Evans Bancorp, Inc.
Q3 2018 Earnings Call Transcript

Published: 28 Oct 2018

[Operator:]

Greetings, and welcome to the Evans Bancorp Third Quarter 2018 Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce Craig Mychajluk, Investor Relations for Evans Bancorp. Please go ahead, Craig.

[Craig Mychajluk:]

Yes. Thank you, and good afternoon, everyone. We certainly appreciate you taking the time 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, Chief Financial Officer. David and John will review our results for the third quarter, and then we’ll 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 it 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 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. 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 Nasca:]

Thank you, Craig, and good afternoon, everyone. As you’ve seen today, we reported third quarter 2018 results with net income of $4.8 million, a 29% increase; and $0.97 per diluted common share, which was up from $0.77 in last year’s third quarter. These results were driven by higher net interest income, which increased 9% and higher fee income, particularly in our insurance business. We’re pleased to continue to deliver positive results to our shareholders, while providing sophisticated and responsive solutions for clients and living our values as a long-tenured corporate citizen in the Western Europe market. In this role as a community financial institution, we’re making a more significant financial commitment to the betterment of the markets we serve. Our loan portfolio continued to expand this quarter with an 11% annualized growth rate, in line with our recent history of consistent double-digit loan growth. This commercial loan growth continues to be the catalyst for our overall strong performance. As noted in last quarter’s call, we closed on the acquisition of the Richardson & Stout Insurance Agency on July 1. This strategic acquisition significantly deepens The Evans Agency’s leadership bench, broadens its geographic footprint, leverages the two agencies’ complementary products and services and provides a bigger platform through which to further scale our insurance business. Integration of our newest operation has been seamless to both clients and employees. The addition of R&S led to the biggest revenue quarter in the agency’s history at $3.2 million, about $800,000 of which is attributable to R&S. In other corporate developments, we celebrated the opening of our first business and relationship center in downtown Buffalo yesterday with employees, valued clients and dignitaries. This location with its new format will be a key building block in the evolution of our delivery strategy. As funding becomes more important due to the current interest rate environment and our strong asset growth, we believe we are positioning the bank to succeed in attracting commercial deposits and additional clients. In discussing funding, our results this quarter were impacted by the industry-wide trend of rising deposit betas due to customer demand for higher yield and intense competition from other financial institutions. We maintained vigilance on funding costs and profitability as the yield curve continues to flatten. We’re working diligently each day to make banking more convenient and efficient for our clients and improve the client experience by providing digital and mobile solutions customers have come to expect, so that we are able to provide value beyond just commodity pricing. While we anticipate that deposit costs will continue to increase, we believe fourth quarter betas will slow from the accelerated pace we’ve experienced in the third quarter. Before I hand things off to John, I want to talk for just a minute about Evans’ strong commitment to the Western New York community. Evans has, throughout its 98-year history, been viewed as a model of corporate citizenship. With the rapid growth we have experienced over the past few years along with some federal income tax relief as a result of tax reform, we are in a better position to demonstrate our values through a more significant financial commitment to the communities we serve and who have supported us. The $350,000 expense recorded this quarter is part of an anticipated $500,000 spend that will be spread over 3 important initiatives in the next couple of quarters. I’m excited to be able to announce more detail on these initiatives in the coming weeks. We believe that our results will allow us to continue this type of financial commitment to community initiatives on an annual basis. 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 any questions you might have. John?

[John Connerton:]

Thank you, David, and good afternoon, everyone. As David stated, net income was $4.8 million or $0.97 per diluted share in the third quarter of 2018 compared with $3.7 million or $0.76 per diluted share in the -- in last year’s third quarter. Net income was $3.8 million or $0.77 per diluted share in the trailing second quarter of 2018. The increase over both comparative periods primarily reflects higher interest income from loan growth, higher noninterest income due to increased insurance revenue and a lower income tax provision. Turning to the balance sheet. Loans grew $30 million in the third quarter, which equates to an annualized rate of 11%. Loan growth from the end of last year’s third quarter was $158 million, a 16% increase. In the third quarter, loan growth was a result of expansion in commercial real estate portfolio of $11 million, residential mortgages of $11 million and C&I loans of $8 million. As David noted, we expect positive growth trends to continue and to finish the year strong, given the current size of the commercial loan pipeline. Total deposits of $1.2 billion grew to -- grew $33 million in the quarter or 3% and were $183 million or 18% higher than the balance at the end of last year’s third quarter. Consumer savings deposit growth has been challenging as preferences move toward term product and higher rates and local market competition has stiffened. Consumer savings deposits declined $20 million during the quarter, while time deposits grew $41 million. The company also acquired $12 million in brokered time deposits. Net interest income decreased $0.1 million from the second quarter of 2018, but increased $1 million or 9% from the prior year third quarter. Our net interest margin was 3.73% for the third quarter of 2018, down from 3.89% and 3.91% in the linked second quarter of 2017 third quarter, respectively. Last year’s third quarter included a 14 basis point benefit from interest income recognized on 2 sizable nonaccrual loans that paid off at that time, which would imply a net interest margin of 3.77%. The compression in our net interest margin is attributable to increasing funding costs impacted this quarter by rising short-term rates and intense competition in the local marketplace for deposits. As we have seen across the banking industry, deposit betas have accelerated recently and Evans is no different. Banks including Evans have attempted to hold the line on deposit costs since the Fed started its campaign to increase the federal funds interest rates to more normal levels at the end of 2015. We started to see the pressure on deposit costs pick up this quarter as the Fed has raised target overnight rates seven times in the past 22 months. Our cumulative beta since December 2015 was 22%, up from 12% last quarter, compared to management’s expected full-cycle beta of 44%. Beta movements are not linear from quarter-to-quarter and can have variability as we strategically manage the balance sheet. This quarter, particularly, was impacted by the decision to extend the duration of some of our funding with the purchase of brokered CDs and longer-term consumer CDs. Our expectation is that our cost of funds will continue to increase throughout the remainder of the year. However, the beta will moderate to the long-term cycle expectation. Turning to asset quality. The $252,000 provision for loan loss for the third quarter of 2018 reflected loan growth and an increase in net charge-offs. We continue to have confidence in our portfolio’s overall credit quality. Despite the slight increase, quarterly charge-offs remain low at 10 basis points. Last quarter saw fairly large increase in our nonperforming loan ratio from 1.34% at the end of the first quarter to 2.06% at June 30. The ratio dipped back down slightly to 2% at the end of the third quarter. The large increase in nonperforming loans in the second quarter was attributable to $9 million commercial construction loan that had matured. Due to mechanic’s liens placed on the collateral by subcontractors and unpaid past due interest, the bank was able to extend the loan. The third quarter saw...

[David Nasca:]

Was unable to extend.

[John Connerton:]

Was unable to extend the loan. The third quarter saw some positive developments with this relationship. We agreed to a forbearance with the borrower to avoid foreclosure. An equity partner injected additional funds into the project to cure all the mechanic’s liens, and the borrower was able to pay all past-due interest. We are encouraged by these recent developments, but we’ll continue to monitor the situation closely. Noninterest income for the quarter of $4.8 million was up $1.4 million from last year’s third quarter and $1.1 million from the linked quarter. The largest component of this increase was insurance revenue of $3.2 million, which increased $1.2 million from the linked quarter and $1 million year-over-year. Much of the increase is attributable to R&S acquisition, which contributed approximately $800,000 in revenue this quarter. Noninterest expense of $11.5 million were up $1.2 million or 12% from the trailing quarter and $1.6 million or 16% from last year’s third quarter. The increase in total expenses includes $350,000 related to planned community contributions, as David discussed earlier. Salary and benefit costs, our largest expense line, were $7.1 million, an increase of $615,000 from the linked quarter and $819,000 from the prior year third quarter. About $400,000 of that increase is attributable to the addition of 15 employees from the R&S Insurance Agency acquisition. Income tax expense for the quarter was $346,000, representing an effective tax rate of 6.7% compared with an effective tax rate of 23.3% in the previous quarter and 16.6% in last year’s third quarter. The effective tax rate for each of the third quarters of 2018 and 2017 reflects the benefit of historic tax credit investment transactions. Excluding the impact of historic tax credit transactions, the effective tax rate for the third quarter of 2018 and 2017 was 20.5% and 29.0%, respectively. The $712,000 benefit from the historic tax credits and the income tax expense line in this quarter is mostly attributable to a change in the estimated timing of the state historic tax credit refund as federal taxable income, resulting in a different applicable tax rate as a result of tax reform. That concludes my comments. So I would -- I now would like to open up the line for questions.

[Operator:]

[Operator Instructions] Our first question today is coming from Alex Twerdahl from Sandler O’Neill. Your line is now live.

[Alex Twerdahl:]

I just wanted to start talking about the margin a little bit more. One thing that kind of jumped out at me as sort of surprising is that loan yield didn’t rise this quarter, just given the variability that you have in a large portion of your loan book. Can you just talk a little bit about why that might have happened?

[John Connerton:]

Yes. Alex, this is John. Typically we’ve said, a 25 basis point Fed move would move us about 5 to 6 basis points in total loan yield. A portion of our loan yield is our fees from prepayments and late fees. And typically, we have a predictable amount. This quarter, we actually had a very atypical low quarter on prepayment and fees. So that if it was more of a typical period, we would have seen that our loan yield would have been about that 5 to 6 basis point increase, but that suppressed that loan yield. So we have had some benefit from that Fed move, but it was suppressed by the atypical reduction in those fees.

[Alex Twerdahl:]

So we get the fee is coming back as normal in the fourth quarter. We can see a pretty nice pickup in the loan yield, just given that we had the hike in September?

[John Connerton:]

Yes. That’s correct.

[Alex Twerdahl:]

And then just to drill in a little bit more on what you’re talking about with deposits. I appreciate it’s pretty tough for all banks out there growing deposits, and it’s getting more expensive. But when you talk about the slowdown in betas in the fourth quarter, is that due to some seasonality in the municipal book of deposits coming back onto the balance sheet that can maybe suppress the rising cost of deposits at least for the short term?

[John Connerton:]

That should help us, but I also think we’ve kind of made a concerted effort to manage our balance sheet with some funding in the in the third quarter with some longer-term CDs that -- right now, we don’t have those promotions out there. So the aggregation of deposits that we have in the fourth quarter will be at a lower cost than it was accelerating in the third quarter.

[David Nasca:]

And we’re hopeful that we’re starting Alex, we’re hopeful that we are also starting to get -- we’ve made a concerted push for a long time to go after commercial checking DDA. We’ve had some pretty good success around our lending here in the last couple of quarters that has also provided some deposit that should help balance that cost as well.

[Alex Twerdahl:]

So when you kind of put those two things together, I mean, we got a decent amount of margin compression in this quarter. But if you look versus the first quarter of this year, is much less. As we kind of look into the fourth quarter, given the slowdown in the cost of funds, maybe the pickup again in the yield on assets as we discussed I mean, as you look out, does your crystal ball tell you that maybe the margin can be kind of flattish? Or are we still going to see some pretty decent pressure in the fourth quarter?

[John Connerton:]

Our expectation is that our margin would stabilize. Second quarter was probably the best, kind of all stars aligned for as high as it was. And then holding off those increases in cost of funds, I think, as we look forward that a stabilized margin where it is now is kind of our expectation.

[Alex Twerdahl:]

And then just switching gears over to the fee side just because it’s the first quarter with the acquisition. How should we be thinking about the run rate for fees? I know that you’ve done some things through insurance to kind of smooth out the revenue line there. Is this kind of for insurance specifically? Is this kind of sort of $3 million in the quarter? Is that a decent runway to start from going forward? Or is there going to be a fair amount of seasonality as we look into 2019?

[John Connerton:]

Third quarter is -- we did smooth out some of that from a profit-sharing perspective, Alex, as you suggested, but third quarter is always -- is still going to -- with some of the renewals we have in July is always going to be higher than typical. So I think it’ll be slightly down from here, but it will still have some cyclicality, but pushing -- making those adjustments did help that. I think for the new -- for R&S, in total, I think we’ve talked about this in total revenue. It’s about $2.5 million for the full year, so the add-on from them, which should be about equal each quarter.

[Operator:]

[Operator Instructions] Our next question today is coming from Joe Fenech from Hovde.

[Joe Fenech:]

On the funding side of the equation, aside from the actions you guys took with respect to the brokered CDs, was there anything else that you did specifically with respect to deposit pricing that drove that increase of funding costs or was it mostly just tied to the -- to what you talked about on the brokered side?

[John Connerton:]

We had some longer-term consumer -- Joe, this is John. We had some longer-term consumer promotions out there also to expand out a little bit as we expected rates to kind of move higher. We took advantage earlier in the quarter of local consumer CD deposits also.

[David Nasca:]

So we have some specials out there.

[John Connerton:]

Yes.

[Joe Fenech:]

Okay. And no similar type action contemplated for the fourth quarter? And if so, is that kind of one of the reasons underlying why you think we get a little bit more stability in NIM in the fourth quarter?

[John Connerton:]

That’s exactly right, Joe. We don’t have -- we’re not out there with the longer-term promos.

[Joe Fenech:]

Okay. And then was the acquisition more opportunistic or do you guys have an appetite to kind of further scale up the business? And if so, do you see opportunities out there to do that?

[David Nasca:]

I think, there might be some opportunities out there. We’ll integrate what we’ve got here. This was strategic and that it brought leadership to the table. And we knew these guys, as you know, from the buying group that we were in, CFS. So we’re always talking to people. We wouldn’t shy away from another opportunity if it presented itself. And we have ideas, but I think, right now, we’re going to integrate what we’ve got. And we wouldn’t shy away from it, as I said, if there was an opportunity.

[Joe Fenech:]

And sorry to hop around here, but just one more for me. And then in terms of capital, can you guys remind us of the lower bound on the TCE ratio? You’re towards the lower end of the kind of recent range 8.25% on TCE in light of what seems to be a pretty healthy growth outlook for the foreseeable future. Are you comfortable with kind of mid-7 handle on that over time, or just talk about capital…

[John Connerton:]

I think that -- this is John, Joe. I think that ratio is kind of where we like it. And the movement down to the lower 8s there were -- was due to the R&S. We used some of that capital for that. So I think we’re -- based on where we are now and the growth rates -- the double-digit growth rates that we have had and expect in the future, we think we’ll probably maintain that with the capital that we’re generating from bottom line.

[David Nasca:]

Yes. I think that our capital growth has ramped up from our earnings. And we -- for -- as we’ve talked before, we foresee that to start refilling the pot, but we like this level.

[Operator:]

Thank you. 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:]

I’d just like to thank everybody for coming today, joining our teleconference. I hope you can join us in February when we report the fourth quarter 2018 results, which we look forward to. But I will say, have a wonderful day to everyone.

[Operator:]

Thank you. That does conclude today’s teleconference. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.