Evans Bancorp, Inc.
Q2 2017 Earnings Call Transcript

Published: 28 Jul 2017

[Operator:]

Greetings and welcome to the Evans Bancorp Second Quarter 2017 Financial Results Conference Call. At this time, all participants are in a listen-only mode. An interactive question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I'd now like to turn the conference over to your host Mr. Craig Mychajluk. Thank you. You may begin.

[Craig Mychajluk:]

Thank you and good afternoon everyone. Certainly, appreciate your time today and your interest in Evans Bancorp. On the call today, we have David Nasca, our President and CEO; and John Connerton, CFO. David and John will be discussing the results of the first quarter and they will also review the Company's initiatives and progress in our markets and strategies. You should have a copy of the financial results that were released today after the market closed. And if not, you can access them on the Company's website at www.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 the Securities and Exchange Commission. You can fine those documents on our website or at sec.gov. So with that, let me turn it over to David to begin.

[David Nasca:]

Thanks, Craig, and good afternoon everyone. As you've seen from our news release this afternoon, the Company posted a strong net income of $2.6 million this quarter or up 31% from last year's second quarter of $2 million. As John is going to lay out in a bit more detail, this quarter is one of continued significant performance for us. We're especially pleased with our 13% annualized loan growth, C&I in particular grew 6% for the quarter or 24% annualized. As expected, interest from new clients continues to grow as KeyBank performs annual reviews for the first time on former First Niagara customers. Beyond C&I, the increase in loan growth was particularly impressive because it was across the board, including traditional commercial middle market segment. Anecdotally, we moved from fifth place to second place in dollar terms in SBA lending across Buffalo and Rochester. Our pipeline continues to be robust indicating the current growth rates are expected to continue. In support of our lending capabilities, we are pleased to announce the addition of a new Chief Lending Officer. This individual has over 26 years of experience as a business and professional banking leader in our market with M&T Bank. He will bring a strong focus on building market share specifically in the C&I arena, but also brings expertise in credit, portfolio management and operational process to facilitate the momentum we have experienced over the last several years. With another interest rate increase by the Fed in June, net interest income was up on higher rates and increased loan production. Credit quality remains strong and fee income has, up reflecting success in our non-interest sensitive businesses. Key components of our strategy are growing commercial business lines in banking, insurance, government and employee benefit segments. Results this quarter highlighted those efforts as insurance services and fee income increased 22% from the prior year period with employee benefit being a strong contributor to the increase. A significant component of our deposit growth was municipal deposit, which grew $19 million in the quarter as a result of the acquisition of core businesses from new municipal customers. This is an outcome of executing on our strategic plan to expand into government banking, which included the addition of well respected and experienced individual to direct our efforts in late 2016. Evans community focus and support extends to financing historic rehabilitation projects in the city of Buffalo and the Company enhances its yield by investing in related tax credits. During the quarter, the bank invested in a development project underwriting a loan that rehabilitated three separate school buildings for reuse in the housing in North and South Buffalo. The impact is evident on the income statement within several different line items, but results in reduction of the bank's tax liability providing position investment returns. John will go through that a little more in a couple of minutes. Expenses were in line with expectation although based on our strong year-to-date performance we've recognized cost for additional incentive compensation. Despite strong performance, I assure that we remain focused on expense control. Lastly, this quarter, the Company was added to the Russell 2000 Index, an exciting milestone recognizing our strong growth over the last few years and providing broader investor access for our shares. With that, I'll hand it over to John Connerton, our CFO for a more detailed look at second quarter results.

[John Connerton:]

Thanks, David, and good afternoon everyone. Net income was $2.6 million or $0.54 per diluted share in the second quarter of 2017, a 31% increase from $2 million or $0.46 per diluted share in last year's second quarter. Net income was $3.1 million or $0.66 per diluted share in the trailing first quarter of 2017. As David noted the strong performance compared with last year, last year's second quarter reflect higher non-interest income and net interest income, the decrease when compared with the linked first quarter was mostly result of higher provision for loan loss due to stronger loan growth and lower non-interest income. Return on average equity was 9.13% for the second quarter of 2017 compare with 11.59% in the trailing first quarter and 8.56% in the second quarter of 2016. Our efficiency ratio measurably improved from the prior year to 68.9% compared with 68.6% in the first quarter of 2017 and 76.3% in last year's second quarter. Turning to the balance sheet, after the high volume of loan closings in the fourth quarter of 2016 and somewhat muted loan growth of $3 million in the first quarter of 2017, stronger growth trend returned in the second quarter. Loans grew $31 million which equates to an annualized rate of 13% in the second quarter. The growth was split between commercial real estate and C&I with 16 million in growth in C&I balances and 14 million in growth in our CRE portfolio. Over the trailing 12 month period, loans have grown at $122 million or 14%. We expect the stronger growth trends to continue for the rest of 2017 given the strength of our commercial loan pipeline at the end of the second quarter. The Company also ramped up its investment purchases in the second quarter after raising 14 million capital in the first quarter of 2017. While the long-term plan is for the capital to support for a loan growth, management has increased investment security purchases to leverage the additional capital more immediately. Investment securities were a $143 million at June 30th, up from a 116 million at March 31st and a 110 million at the end of last year's second quarter. Total deposit crossed the $1 billion mark in the quarter, finishing at $1.19 billion at June 30th. This represented the growth of $41 million or 4% from March 31, 2016 and is a $149 million or 17% higher than our total deposit at the conclusion of last year's second quarter. The deposit growth reflects growth across various product categories, average demand deposits up $205 million or 5% higher than the first quarter of 2017 and 15% higher than last year's second quarter. This solid demand deposit growth reflects the Company’s ability to gather core commercial deposits in conjunction with this commercial loan growth strategy. Savings deposits growth of $16 million in the quarter and $68 million year-over-year reflects the success in the Company’s government banking initiative as several new municipal relationships were forged in the second quarter with promising leads for future growth in the coming months. In terms of consumer deposit growth, the Company has an able to achieve improved time deposit growth over the past few quarter as customers have return to maturity deposits with the rise of short-term interest rates. The Company’s strong balance sheet growth drove an increase in net interest income of $0.5 million or 5% from the trailing first quarter and $1.6 million or 19% from the prior year's second quarter. The Company has also benefited from an expanded margin after 325 basis points increases in the federal fund rate over the past six months. Net interest margin for the second quarter of 2017 of 3.74% improved 7 basis points from the 2016 second quarter. The margin did contract 3 basis points from the 3.77% mark in the first quarter of 2017, as a result of a slight shift in asset mix as a result of higher investments securities and interest bearing cash. As I just mentioned the bank's loan yields have benefited from variable loan re-pricing due to an increase in the prime rate after the Federal Reserve increased its target rate by 75 basis points since December of 2016. Loan yields were 4.54% in the second quarter compared with 4.49% in the first quarter of 2017 and 4.46% in the last year's second quarter. The aforementioned investments purchases resulted in a slight shift in the Company’s interest earnings asset mix with investment securities and interest bearing cash now comprising 13% of earning assets compared to 11% in the first quarter. This resulted in a decrease in overall asset yields from 4.27% in the first quarter of 2017 to 4.23% in the second quarter. Despite the increase in short-term interest rate, the Company’s funding costs have held steady as the cost of interest bearing deposits for the second quarter of 60 basis points was unchanged in the first quarter and 2 basis points lower than the 62 basis points in last year's second quarter. Turning to asset quality, credit trends were mix but charge-offs remain at a historical lows, criticize loans increased $5 million from March 31, 2017 and a $1 million than at the previous year end. The increase in criticized loans in the recent quarter reflected several downgrade of commercial real estate and C&I loan relationships. The downgrades, however, were for various reasons with no particular industry concentration. Total non-performing loans were 1.42% of total loans outstanding at quarter end compared with 1.30% for the trailing first quarter end and 1.88% as of June 30, 2016. The increase in the quarter was primarily attributable to two commercial loans that are 90 days past due, but remain in current status as they are well secured and in the process of collection. Non-performing loans as a percentage of total loans remains significantly down from last year and charge-offs have continued to be at extremely low level. The Company had recoveries of 8 basis points in the quarter compared with net recoveries of 4 basis points and 1 basis point in the first quarter of 2017 and second quarter of 2016 respectively. The $0.4 million provision for loan loss for the second quarter of 2017 reflects the strong loan growth in the quarter as well as an increase in criticized loans somewhat offset by a sustained historically low charge off ratio including $0.2 million in net recoveries in the recent quarter. The release of allowance for loan loss of $0.4 million in each of the first quarters of 2017 and second quarter 2016 resulted from decreases in criticized loans and a continued decline in historical lost factors in the reserve calculation, reflecting an improving economy and credit quality of the Company's loan portfolio. The first quarter of 2017 was also impacted by the slowdown in loan growth. Non-interest income for the quarter was up approximately $800,000 from the last year's second quarter, but down $400,000 from the linked quarter. The first quarter includes higher seasonal profit sharing revenue of $400,000 as part of the overall insurance service and fee revenue. At current quarter and last year's second quarter included the impact of net reduction of non-interest income of $0.3 million and $0.6 million respectively related to an investment in historical rehabilitation tax credit. There were no comparable transactions in the first quarter of 2017. The largest driver of the increase in the non-interest income was insurance revenue, which is $1.9 million in the second quarter compared with $2.2 million in the trailing first quarter and 22% higher in the $1.6 million in revenue in last year's second quarter. Employee benefits revenue important focus for the Company after hiring several industry veterans experienced significant growth in the quarter. The year-over-year increase was also driven by continued growth in commercial lines insurance commissions and personalized revenue bolstered by incremental revenue from the two recent insurance agency acquisitions. As we get into 2016, we continue to invest in the community through the financing of the historic rehabilitation projects in Buffalo and investing in the related tax credits from those projects. The accounting requires a bit of complicated presentation, but the bottom line impact of the bank this quarter is a small loss of less than $100,000 with $0.3 million reduction in non-interest income offset by a benefit than a tax to sales line of $0.2 million. We expect additional benefit in the tax line of $0.2 million with no further impact to non-interest income related to this particular project in our last few quarters of 2017. We also expect multiple other projects to be placed in service in 2017 and in 2018 all of which will positively impact the bottom line in the year they're have placed in service. Expenses increased from the trailing quarter by 3% or about $300,000 and increased 7% or $600,000 from last year's second quarter. The increase reflects higher salaries and benefits costs in the current quarter. Salaries and benefits were $6 million in the second quarter of 2017 compared with $5.7 million in the linked quarter and $5.5 million last year second quarter. Due to the Company's performance to-date, additional incentive compensation was approved in this year's second quarter. This accounted for almost all of the increase from the first quarter. Our management does not expect the material impact when comparing a full year 2017 to 2016. Accruals need to be made when certain bonus targets are determined likely to be achieved. Similar accruals were not made in the prior year until the fourth quarter. The increase in the last year's second quarter also includes an increase in salary cost for strategic personnel hires in annual merit raises. Other expense variances in the quarter included an increase in the technology expenses related to the implementation of the new online banking platform in the second quarter of 2017 and a reduction in the professional service expenses that were incurred in the first quarter of 2017 and the second quarter of 2016, in connection with the significant technology projects, including last year's conversion to a new core banking system and this year's conversion to the new online banking platform. The effective tax rate of the quarter was 24.8% compared to 30.8% in the first quarter of 2017 and 18.3% in the second quarter of 2016. The low effective tax rate in the quarter in 2016's second quarter reflects the impact of the tax credit investment transaction. Excluding the historic tax credit transaction, the effective tax rate for this quarter was 29.3%. That concludes my comments for today. So, now, we would like to open it up for questions.

[Operator:]

Thank you. At this time we'll be conducting a question-and-answer session. [Operator Instructions] And our first question comes from Joe Fenech from Hovde Group. Please go ahead.

[Joe Fenech:]

David, you made the comment on last quarter's call that the loan pipelines are strong as they've been in some of the strongest periods that you had last year. Can you talk specifically -- I know loan growth was pretty good this quarter, but could you talk specifically relative to your expectations on last quarter's call about how that played out over the second quarter and then how the pipeline specifically compare now to the optimism you had last quarter?

[David Nasca:]

I'll start at the end and work backwards, and we're still optimistic. The pipeline is still very strong. I think we showed with this quarter with increased growth that we got some of the closings we expected. We expect more to continue out into the third quarter. We could have probably done a little more, if we could have gotten a couple of things to the closing table which didn't get there, but I guess the team is still optimistic, Joe.

[John Connerton:]

I'd just add in. We did have -- we did have probably more significant pay off than we did in the -- even in the first quarter, which had some accelerate payouts too. So that did mute a little bit of our accrual in this quarter.

[Joe Fenech:]

And then guys can you talk a little more detail about the new opportunity -- not new opportunity, but the continuing opportunities you see from the First Niagara key situation that you alluded to David in your opening remarks, the annual reviews and one on your anniversary. I'm just wondering in your view. Does that just extend the opportunity from what it's been in terms of the magnitude of it? Or you're expecting to be a step up for banks like yours, and if so, how long do you see that persisting?

[David Nasca:]

Okay, we see it persisting for at least another year and it depends when you're talking about deposits, we think maybe another year. We think loans could be a little longer. We see it persisting because I think Keycorp is still figuring out which businesses they really want to emphasize. They're going through the First Niagara portfolio right now. There're something's they want to do. They're short of figuring out the things that First Niagara did well and they're determining if they want to be in those. And it's causing enough consternation where two things are happening. One is, there is business available. And two is, there's a lot of talent starting to come on the market, right now. And we've benefitted from some of that as well, obviously.

[Joe Fenech:]

And then, John, what was CRE concentration at quarter end?

[John Connerton:]

I think, Joe, about 353.

[Joe Fenech:]

353, okay, I'm sorry to hopple down here. Just wonder, I had a couple of more things, if I can. Guys, on the expense line, I know you made the comment about some of the kind of one-off this quarter, but some of the new hiring and the incentive comp, sounds like it stays with you. My question is, is all that pretty much in the run rate here at $9.3 million or so called in operating costs? Or is there a little bit more of a step-up that we need to be thinking about into back half of the year?

[John Connerton:]

No, I think the 9.3 at least for the quarter is a little higher because we accrued all of that bonus which is around $300,000 in the current quarter, but for the six months period we would expect that run rate further is about correct. And what I’d say, Joe is, we have also some of the additional personnel adds, replaced some like our Chief Lending Officer's replacement, and that is not materially different.

[Joe Fenech:]

Okay. And then two more quick ones, if I can. On the downgrades of you said several commercial loans this quarter with no real comments seen there. Can you give us some example maybe David of the profile of a relationship that’s struggling a little bit? What are some examples of what that looks like that kind of led you take action? I am not asking for a company obviously you are dealing with, but just the profile of maybe some of these things. Where are the people struggling?

[David Nasca:]

We had one manufacturing company that works -- it's not in the energy business but works with the energy business and they were moving due to regulatory concerns and they decided when they removing they sort of shutdown and kept shutting down. So that kind of stop happens although that’s unusual. We had some real estate things that matured that we are still looking at renewing them and they just may have gone over 90 days in maturity. So as John mentioned they are well secured. We just got to get them renewed. Maybe they loss the tenant and that’s just in the middle of all these. We have got -- I don’t know.

[John Connerton:]

I would suggest that because of the diversity of our portfolio, Joe. As David just kind of indicating, it would be across the Board. We do expect those downgrades have a good probability of being upgraded in the shorter rather than run. It just temporary -- in our opinion most of those are temporary issues that should right themselves.

[David Nasca:]

I guess I would also say the management of those credits, we think it is strength, right. When these credits -- I always say, we are little conservative going in. We make sure that we manage those hired you seen us have recoveries as oppose to charge-offs, so don’t confuse the increase in non-performing with an automatic increase in charge-offs that kind of doesn’t -- those aren’t linked.

[Joe Fenech:]

Okay great. And then last one for me guys. You made some changes and enhancements as you've talked about in the insurance area and that’s clearly showing through here. Is there anything unusual in this result this quarter? Or do we need to continue to reset our expectations and we continue to see maybe double-digit year-over-year increases here over the balance of the year?

[David Nasca:]

I would say a couple of things, I not looking to see reset of expectations. We do see some ramping in the employee benefits business as we mentioned. I think commercial lines continues to perform strongly and I think the other things is there some seasonality and that you have profit sharing in the early -- in the first quarter that may have bled a little into the second quarter. There will be another bite of that apple, not as big. So I think there is some ramping, but it's not outside. It will just be the kind of the ramp that you've seen.

[Joe Fenech:]

Okay. Thank you, David. Thank you guys.

[John Connerton:]

Joe, now just coming back to your criticized assets, I mean just maybe a note there. If you look at a history in our 10-Q our criticized asset, it does bump around in the level that is that now is not unusual in comparison to our history. So just wanted…

[David Nasca:]

That's down from last year same quarter. So, there is some bumping just because of our size.

[John Connerton:]

Just a second thought on that.

[Operator:]

[Operator Instructions] And our next question comes from Alex Twerdahl from Sandler O'Neill. Please go ahead.

[Alex Twerdahl:]

Just a couple of questions from me. First off, I just want to drill on a little bit to the margin and some of the moving parts. I think you alluded earlier to about a third of the loan portfolio being tied to or to being variable. Can you just confirm that's all tied to primary, is that right?

[David Nasca:]

That's correct.

[Alex Twerdahl:]

Okay. And then on the deposit side you guys have done really nice deposit growth this quarter. It looks like the cost to deposits has basically been flat sequentially. Can you just talk a little bit about some of the pressures that you may or may not be seeing in your markets whether or not this kind of growth can continue and at the cost that you've been doing in that?

[John Connerton:]

Yes, let me start with this one. Couple of things, one I think what we try to do -- part of the strategy is government services, right. So, as we had mentioned previously, the government municipal deposits coming in at a much lower cost of funds than the regular consumer deposits. They're somewhere between 9 and 25 basis points depending on whether we use straight collateral or we use municipal letters of credit from that Federal Home Loan Bank. And we have collateral, so they're kind on the lower end of that range. That's one thing that's helping us not to raise the cost of funds. Secondly to your question, we continue to grow, core commercial checking maybe not as fast as we like as we have a slower first quarter, but that continues to be a focus of ours. So that would help to maintain the cost to deposits to where it is. Then the third implication to your question might be with competitors in the market and the fact that consumers are moving more towards time deposits is there going to be pressure going up. We think there is a point as that happened, we think maybe it's a 25 basis point or so in fed raises from here. We are seeing some competitive pressures in some places where we haven't felt the need to have to follow those at this point. And we are trying to give everybody a reason to not go up. So I think right now the competition isn't having such an impact that we feel that we're getting undue pressure on those margins for deposits.

[Alex Twerdahl:]

Okay great. That's very helpful. And then just maybe if you can elaborate a little bit more on the leverage that you added during the quarter and whether or not that strategy is now on the balance sheet done or if there is additional capacity for further leverage, if we get a little bit of a yield curve at any point in the foreseeable future?

[John Connerton:]

That'd be nice.

[David Nasca:]

I think as I suggested, the short term from the perspective of utilizing some of that capital, Alex, that is in the plan and what we have in there is probably -- what we did in this quarter is probably about 60% of what we think we will need to do based on our expectations of loan growth. So there's a little bit more to come, but not a huge amount.

[Alex Twerdahl:]

And then just the tax rate, you talked obviously about the moving parts of the tax credit, but the $200,000 of remaining tax benefit that you'll see. Is that come equal part in the third quarter, in the fourth quarter and just incorporating that what tax ratio we're modeling, is it 29% or 28% or there is something I'm missing?

[John Connerton:]

So, that 200,000 will come in a -- come evenly over the next two quarters, and I think, I did mention that we're going to have some other projects come through. And that may -- that'll impact down our effective tax rate. So, I think for the rest -- for the remaining quarters where we stand that will be a little soft of that for those two quarters.

[Operator:]

Thank you. This concludes the question-and-answer session. I'd like to turn the floor back over to management for any closing comments.

[David Nasca:]

Okay, thank you all for joining us today on the teleconference. We look forward to you joining us again in October when we report our third quarter 2017 results, towards the end of October. Thank you for spending some time with us and have a great day.

[Operator:]

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