Evans Bancorp, Inc.
Q3 2017 Earnings Call Transcript

Published: 31 Oct 2017

[Operator:]

Greetings and welcome to Evans Bancorp Third Quarter 2017 Financial Results. At this time, all participants are in listen-only mode. A brief 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, Craig Mychajluk, Investor Relations fo Evans Bancorp. Please go ahead.

[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. Dave and John will be discussing the results of the third quarter and they’ll also review the company’s initiatives and progress in our markets and our strategies. You should have a copy of the financial results that were released today after the market closed, 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 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:]

Thanks, Craig. Good afternoon, everyone. As you’ve seen from our news release this afternoon, the company posted significant results and record net income of $3.7 million this quarter, which is up 68% from last year’s third quarter results of $2.2 million. As John is going to layout in more detail, this quarter is one of continued exceptional performance, evidencing the success of our community-focused, relationship-driven business model. The results reflect delivery on our strategic objectives to increase market capture of business – of commercial business, primarily in loans, insurance and employee benefits, in addition to increasing our government banking presence. Our focus will also be to drive core deposits through these commercial relationships. During the quarter, we grew commercial loans a net $19 million, or 9% on an annualized basis, despite larger than normal payoffs. We’re especially pleased that this growth was driven by new customer acquisition. This is a reflection of our efforts to be present in the market as a strong competitive choice for our clients. In support of those efforts, we continue to increase lending capacity by adding experienced commercial loan officers. As we also discussed last quarter, two new executives were added in the last several months, our Chief Risk Officer and Chief Commercial Banking Officer, and they are settling in well. Our commercial loan pipeline remains robust indicating that current growth rates can be expected to continue and credit quality remains strong with sustained historically low charge-offs. Net interest income improved as a result of increased loan production and full quarter benefit of the Federal Reserve’s 25 basis point interest rate increase in June. Fee income is up for the quarter with insurance services increasing 17%, or approximately $315,000 from the prior year-end period. Employee benefits is a strong contributor to that increase, reflecting the execution of our strategy to grow this business segment with the addition of new talent and leadership this year. We also continue to make progress in our government banking efforts. Municipal savings deposits grew $6 million in the quarter is a subset of our overall $13 million deposit growth. The expansion was a result of new municipal client acquisitions, including their core banking business. The expenses were elevated compared to the prior year, partially due to investments we have made in strategic hires related to strengthening employee benefits and government banking. As I previously indicated, we are pleased with the top line revenue and balance sheet success of these investments. Excluding these strategic expenditures, we remain focused on controlling expenses and experienced single-digit core expense growth. Lastly, this quarter, Evans further demonstrated its role in Western New York’s continued economic renaissance by financing another historic rehabilitation project in Buffalo. The renovation of a commercial building for reuses offices in the Theatre District of downtown Buffalo. The impact is deconstructed on several lines on the income statement due to accounting policies. But overall, the reduction of the bank’s tax liability provides a positive investment return of over 20%. With that, I’ll hand it over to John Connerton, our CFO for a more detailed look at third quarter results.

[John Connerton:]

Thanks, David, and good afternoon, everyone. Net income was $3.7 million, or $0.76 per diluted share in the third quarter of 2017, a 68% increase from $2.2 million, or $0.51 per diluted share in last year’s third quarter. Net income was $2.6 million, or $0.54 per diluted share in the trailing second quarter of 2017. As David noted, the strong performance compared with last year’s third quarter, as well as the linked second quarter reflects higher non-interest income and net interest income in addition to lower provision for loan loss. Return on average equity was 12.71% for the third quarter of 2017, compared with 9.13% in the trailing second quarter and 9.23% in the third quarter of 2016. Our efficiency ratio measurably improved from the prior year to 66.2% compared with 68.9% in the second quarter of 2017 and 70.2% in last year’s third quarter. Turning to the balance sheet, loans grew $22 million, which equates to an annualized rate of 9% in the third quarter. Commercial loan demand rebounded in the second quarter and third quarter after weaker commercial loan demand in late fourth quarter of 2016 and early first quarter of 2017. The current quarter growth was impacted by the company’s concerted effort to exit leveraged syndicated national credits. The company chose not to participate in the renewal of an $11 million leverage loan in the third quarter of 2017, resulting in an early payoff of the balance. The company has $12 million remaining in its leverage SNC portfolio as of September 30, 2017. While the company is not actively marketing these remaining loans, it does not plan to originate any new loans in this portfolio in the foreseeable future. We expect the stronger growth trends to continue through the rest of 2017, given the strength of the commercial loan pipeline at the end of the third quarter. Total deposits grew $13 million in the quarter, or 5% on an annualized basis. The deposit growth reflects growth across various product categories. The categories with the most impact included demand deposits and savings deposits. Demand deposits of $216 million were focused on higher than the second quarter of 2017 and 10% higher than last year’s third quarter. This solid demand deposit growth reflects the company’s ability to gather core commercial deposits in conjunction with its commercial loan growth strategy. Saving deposits growth of $5 million in the quarter and $56 million year-over-year reflects the success of the company’s government banking initiative. In terms of consumer deposit growth, the company has been able to achieve improved time deposit growth over the past four quarters, as customers have returned to maturity deposits with the rise in short-term interest rates. The company’s strong balance sheet growth drove an interest – an increase in net interest income of $1 million, or 10% from the trailing second quarter and $2.0 million, or 22% from the prior year third quarter. Net interest income benefited about 400,000 in the quarter from the payoff in full of two unrelated loans that were formally in non-accrual. At the time of payoff, 400,000 in interest payments previously received were recognized as income. The benefit contributed 14 basis points towards the quarter’s net interest margin and 16 basis points towards the loan yields during the quarter. When adjusting for this benefit, net interest margin improved to 3.77% for the third quarter of 2017 from 3.74% in the linked second quarter and 3.65% from the 2016 third quarter. The company has benefited from a widening margin after 325 basis point increases in the federal funds rate over the past nine months, including the 25 basis points increase in June. Typically, a 25 basis point increase in Fed funds equates to an increase of 5 to 6 basis points in margin for the company. These benefits were somewhat offset by an increase in the bank’s cost of funds during the quarter. As just mentioned, the bank’s loan yields have benefited from a variable loan repricing due to an increase in the prime rate after the Fed reserve increased its target rate by 75 basis point since December 2016. Loan yields adjusting for the benefit from the non-accrual loan payoffs were 4.60% in the third quarter compared with 4.54% in the second quarter of 2017 of 4.37% in last year’s third quarter. The company’s core funding costs have risen due to consumer preferences returning to maturity deposits as the cost of interest-bearing deposits for the third quarter of 62 basis points was higher than the second quarter by 2 basis points and higher than the 56 basis points in last year’s third quarter. Turning to asset quality. Credit trends were trending positive as charge-offs remain at historical lows and criticized loans were down slightly by about a $1 million from June 30, 2017. Total non-performing loans were 1.34% of total loans outstanding at quarter-end, compared with 1.42% from the trailing second quarter and 1.67% as of September 30, 2016. The company had net charge-offs of 6 basis points to average loans in the quarter, compared with net recoveries of 8 basis points in the first quarter of 2017 and a charge-off ratio of 0.03% in the third quarter of 2016, respectively. The $200,000 provision for loan losses for the third quarter of 2017 reflects loan growth in the quarter somewhat offset by a decrease in specific reserve on impaired loans. Non-interest income for the quarter was flat from last year’s third quarter, but up about $300,000 from the linked-quarter. The largest positive driver of the increase in non-interest income was insurance revenue, which was $2.2 million in the third quarter compared with $1.9 million in the trailing second quarter and 70% higher than the insurance revenue in last year’s third quarter. The increase in the linked-quarter was due mainly to the seasonal increase in commercial lines insurance commissions. The year-over-year increase was driven by employee benefits revenue, as our investment in hiring a couple of industry veterans provided significant growth in the quarter. Additionally, growth was bolstered by continued growth in commercial lines insurance commissions and incremental personnel lines revenue from the two recent insurance agency acquisitions. The current quarter and the linked-quarter include the impact of a net reduction of non-interest income of approximately $400,000 and $300,000, respectively, related to investments and historic rehabilitation tax credits. There were no comparable transactions in the third quarter of 2016. The accounting requires a bit of complicated presentation. But the bottom line impact for the bank this quarter is a positive increase in the bottom line of $300,000, with a $400,000 reduction in non-interest income offset by a benefit in our tax expense line of $700,000. We expect additional benefit in the tax line of approximately $200,000 with no further impact to non-interest income related to these projects in the last quarter of 2017. We also expect multiple other projects replacing in service in 2017 and 2018, all of which will positively impact the bottom line in the year they’re placed in service. Non-interest expenses increased from the trailing quarter by 6%, or about $500,000 and increased 13%, or $1.1 million from last year’s third quarter. The increase reflects higher salaries and benefit costs in the current quarter. Salary and benefits were $6.3 million in the third quarter of 2017, compared with $6 million in the linked-quarter and $5.4 million in last year’s third quarter. Half of the year-over-year increase is due to additional incentive compensation, strategic investments and non-recurring severance costs. Due to the company’s performance to-date, additional incentive compensation was accrued in this year’s third quarter. While management does not expect a material impact when comparing the 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 from last year’s third quarter also includes personnel costs for the company’s investment of strategic initiatives, such as employee benefit services and government banking. These investments have paid off with top line revenue growth and significant new core deposit relationships. The remaining increase in salaries and benefits from the prior year includes personnel adds in the company’s traditional lines and support such as commercial lending, commercial credit analysis and the retail bank, along with normal merit and benefit increases. Technology and communication expenses were $0.7 million in the third quarter of 2017, an increase of $0.2 million from last year’s third quarter, but down from $0.8 million in the second quarter of 2017. Technology expenses increased from the prior-year period due to a new online banking platform that was implemented in the second quarter of 2017 and a new core banking system that was converted in 2006 – 2016. Although the new core system was implemented in the beginning of the second quarter of 2016, there were credits and rebates associated with the new contract that were applied in the third quarter of 2016. The effective tax rate for the quarter was 16.6% compared with 24.8% in the second quarter of 2017 and 17.5% in the third quarter of 2016. The low effective tax rate in all periods reflects the impact of the tax credit investment transaction. Excluding the historic tax credit transaction, the effective tax rate for this quarter was 29.0%. That concludes my comments for today. So now I would like to open the line up for questions.

[Operator:]

Thank you. We’ll now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question comes from the line of Alex Twerdahl with Sandler O’Neill. Please proceed with your question.

[AlexanderTwerdahl:]

Hey, good afternoon, guys.

[John Connerton:]

Good afternoon.

[David Nasca:]

Good afternoon, Alex.

[AlexanderTwerdahl:]

Hey, first, I just wanted to get a little bit more clarity on a couple of the comments you had in your prepared remarks. First on expenses. It sounded to me like based on the accrual of some of those incentive comp, or some of these incentive comp in the third quarter, does that mean that we should expect expenses – non-interest expenses to decline in the fourth quarter, because that was completely taken care of in the third quarter, or should we expect this run rate to continue into the fourth quarter?

[David Nasca:]

Well, I think, we’ve – I mentioned that there was some severance also in the third quarter that will not continue, but second quarter’s run rate is – will include the incentive, or did include the incentive compensation, and it will continue in the fourth quarter. So second quarter’s run rate is probably a more appropriate run rate when adjusted.

[AlexanderTwerdahl:]

Okay. How much was the severance comp?

[David Nasca:]

Severance comp was about $200,000.

[AlexanderTwerdahl:]

Okay. And then I was wondering, David, if you can give us a little bit more color on the dynamics for loan growth during the quarter, you mentioned a $11 million loan that you’re allowed to payoff? In previous calls, you talked about some – a lot of competition and loans kind of paying down away from you. Did you see a fair amount of that during the third quarter as well as kind of an offset to the strong loan originations, or maybe just talk a little bit more of that what you’re seeing from a loan growth dynamic standpoint?

[David Nasca:]

Okay, I got to decompose that a little bit. I guess, what I’d say is, we’re still seeing a pretty significant loan growth. We are – it was muted in the quarter, because if you take the $11 million in the syndicated national credit out, if you put that back in instead of growing at 9%, we would have grown about 14% annualized. So we think there’s still strong growth there. I think, with the way we characterize it is unexpected payoffs. But syndicated national credits, we’re moving away from for lots of reasons. We don’t think that’s a community bank platform for us to necessarily be involved in number one. Number two, I don’t think the OCC loves it for any other banks. And it was really – they were clubber or party deals, whatever you want to call them, but we’ve had enough production to keep ourselves busy without joining these partnership deals. I don’t see – we can’t – we budget a little bit for some payoffs, but they’re always a little unusual, because we’re not sure when they’re coming and when they’re not. We have not lost these necessarily to other local competition though to answer the other part of the question. We’ve lost some deals probably the conduits or insurance companies, but most of the other deals, the big deals that we lost, the Shared National Credit was the largest one. Does that answer your question?

[AlexanderTwerdahl:]

Okay.

[John Connerton:]

Alex, just to slight added to David, those are leverage Shared National Credits, so not all Shared National Credits, obviously.

[David Nasca:]

Right.

[John Connerton:]

Yes.

[AlexanderTwerdahl:]

Got it. And then just finally, can you breakout in the insurance services line how much of the increase, the year-over-year increase in the first nine months could be attributed to the acquisitions you did earlier this year versus the employee benefit revenue growth?

[David Nasca:]

So on the acquisitions, it’s’ around $100,000 a quarter.

[AlexanderTwerdahl:]

Okay. All right. Thanks for taking my questions.

[David Nasca:]

All right. Thank you.

[Operator:]

[Operator Instructions] The next question is from the line of Joe Fenech with Hovde Group. Please proceed with your question.

[Joseph Fenech:]

Good afternoon, guys.

[David Nasca:]

Good afternoon, Joe.

[John Connerton:]

Hi, Joe.

[Joseph Fenech:]

Hey, David, one of your competitors, it doesn’t hold a call, talked a little bit about, also had very or had very strong loan growth in the third quarter on a net basis, talked about the dynamics around the First Niagara opportunity, and you’ve talked about this in the past is the one-year anniversary that you felt will kind of create renewed opportunity. Dave talked about it as though extending through the end of the year, they didn’t move out an opportunity in the next year as well from that. Can you talk a little bit about or update us on what you’re seeing there, and your thoughts on kind of how long this opportunity extends out into?

[David Nasca:]

Yes, and again, I’ll break that into two separate answers. I – we think the opportunity breaks out for a period of time into next year for certain. We continue to see that opportunity play itself out. That said, this is a second part of my comment, I would suggest that, we are now positioned as a likely competitive option for people. So whether, obviously, this – that transaction happen. But now I think the new normal is that, we’re going to get shots to play when people are up for bid, if you will, there’s not bids. But when people are looking at their deals, we’re being considered more frequently than in the past. So while I think the opportunity was created by that transaction, I think, it’s now, I don’t want to say a more permanent opportunity, but it’s a more standard opportunity for us that will continue based on our competitive positioning as much as anything.

[John Connerton:]

Included in that, Joe, the competitive positioning is, we’ve acquired some individuals that – from that shakeup, and their centers of influence are the same that they were before and we’ll still get opportunities as they work those deals to David’s point as we get – as their loans come kind of come up from the perspective of looking at them.

[Joseph Fenech:]

Okay, that’s helpful. And then, David, you guys have done such a great job the past few years and you laid the groundwork for this, a lot of this in the first several years after you joined Evans. And then obviously, there were some of the outside opportunities that you talked about, First Niagara and the Buffalo Billion, and things going on in Western New York. All that is obviously manifested you guys, like I said, you’ve done a great job. Take us through like the – how does the story evolved from here out looking out over the next couple of years? Does it – is it just kind of continuing to harvest those opportunities that you see, or does the story extend to include maybe M&A, or anything else on the horizon that we might not be thinking about as it relates to Evans at this point?

[David Nasca:]

Okay, a little bit of a longer answer, which I’ll try to make short. I think how it continues is, we continue to see organic opportunity here going forward whether that extends a little bit further outside of the market, say, moving towards Rochester, Syracuse, those kinds of things, I don’t know. But certainly, we’ve already done business in those locales and they’re pretty similar to where we are now. In terms of the M&A view from this seat, there is not a lot of opportunity here, because the market largely up through Albany has been cobbled together by in the old days First Niagara and M&T. So there’s not a lot of low-hanging fruit, if you will, pardon the term, that we think are opportune acquisitions for us. Certainly, a good size acquisition for us might be $0.5 billion bank. There’s not a ton of those hanging around. In terms of buying different lines of business, we certainly are taking those opportunities to both start and buy, and an example of that would be the employee benefits business. While we didn’t acquire a business, we acquired somebody who basically started the business underneath our umbrella, because he was looking to purchase the business he was in. So there’s opportunities that might not be right inside the box, that might be a little outside the box that will certainly try to take advantage of. We’ve done some acquisitions in insurance. We think there’s greater opportunity in municipal banking going forward. So we think, there’s a lot of sort of continuing to block and tackle in our existing business that will take us further. But we don’t see tremendous opportunity for M&A right now. Then that said, as we get bigger, we’ll be opportunistic. If something is there, we certainly think we could be a buyer. We have people that have come mostly from larger institutions who have done that sort of work in the past. We just haven’t really had a swing at this point. And I would say to you, again, from my seat, there has been a lot more talk than action in the middle market end, a lot of the big – a lot of the transactions have been big. And you know, because you’ve been involved. But they’ve been more in the First Niagara kind of category, which we wouldn’t be a player there anyway unless somebody was coming after us. And again, that’s whatever drive shareholder value is what we’re about.

[Joseph Fenech:]

Okay. I totally appreciate your comments about the opportunities or lock thereof from an M&A standpoint in your markets. As you think about market extension opportunities to markets that are nearby, shall we say, with more opportunity. Do you kind of look at it like, if there’s an opportunity in those markets, that would be something that you would consider, or do you not want to dilute sort of the characterization of the Evans story as gaining that pure play on the markets that you’re in?

[David Nasca:]

That’s a tough question. Here is the way, I guess, I’d frame that. I think, we don’t think it would be dilutive. We think it would be additive to our existing pure play kind of action, because it would be the same kind of business with the same kind of people. It would be just be an expansion of our existing territory, which is in, as you know, Rochester is 57 miles away, it’s not like it’s a hard drive. That said, we have a lot of opportunity still existing in our current market. If you look at our market share, we’re somewhere between depending on which surveys you look at, we’re somewhere between 2.5% and 5% market share. That leaves an awful lot of opportunity in the existing market before we really say that there’s a lot more opportunity somewhere else. So we’ll continue to focus hard where we are. We still think there’s opportunity for our business model to continue to improve. But there are opportunities that are being brought to us. We have clients that straddle these markets in upstate. I would tell you, Rochester looks a lot like Buffalo, Syracuse looks a lot like Buffalo. Those kinds of markets are opportunities as well, and we have clients that are not just solely in our market. So we have followed clients in the past. We know other banks that need participants in some of their deals, we’ve been involved in those. So again, I’ll apologize for a long answer, but I don’t think it’s either/or, I think it’s both end.

[Joseph Fenech:]

Okay. Great color. Thanks, David.

[David Nasca:]

You’re welcome.

[Operator:]

Thank you. At this time for closing comments, I’ll turn the floor back to management.

[David Nasca:]

Okay. Well, listen, I’d like to thank everybody for taking the time to share with us today. We’re always happy to do this. We probably won’t be talking to some of you through the holidays. So I’d say, wish you all a great holiday, Thanksgiving and the rest of the holidays with your families. And thank you for either investing in or being interested in Evans Bank. Have a great one.

[Operator:]

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