectation is that third and fourth quarter will be more consistent with prior years.

[Alex Twerdahl:]

Okay. And then with...

[John Connerton:]

There is actually a spend in the third quarter that you need to consider, though, Alex.

[Alex Twerdahl:]

The season -- so if I look at third quarter 2019, that's kind of the right starting point for 3Q '20?

[David Nasca:]

Exactly.

[John Connerton:]

Yes.

[Alex Twerdahl:]

Great. And then on expenses, you got about two months of FSB in there, obviously, backing up the $5 million of merger expenses. What's the right starting point for expenses in the third quarter? Because obviously, there's some moving parts with the economy being shut down. It looks like you didn't spend as much on things like advertising. Will some of those line items normalize? Or are we going into kind of a new normal for the next couple of months as you kind of work through PPP and some other items, COVID-related?

[John Connerton:]

I think if you back out the merger related, there's two months of FSB costs in those numbers, so -- which is approximately about $1 million. So you would assume that there'll be another $0.5 million increase just based on an additional month of FSB. But other than that, I think some of the elevations were more onetime items because of COVID. Obviously, if things deteriorate up here, they might -- it might drive our costs higher, but we would expect that the costs stabilize beyond -- or excluding the FSB increase in the merger-related costs.

[David Nasca:]

Yes. So there's some ups and downs there, right?

[John Connerton:]

Yes.

[Alex Twerdahl:]

Yes. And then just finally, as you think about the provision going forward, obviously, a big build in the first quarter, a little bit more in the second quarter. As you kind of think about the moving parts that are going to impact the reserve going forward, is the biggest piece at this point just what happens with those deferral loans, the $120 million are going to get the extension as they come off, whether or not they migrate into nonperforming or get charged off?

[John Connerton:]

Yes. I think that's going to be -- as this -- as the economy opens back up and the success of their reopening or if it shuts back down, that will -- and certainly, if there's more guidance, we're there's some flexibility in how we account for these. Barring that, I think it's going to be individual credits. And specifically, as we suggested, looking at that hotel portfolio and how that comes back and whether or not we think our collateralization holds, which we think we have a pretty good collateralized portfolio. So that will really tell the tale as far as third quarter's provision is more specific related to individual credits.

[Operator:]

[Operator Instructions]. We've reached the end of our question-and-answer session. I'd like to turn the floor back over to management for any further or closing comments.

[David Nasca:]

All right. Thank you, Kevin. I'd like to thank everybody 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, and we look forward to talking with all of you again in October when we report our third quarter 2020 results. With that, I'd say, have a great day and stay safe in this unusual health crisis that we've been facing for the last 5 months. So thanks for being with us.

[Operator:]

Thank you. That does conclude today's teleconference. You may disconnect your lines, and have a wonderful day. We thank you for your participation today.