Evans Bancorp, Inc.
Q3 2019 Earnings Call Transcript

Published: 25 Oct 2019

[Operator:]

Greetings, and welcome to Evans Bancorp Third Quarter 2019 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.It is now my pleasure to introduce your host, Craig Mychajluk. Please go ahead.

[Craig Mychajluk:]

Thank you. 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 third quarter and then we will open it up for questions. You should have a copy of the financial results that were released today after the market close. If not, you can access them on our website at 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 Securities and Exchange Commission. You can find those documents on our Web site or at sec.gov.So with that, let me turn it over to David to begin.

[David Nasca:]

Thanks, Craig. Good afternoon, everyone. Today we reported third quarter 2019 results with net income of $5.2 million, which is up 8% compared to last year's third quarter. The positive results compared with the same period a year ago were driven by higher net interest and fee income, and a benefit in our provision for loan losses from a large recovery on a workout loan.The quarter, while strong, had a small number of items that are not typical and they had an impact on our normal operating results. John will run you through those and all the numbers in a second, but I thought I would provide some brief highlights here. The quarter's financial results were robust in a number of categories and reflect the progress we are making on several of our strategic initiatives, specifically investing in talent to drive organic growth and profitability through deep relationships, diversifying revenue streams, leveraging technology to build operational effectiveness and scale, and accelerate digital transformation to enhance client experience. Enhance focus on risk management, and positioning ourselves as a viable and a valuable community partner and resource.Although, the growth rate in commercial loans slowed this quarter at about 2% annualized rate, it is not reflective of the strong origination volume we experienced during the period. We continue to win new business and relationships and are able to effectively compete against all competition. The lower growth was largely a result of higher construction loan closings, which typically have lower funded balances and higher cyclical payoffs with seasoning.In addition to loan origination success in the quarter, the focus on deepening relationships allows us to better sustain company performance. This has reflected with growth in demand deposits of $27 million during the quarter, demonstrating our ability to provide full solutions to our clients. While growth in our loan portfolio is important to the company's strategic plan, credit quality is as important as ever. We're focused upon maximizing through the cycle returns rather than generating growth for growth's sake at lower quality. Credit quality remains strong with net recoveries of 19 basis points, reflecting our commitment to disciplined underwriting and a moderate risk profile.There is much uncertainty in the operating environment, including impact of interest rates and the flat yield curve, international trade, business confidence and geopolitical volatility. Evans has shown over its history an ability to navigate these and other challenges, and deliver profitable results to shareholders. We will continue to focus and control the things that we are able to, including working improved the client experience through investing in our associates and their development and the tools they use to provide solutions for customers' changing need.Technology is the major tool we are investing in and looking to leverage in areas, such as data analytics, risk management and operational effectiveness, allowing for faster and more data driven insights and an improved client experience. As technology and digital products become more into grow to operating models, data security and privacy take on an ever increasing priority and focus. We, like most financial institutions, are routinely tested by threats and respond diligently to them. We have seen a rising level of investment in threat monitoring, target hardening and resiliency. This is all part of a digital transformation in the industry and we will address, among other things, legal and regulatory requirements.Finally, as we plan for the company’s 100th year anniversary in 2020, we highlight our history of striving to be a valuable community partner, noting our additional commitment to our partnership with the United Way on an innovative program which has been recognized nationally. Work/Life Solutions is a program delivered in conjunction with employers to provide financial proficiency, small dollar loans and savings programs and social services advocacy to help employees' persistent employment as opposed falling out of the workplace due to the fiscal and social challenges. Overall, we are most pleased with the quarter and thank all our associates for their continued hard work and commitment to drive our business forward and help our communities thrive.With that I’ll turn it over to John for a closer look at our third quarter results. And then we will take you into questions. John?

[John Connerton:]

Thank you, David and good afternoon everyone. As David stated, net income was $5.2 million or $1.04 per diluted share in the third quarter of 2019 compared with $4.5 million or $0.90 per diluted share in the last year’s third quarter. Net income was $4.4 million or $0.88 per diluted share in the trailing second quarter of 2019. The increase from last year’s third quarter and the trailing second quarter of 2019 reflects higher net interest income due to loan growth and a provision benefit from a large recovery, partially offset by an increase in non-interest expense.Reviewing the balance sheet. Loans grew $7 million in the third quarter, which equates to an annualized rate of 2%. Loan growth from the end of last year’s third quarter was $64 million or 6% increase. As David referenced earlier, the company had a strong origination activity of $75 million during the third quarter predominantly in commercial real estate loans, which was consistent with the $78 million average origination volumes during the last four quarters.Also, as David mentioned, the large component of the commercial real estate loans were construction loans, which had a low funding percentage. These loans will benefit future period those draws are made on the committed amounts during construction, but muted loan growth in this quarter. Additionally, growth for the quarter was impacted by some sizable payoffs that occurred. Payoffs are expected during the year, but can be volatile from quarter-to-quarter. Although, third quarter had a larger volume of payoffs than the previous two quarters, payoffs for the year have been historically typical.Total deposits of 1.3 billion were $43 million or 4% higher than the balance at the end of last year’s third quarter. The year-over-year increase reflects growth of $36 million in commercial and retail demand deposits and $31 million in NOW deposits, partially offset by decreases in time deposits of $17 million and savings of $6 million. The total NOW deposit increase was primarily due to higher municipal and business customer balances.Total savings deposit decreased $6 million from the prior year period, reflecting $11 million decline in consumer savings deposits, offset by increases of $3 million in municipal deposit and $2 million in commercial deposits. The deposit mix has changed industry wide as consumer preferences moved toward term products with higher rates.In response to Fed Funds interest rate decreases this quarter, we are managing the balance sheet to limit the impact to the company's net interest margin and have focused our pricing discipline on areas where we have the ability to reprice to benefit our cost of funds and limit any loss to core relationships. This focus has resulted in a decrease in consumer time deposits of $13 million during the third quarter and a decrease of $17 million compared to the prior year third quarter.The company’s strong balance sheet growth drove an increase in net interest income of $1.5 million or 13% from the prior year third quarter, and $0.5 million or 4% from the trailing second quarter. The 2019 third quarter included $200,000 of interest related to the recovery of a single commercial loan that was written off in a previous period.The net interest margin was 3.94% for the third quarter of 2019, up from 3.87% in the linked second quarter and 3.73% in the third quarter of 2018. When excluding interest related to the credit recovery, the margin was 3.89%, an increase of 2 basis points from the 2019 second quarter and 16 basis points from the third quarter of 2018. The modest increase from the linked quarter resulted from a change in the mix of interest earning assets reflecting the utilization of cash to achieve loan growth.While the change from the prior year reflects increased yields on loans offset by higher funding cost due to higher interest rates in competitive deposit market pricing. The company's deposits beta were stable during the third quarter. Our cumulative beta, which is the beta on our total interest bearing deposit since December 2015, was 31%, while it was 28% before March 31 2019 compared to our long-term expectation of 46%.Competition for funding remains robust. We are concentrating our deposit pricing on acquiring and defending core deposit relationships, and we'll be strategic in targeting and retaining these core relationships. The interest rate environment, including the flat yield curve, will continue to present headwinds to our margin. We're focused on disciplined loan pricing, while maintaining strong levels of growth. While the margin did expand in the third quarter, we expect to experience a level of compression of between 11 basis points and 13 basis points for the remainder of the year. This compression will be a result of a full quarter of the last two Fed Funds interest rate cuts.Turning to asset quality. The $431,000 reduction in provision for loan loss for the third quarter of 2019 reflects a decrease in net loan charge-offs due to the single commercial loan recovery of $731,000, partially offset by an increase in non-performing loans. This is a decrease from the $252,000 provision recorded in last year's third quarter.We continue to have confidence in the overall quality of credit in our portfolio as we experienced net recoveries of 0.19%, our allowance to loan ratio remained at 1.26% and our non-performing loan to total loans ratio increased slightly from the linked quarter to 1.13%. The increase in the non performing loan ratio was due to one commercial relationship of $2 million.Quarterly non-interest income of 5.2% was up $400,000 from last year's third quarter and linked quarter. The increase in both periods is due to increase deposit service charges and other income. The increase in deposit service charges compared to the prior periods reflects new service offering, including overdraft protection for small business customers. The increase in other income was due to $200,000 in insurance proceeds related to legal and professional fees incurred to respond to a data security incident and related matters.During the third quarter of 2019, the company learned of an incident involving company emails and information contained in those emails that may have been access or acquired by an unauthorized party in an attempt to facilitate a fraudulent wire transfer. All parties acted promptly and stopped any wire transfer from occurring. We have no evidence that any personnel information was misused by any unauthorized person. The company promptly provided notice to potentially impacted persons.The company’s insurance carrier provided coverage for the incident costs and the recoveries reflected as an increase in other income, while the expenses are separately recognized on the professional services line in the current quarter. The net impact includes the company’s deductible of $25,000 paid in the third quarter.Insurance revenue of $3.2 million was flat with last year’s third quarter, and up $324,000 from the second quarter of 2019. The increase from the linked quarter is due to seasonal fluctuations and policy renewals by larger municipal customers, which is typical to third quarter. Non-interest expenses of $12.3 million increased from the trailing quarter by about 1% or about $100,000 and increased 7% or $800,000 from last year’s third quarter. The increase from last year’s third quarter includes an increase of $600,000 or 8% in salaries and benefits costs and $400,000 or 72% in professional services. Higher salary expense in comparison to the linked quarter reflects $150,000 in severance cost. The increase in salaries from last year’s from third quarter is mainly due to strategic personnel hires to support the company’s growth.The higher professional service fees were largely a result of onetime legal and professional fees related to the incident previously described. These increases were offset by a decrease in FDIC expense of $300,000. Income tax expense for the quarter was $1.8 million, representing effective tax rate of 25.6% compared with an effective tax rate of 21.1% in the previous quarter and 6.7% in last year’s third quarter. Last year’s third quarter income taxes were reduced by $700,000 due to a change in estimate of when certain state historic tax credit will be taxable for federal purposes. Historic tax credit transactions lowered the effective tax rate by 13.8% in the third quarter of 2018.That concludes my comments. So I now would like to open the line for questions.

[Operator:]

Thank you. We will now be conducting a question-and-answer session [Operator Instructions]. Our first question comes from Alex Twerdahl with Sandler O’Neill. Please go ahead.

[Alex Twerdahl:]

First off just to clarify, John, in your margin commentary for the fourth quarter, the 11 basis points to 13 basis points. Does that contemplate another rate cut next week?

[John Connerton:]

That only includes the two cuts that have occurred in the third quarter.

[Alex Twerdahl:]

And maybe you can kind of walk through some of the moving parts in the margin to help us understand kind of where it might shake out beginning of next year, assuming we do get a cut next week? I know you have 2% of your loans that are floating rate that would adjust pretty quickly, but then also some ability to reduce your cost of funds, so associated with the municipal deposits. Maybe you can just kind of walk us through and sort of maybe give us some expectation for where maybe we might start 2020 with the margin?

[John Connerton:]

So any 25 basis point decrease now, as our C&I portfolio becomes a larger percentage of our main portfolio, we have probably somewhere between 5% to 8% but to your point, we are concentrating on reducing some of our cost of funds. So I would say an additional 25 basis points would probably be anywhere between 3 basis points and 4 basis points for the quarter.

[Alex Twerdahl:]

And then, I know you talked about the loan origination volume being pretty strong despite seeing a bunch of payoffs keeping volumes flat. Maybe give us an update on what the outlook might look like heading into the fourth quarter for loan pipelines, as well if there's any big paid outs that you foresee coming in the near term?

[John Connerton:]

As far as pay downs, we don't see any large pay downs coming through, that would be atypical for a particular quarter. And as far as the pipeline, we're having -- we still have a robust pipeline that is going to probably drive originations typical as has been over the last three quarters.

[Alex Twerdahl:]

And would those be skewed more towards some of the commercial loans that you've been talking about, the construction loans or is it more of a true C&I or CRE focus?

[John Connerton:]

Again it can be clunky, but what's in the pipeline right now does have more of a C&I flavor to it.

[Alex Twerdahl:]

And then just some of the things you've done to products that you've added on the fee income line. I know that there is a lot of seasonality in the insurance line, but there's service charges on deposits. Is this level that we saw in the third quarter kind of the right run rate to start going forward, or is there a little bit of noise still in that number?

[John Connerton:]

No, I think that's the safe, Alex. I think that's the right number.

[Alex Twerdahl:]

And then just the final question from me is, maybe you touched on the tax rate. It's a little bit high, and I know you talked about a few different things. So what should we be modeling for tax rate for the fourth quarter and then heading into 2020, assuming you don't do any tax credits or anything like that?

[John Connerton:]

Assuming no tax credits come through, 23% to 24% is kind of where we’re running.

[Alex Twerdahl:]

For the fourth quarter?

[John Connerton:]

For the fourth quarter, yes.

[Operator:]

[Operator Instructions] There are no further questions at this time. I would like to turn the floor over to management for closing comments.

[David Nasca:]

Okay, thanks very much. I'd like to thank you all for joining us today for the teleconference. I hope you can join us in the New Year when we report our fourth quarter 2019 results. We hope you have a great day, and happy Thanksgiving.

[Operator:]

This concludes today's teleconference. Thank you for your participation.