Evans Bancorp, Inc.
Q4 2017 Earnings Call Transcript

Published: 2 Feb 2018

[Operator:]

Greetings, and welcome to the Evans Bancorp Fourth Quarter 2017 Financial Results Conference Call. At this time, all participants are in listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Craig Mychajluk, Investor Relations for Evans Bancorp. Please go ahead.

[Craig Mychajluk:]

Yes. Thank you, Hector, 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 CEO; and John Connerton, CFO. David and John will review our fourth quarter and full year results, and then we'll open it up for questions. You should have a copy of the financial results that we released today after the market closed. If not, you can access them on our website, 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. I'd also like to point out today to provide investors with greater visibility of our operating results. In addition to the results measured in accordance with U.S. Generally Accepted Accounting Principles, or GAAP, the company is presenting in our results, excluding the impact of the TCJA and its - our historic tax credit investment activity. And the presentation of those non-GAAP measures and the reconciliations are provided in our earnings release. So with that, let me turn it over to David to begin.

[David Nasca:]

Thanks, Craig, and good afternoon, everyone. As you've seen today, we reported full year 2017 results with record net income of $10.5 million or $2.16 per diluted common share. Our results were impacted, as Craig mentioned, by new federal tax legislation that was signed into law in December. The good news, however, is that the reform will also produce future benefits for our shareholders due to the lower corporate taxes. Tax reform is also giving us the flexibility to invest more in our businesses, our communities and our associates. Yesterday, we announced a $1,000 bonus to all of our non-senior level associates, which is approximately 86% of our employee base. We also recently made a $300,000 contribution to the bank's foundation, which is the largest such contribution in our history. And the benefits provided by tax reform will also allow the company to increase its returns to shareholders and provide additional investment in our community. Evans is currently researching initiatives that will be impactful and make a difference in the fabric of the communities that is responsible for our success. This will continue to solidify our position as the true Western New York-focused community bank. Results this quarter have some noise in them, and John will walk you through all the various components. If you exclude the onetime write-down of deferred tax assets, non-GAAP net income was $12.6 million or 52% higher than 2016, which we are extremely proud of. 2017 was an impressive year for Evans, and I want to thank all of our employees for their hard work and our clients for the confidence they continue to show on us. This is a reflection of our efforts to be present in the market as the community bank of choice and the maturation of our client-facing associates. We grew loans and deposits and added customers across all of our businesses last year. We also generated record fee income for the year. We executed on each of our strategic priorities in 2017, which I'll detail heretofore

[John Connerton:]

Thank you, David, and good afternoon, everyone. Net income was $1 million or $0.20 per diluted share in the fourth quarter of 2017 compared with $2.3 million or $0.53 per diluted share in last year's fourth quarter. Net income was $3.7 million or $0.76 per diluted share in the trailing third quarter of 2017. Return on average equity was 3.32% for the fourth quarter of 2017 compared with 12.71% in the trailing third quarter and 9.70% in the fourth quarter of 2016. The decrease in net income was primarily attributable to the $2.1 million write-down of the company's deferred tax asset related to tax reform, also called Tax Cuts and Job Acts of 2017. Excluding the impact of the tax reform, net income for the fourth quarter increased 31% to $3.1 million or $0.62 per diluted share. The impact of the tax reform was $0.43 per diluted share. And ROE was 10.27%, excluding the impact of the tax reform. For the full year 2017, net income was $10.5 million, up 27% from $8.3 million in 2016. Earnings per diluted share increased 14% or $0.26 to $2.16 per diluted share. Excluding the impact of tax reform, net income for the full year of 2017 was up 52% to $12.6 million or $2.59 per diluted share. The return on average equity was 9.11% for 2017 compared with 8.74% in 2016. The efficiency ratio for 2017 measurably improved to 68.5% from 74% in 2016. Turning to the balance sheet. Loans grew $67 million, which equates to an annualized rate of 27% in the fourth quarter. For the year, the loan portfolio increased $123 million or 13% to $1.1 billion. Loan growth in the fourth quarter and the full fiscal year was predominantly in the commercial real estate and C&I loan portfolios. As David noted, we expect the strong growth trends to continue into 2018 given the strength of the commercial loan pipeline at the end of the fourth quarter. Total deposits grew $19 million in the quarter or 7% on an annualized basis, while for the year it increased $111 million or 12% to $1.1 billion. The deposit growth reflects growth across various product categories. Demand deposits were 2% higher than the third quarter of 2017 and 9% higher than last year's fourth quarter. NOW deposits increased 23% for the year and 13% in the quarter, while time deposits grew 32% for the year and 12% in the quarter. The growth in demand deposits is in large part because of the company's ability to gather core commercial deposits in conjunction with its commercial loan growth strategy, while the increase in NOW deposit reflects the company's continued success in its government banking business line. In terms of consumer deposit growth, the company has been able to achieve improved time deposit growth as customers have returned to maturity deposits with the rise in short-term interest rates. The company's strong balance sheet growth drove an increase in net interest income of $0.1 million or 1% from the trailing third quarter and $1.8 million or 19% from the prior year fourth quarter. Net interest margin was 3.79% for the fourth quarter of 2017, down from 3.91% in the linked-quarter, but up from 3.66% in the 2016 fourth quarter. The trailing third quarter's net interest income benefited $0.4 million from the payoff in full of two loans that were formally in non-accrual status. The increase in net interest margin year-over-year was due to on improvement in loan yields, which have continued to benefit from the repricing of variable-rate loans tied to the company's prime rate. The company's core funding costs have risen due to rising market rates and competitive pricing pressures as the cost of interest-bearing deposits for the fourth quarter of 64 basis points was higher than the third quarter by 2 basis points and last year's fourth quarter by 5 basis points. Turning to asset quality. Credit trends have been trending positive as charge-offs remain low, and criticized loans were down significantly by $8 million from the end of the third quarter and previous year-end. Total non-performing loans were 1.29% of total loans outstanding at quarter end compared with 1.34% from the trailing third quarter and 1.28% as of December 31, 2016. The company had net charge-offs of 30 basis points of average loans in the quarter compared with charge-off ratios of 0.6% and 0.7% in the third quarter of 2017 and fourth quarter of 2016, respectively. The increase was driven by an isolated instance of a large commercial charge-off. The $602,000 provision for loan loss for the fourth quarter of 2017 was mostly due to the quarter's significant loan growth and the single charge-off of a C&I loan in the quarter that I just mentioned. Non-interest income for the quarter was up almost $400,000 from last year's fourth quarter because of the increased insurance revenues and a gain on bank loan life insurance claim, but down $300,000 from the linked-quarter due to seasonal insurance revenue. The current quarter and linked-quarter included the impact of a net reduction of non-interest income of approximately $500,000 and $400,000, respectively, related to the investments in historic rehabilitation tax credits. This impact was $300,000 in the fourth quarter of 2016. We expect other projects to be placed in service in 2018, all of which will positively impact the bottom line in the year they are placed in service. These projects are expected to comply with the transitional provisions in tax reform that allow projects already in progress to receive a full benefit of the historic tax credit in the year the project is placed in service as well as the rule before tax reform. Under the new tax law, the benefit for new projects will be spread over 5 years. We expect this change to have a significant impact on the historic tax credit market. Non-interest expenses has increased from the trailing quarter by 6% or about $0.6 million and increased 14% or $1.2 million from last year's fourth quarter. Expenses this quarter include a $300,000 contribution to the Evans Bank foundation, as David had mentioned, but not the onetime $1,000 bonus to our non-senior level employees that was announced earlier today. The increase from last year's fourth quarter includes an increase of $0.5 million or 8% in salaries and benefits costs and $121,000 or 19% in technology expenses. Higher salary expenses reflect strategic or personal hires made in '17 to support our growth strategy, while the higher technology expenses reflect the implementation of our new online banking platform in 2017. Income tax expense for the quarter was $2.2 million, representing an effective tax rate of 69% compared with an effective tax rate of 16.6% on the previous quarter and 7.8% in last year's fourth quarter. The difference was driven by the $2.1 million charge to the company's deferred tax asset due to the new tax law signed in December 2017 and by the impact of historic tax credit investment transactions in 2017 and '16. Excluding the impact of the historic tax credit transactions and the write-down of the deferred tax assets, the non-GAAP effective tax rate for the recent quarter was 29.8% compared with 29% in the linked-third quarter and 30.4% in the last year's fourth quarter. That concludes my comments, so I now would like to open up the line for questions.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from Alex Twerdahl with Sandler O'Neill. Please proceed with your question.

[Alex Twerdahl:]

Hey, good afternoon, guys.

[David Nasca:]

Good afternoon, Alex.

[John Connerton:]

Hi, Alex.

[Alex Twerdahl:]

First off, it sounded like in your prepared remarks that the loan pipelines are still pretty full going into the beginning of 2018, but just kind of a question overall. I mean, do you feel like, at this point, a lot of the low-hanging fruit are fruit associated with the merger disruption in Buffalo, the Buffalo Billions, et cetera? Is that starting to get depleted at this point? Or do you think that there's still just enough of it out there that you can keep it -- the engines working hard throughout the entire 2018 and maybe even beyond?

[David Nasca:]

The latter. I think we can keep the engines working into 2018 and beyond, because as I've said in previous calls with you Alex, I believe we're in a new competitive position in being able to compete for these loans with everybody, M&T, KeyCorp. KeyCorp's still trying to figure out what their - where their interests lie. We do have a lot more competition coming to the market. They are lulling the market a little bit, but we believe that we're in an excellent position given our almost 100 years of presence here as the local community bank. And we believe that this opportunity is going to continue, as I said -- as I've said a couple times. I don't want to be redundant, but we think it's ongoing.

[Alex Twerdahl:]

Great. And then in terms of the ability to fund that, your loan-to-deposit ratio is now just above 100%. I know usually you guys run some deposit promotions early in the year and bring in a lot of liquidity and then sort of deploy it as the year progresses. Is that kind of the plan again for 2018?

[John Connerton:]

Yes. I think that same -- the same scenario will probably play out in 2018, Alex.

[David Nasca:]

I think we're getting opportunities there as well, though, like I said, Alex, in terms of our government banking business has been ramping up pretty nicely. That helped us in the funding side. That is, I'll call it, seasonal, but it comes and goes out. There are tax collections and dispersals. But also, we are running and looking to drive some liquidity from some specials as we do at the beginning of every year.

[John Connerton:]

Just a follow-up on that, Alex, to David's point. December is a low point, specifically for those government banking clients. And so the 100% loan-to-deposit ratio is kind of the high point in our year just our - from the perspective of seasonality.

[Alex Twerdahl:]

Okay. And then the bonuses that you guys announced, can you just clarify for us which quarter those will hit in and the full magnitude of them?

[John Connerton:]

The $1,000 bonus will be in the first quarter. The $300,000 to the foundation was in the fourth quarter.

[Alex Twerdahl:]

Okay. And what's roughly the size when you add up all those - I know you said 86% of your employees. But what's the...

[John Connerton:]

It's about $250,000.

[Alex Twerdahl:]

Okay. And then what -- last question for me is what should we expect the tax rate to look like in 2018 based on what we know now?

[John Connerton:]

Excluding any historic tax credits, our effective tax rate should be around 23%.

[Alex Twerdahl:]

Great. Thanks for taking my questions.

[John Connerton:]

Thanks, Alex.

[Operator:]

[Operator Instructions] Our next question comes from Joe Fenech with Hovde Group. Please proceed with your question.

[Joe Fenech:]

Looked like a pretty straightforward quarter, so some big picture questions for you. I guess, Dave, stripping away the Buffalo billion stuff and the First Niagara disruption, I know this is tough to do, but would you say - and as with tax reform in the early stages here, underlying demand in the market, underlying business activities is stronger than it was 6 months ago, would you say? Or is it kind of about the same?

[David Nasca:]

I think it's about the same. I might even argue that it's a little bit weakened, but I do believe we're getting more swings at the plate, as I said to Alex, Joe.

[Joe Fenech:]

Okay. Any guess as to what leaves you to think it's weakening?

[David Nasca:]

I just think there's some concern -- there's a bunch of things going on. I don't think it's just federal tax reform. New York State is an interesting position because Governor Cuomo is challenging a lot of -- he's made an argument that with the salt issues that he wants to fight, along with a couple other states, against Trump's tax reform. And I think some of the businesses in town are a little, I'll say, put off by the concern of what that might mean. He's also tried to transfer -- he's threatened to increase payroll taxes to offset some of the benefits from the federal side. So I think some of the businesses have at least had a moment of pause, I would suggest. They haven't stopped -- it's not like it was in the first quarter of last year, where everything kind of ground to a halt because they didn't know what President Trump's positions were going to be on everything. I think they're just kind of -- there's some grousing around right now about what's happening. So that's a little long winded, but that's the challenge that we're trying to figure out right now. But we have not seen a reduction in pipelines or activity due to that. We're just hearing anecdotally that -- some concern.

[Joe Fenech:]

Okay, that's helpful, Dave. And then on the expense side, significant investments you guys have made. I ask this question to one of your competitors up there a couple days ago on their call, but the same question for you. I guess you've made some significant investments, and rightfully so, to position yourself to take advantage of this opportunity, and you've done it. Are you kind of where you want to be from an infrastructure? I know you're probably never where you want to be exactly from a people, infrastructure, what have you. But for the most part, should we start to see that spend, if you will, level off a little bit in 2018, 2019?

[David Nasca:]

I'll say yes, but - and I - you've heard this answer from me before, so I'll apologize. I think we will continue to support the business as the business continues to grow. We've had outsized growth for several quarters here, and it has necessitated our requirement to continue to support that growth with - whether it's credit people, whether it's - some of the growth that you saw last year were significant people. Whether it was Chief Risk Officer, whether it was a new commercial banking - Chief Commercial Banking Officer, whether it was the employee benefit side, whether it was the government banking position. I would say we're not going to have -- hopefully, we're not going to have big swings like that, but there is some backfill investment we'll have to do. At $1.2 billion, $1.3 billion, we're still not an organization at this level that's fully scalable in terms of some of those expenses, right? We've talked about that a lot. In the old days, you got to $1 billion, it was pretty scalable. Now there's some question whether you have to get to $5 billion to get scalable, and that's not our goal. But it's just - we continue to make the investments where we think those investments can best support the client, can best support the returns to the shareholders. We're still judicious about the expenses, though, I would suggest.

[John Connerton:]

Yes. Joe, the only thing I would add to David's comments is we have our -- a big component of the 2017 increase in some of our expenses were additions to new business lines and going after -- and specifically, an example of that is employee benefits. So backing those off, I would concur with David that we do still have to sometimes put in some resources to support our typical growth on our typical lines of business, but those should be somewhat normalized. Where we do kind of jump up the percentage increase on the expenses is when we're going after new business lines, as I suggested with employee benefits.

[David Nasca:]

And I would also say one last thing, Joe. This is a long-winded answer. Some of what you saw in terms of the increase in the expense was related to the merit increases that were paid for the performance we attained. So there were heightened performance bonuses that took place because of the success that was attained. So those are kind of the legs of the stool. I hope that gets to the answer that you're thinking about.

[Joe Fenech:]

It's helpful, Dave, Thank you. Thanks, John. And one more for me, I guess, just on your capital. I guess TCE down to around 8.5% -- or around 8.5% here. Just wondering - I'm not suggesting you're near this point, but just wondering what your sort of lower bound threshold is, if you will, and just kind of trying to map that out and really if this growth persists for another two years or so, '18 and '19. Just want to get a sense for where you guys feel comfortable taking that TCE or allowing that TCE level to drift down to?

[David Nasca:]

I'm going to let John hit this, but I'm going to say one thing just from a 30,000-foot level. We continue to organically generate capital, and we are -- we pay attention to that. We did raise capital at the beginning of the year. We thought that was more prospective capital. The growth was a little faster than we expected. But also, the earnings are going to be better than expected this year, which you just saw, and will continue to move that way. I think what you're going to -- what we're going to have to look at is assuring that we continue to generate that capital. And if we don't, then you look at other alternatives. But I'll let John speak a little more specifically on the numbers.

[John Connerton:]

I think - yes. Probably the ratio we like to look at, Joe, is our total risk-based capital. Just -- it seems to be our bigger limiter as we go forward. And we're more comfortable around 11%. And I think as we look out through '18 and '19, to David's point, as far as organically generating those capital, I think we -- taking aside any type of large acquisition, we feel comfortable that we have the capital levels that we're going to need for the growth.

[Joe Fenech:]

Thank you.

[Operator:]

Ladies and gentlemen, we have reached the end of the question-and-answer session. And I would like to turn the call back to management for closing remarks.

[David Nasca:]

Okay. I'd like to thank everyone for joining us today on the teleconference. I appreciate your spending a little bit of your time with us. I hope you can join us in April when we report our first quarter 2018 results. And with that, John, I wish you a wonderful day. Have a great day. Thanks, everyone.

[Operator:]

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