Evans Bancorp, Inc. (NYSE:EVBN) Q2 2022 Earnings Conference Call July 27, 2022 4:45 PM ET
Company Participants
Deborah Pawlowski – Investor Relations
David Nasca – President and Chief Executive Officer
John Connerton – Chief Financial Officer
Conference Call Participants
Alexander Twerdahl – Piper Sandler
Chris O’Connell – KBW
Erik Zwick – Hovde Group
Operator
Greetings. Welcome to Evans Bancorp Second Quarter 2022 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note, this conference is being recorded.
I’ll now turn the conference over to your host, Deborah Pawlowski, Investor Relations for Evans Bancorp. You may begin.
Deborah Pawlowski
Thank you, Shamali, and good afternoon, everyone. We certainly appreciate you taking the time today to join us and your interest in Evans Bancorp. Here with me on the call today, I have David Nasca, our President and Chief Executive Officer; and John Connerton, our Chief Financial Officer. David and John are going to review our results for the second quarter of 2022 and provide an update on the company’s strategic progress and outlook, after which we will then open it up for Q&A.
You should have a copy of the financial results that were released today after markets closed. And if not, you can access them on our 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 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, Debbie. Good afternoon, everyone. We appreciate you joining us for the call today, and I’m going to start with a review of the past quarter and then hand it off to John to discuss the results in detail.
Results for the second quarter were very solid, driven by continued growth in commercial business lending, core deposit traction, especially checking and savings, strengthening margins and a diligent focus on expense management despite the rapidly changing market dynamics, all financial institutions operate in currently.
The team continues to execute our strategy, resulting in the attraction of new business and market share growth with a consistent community and relationship driven focus that centers on the customer. It is our expectation that a rising interest rate environment will drive higher net interest income and margins going forward.
During the second quarter, net income was particularly encouraging as we were up 9% from the first quarter and comparatively, although down slightly to last year’s second quarter, we effectively covered $2.5 million in PPP fees received in last year’s period. We experienced another quarter of significant production performance by hitting $105 million in loan closings, which was led by robust commercial real estate demand and strong progress in commercial and industrial loans.
And while net loan growth was not substantial during the quarter, we are pleased with the positive trend we see in the number of new commitments and loan closings as our teams across the footprint have been performing well in this current market.
We also continue to focus on deposit growth. And while there was a slight dip in this past quarter due to seasonality of municipal deposits, our core deposit balances continue to trend positively. We have exceeded our expectations with core consumer checking balances and commercial deposit acquisition continues to be strong.
An area of highlight during the quarter was continued performance in managing expenses, while simultaneously maintaining targeted technology investments to enhance the customer experience and engagement with digital offerings, as well as drive operational efficiency and effectiveness.
Notable achievements included an upgrade to our core operating system to provide new security features and processing efficiencies, including a new teller system that was implemented throughout the branch, and the kickoff of a commercial efficiency project, which will touch all areas of commercial lending from data collection to underwriting, booking and portfolio management.
Our expectation is that we can facilitate commercial production and documentation in an integrated digital, accountable and streamlined workflow with better controls and an enhanced customer experience. We expect components of the new project to be in rollout in the late third or early fourth quarter.
We discussed on our last earnings call, embarking on a branch network efficiency initiative, which resulted in the closure or repurposing of three locations. To-date, the transition of these branches has been smooth with positive feedback. The expected run rate of annual non-interest cost savings from these changes is approximately $750,000, and we are already starting to see the initial benefits in this past quarter.
Another critical pillar of our strategy, which we believe is a differentiator for Evans is talent and culture. We like all businesses continue to be challenged by the market for associates, competition for top performers and rapid labor cost inflation. We’ve had success in recruitment and key associate retention and believe this is a reflection of our culture and commitment to our associates.
We are aware that employee attitudes and perspectives are evolving, and we are continuously working to drive a culture that is inviting in a place where top talent wants to work. A culture pulse survey was recently completed focusing on fairness, collaboration and communication to determine recommendations and suggestions that we can apply to continue to enhance the employee experience.
We are also excited about our recent promotion during the quarter that will help us continue our cultural momentum toward inclusion, diversity, equity and awareness. Royce Woods, who previously served as Vice President of Community Development and Commercial Banking, was promoted to the newly created position of Chief Diversity, Inclusion and Community Development Officer. He is responsible for collaborating and influencing the overall development, implementation and communication of the organization’s inclusive strategic plan.
Royce has deep ties throughout the market coming from work with the City of Buffalo and a WMBE Advisory and development organization as well as interfacing with several local non-profit boards. His passion for community development work, diversity and cultural evolution will be an asset as he takes on this all-important role at Evans.
There are two other areas we are taking a focused approach to the intersection of associates’ career desires and the company’s needs. First, our insurance account executive development program was recently enhanced with a formalized sales process for new and existing account executives, focusing on sourcing leads, building centers of influence winning at cold calling and utilization of existing technologies to assist with sales processes and data.
We also completed the initial phase of our commercial banking talent development program, which consisted of detailed multi-month on-boarding courses and training built within our online learning management system. Phase 2 of the project will utilize development toolkits to prepare internal candidates for promotion, thus building an internal commercial banking talent pipeline.
Lastly, as a community financial institution, the organization, our associates try to be positioned to play a part and assist in the community in a multitude of ways.
As you may know, on May 14, our community was rocked to its core as a recently motivated mass shooting occurred in East Buffalo within the most prominent and important grocery store in the area, taking 10 lives and injuring three others. The Buffalo community showed its resolve and resilience by coming together in response to this unspeakable tragedy as the true city of good neighbors that it is.
As a community steward evidence is, along with many other community institutions, actively assisting to help make a difference and be a positive influence for equity and justice. Whether it be providing platforms for our associates to assist, expanding already significant associated community involvement, working in a public-private partnership with the city to develop infill housing, or donating money to the recovery fund to support systemic change aligning with our values and commitment to ensure that everyone in our community is treated equitably and able to assess every opportunity and fully realize their potential.
With that, I’ll turn it over to John to run through our results, and then we’ll be happy to take any questions. John?
John Connerton
Thank you, David, and good afternoon, everyone. Net income was $5.7 million, or $1.03 per diluted share, compared with $6.3 million, or $1.15 per diluted share in last year’s second quarter and $4.7 million, or $0.86 per diluted share in the trailing first quarter of 2022. The increase from the sequential first quarter was largely due to higher net interest income. The change from prior year largely reflected lower PPP fees and a sizable credit and provision for loan losses that was taken in last year’s period.
Net interest income increased $1.6 million, or 9% from the sequential first quarter, driving the change with both higher average loan balances and loan offering rates being above the prior quarter due to the Fed’s 150 basis point rate increase since March. Deposit betas have not accelerated to this point as the competitive landscape has not been challenging as of yet.
The slight decrease in net interest income since last year’s second quarter largely reflected the decrease in PPP fees given the deceleration in the rate of remaining loan forgiveness as the program nears its conclusion. During the quarter, we realized $224,000 in deferred PPP fees compared with $500,000 in the first quarter of 2022 and $2.5 million in the second quarter of 2021. Nearly all the original $7.4 million in fees from the first round of PPP have been booked to income.
The second round of PPP originations produced $4.9 million of additional fees, of which $4.8 million has been recognized in income, leaving approximately $83,000 of fees to be booked. The $267,000 provision for loan losses in the current quarter was driven by economic qualitative factors as GDP is showing some weakness. The sequential first quarter provision reflects strong loan growth, while last year’s second quarter had a credit due to the benefit of unwinding the pandemic effect of the economy.
Our balance sheet is well positioned for rising interest rates, and as expected, given recent Fed actions, we saw a 27 basis point lift to net interest margin in the second quarter to 3.45%. I will talk to our net interest margin expectations at the end of my remarks.
Non-interest income was $4.6 million in the quarter, up about $200,000 over each comparable period. Insurance, which is the main driver within this category was up from the linked quarter due to seasonally higher policy renewals for institutional clients. On a year-over-year basis, insurance revenue was down less than $100,000, primarily due to discontinued operations of our insurance claims services business.
The changes in the other income line from the sequential and prior year period was largely due to movements in the fair value of mortgage servicing rights. Deposit service charges have seen a steady rise over the last year, mostly due to higher debit card usage.
Total non-interest expense increased 2% from the sequential first quarter and on a year-over-year basis was down 3% as we have continued to balance our investments around strategic focus areas and are utilizing technology to supplement our efficiency efforts.
We also are beginning to see the initial benefits of the branch rationalization. Salaries and employee benefits, which comprised 64% of total non-interest expenses remain largely unchanged from the first quarter of 2022 and second quarter of 2021.
Advertising expense increased $259,000 from the sequential quarter due to seasonal marketing campaigns. The company’s efficiency ratio was 65.2% in the second quarter, an improvement of 150 basis points since last year’s period.
Turning to the balance sheet, we continue to deploy excess liquidity into investment securities, but those balances up $169 million since last year’s second quarter. We’re also using liquidity to fund loan growth over the last year as total loans increased $53 million, excluding the impact of PPP loan forgiven.
Of the approximately $300 million of PPP loans originated, we had just $3.5 million left at quarter end. This compared with $10 million at March 31st and $146 million at the end of last year’s second quarter.
Looking at the second quarter specifically, commercial loans grew $7 million, but net originations were $87 million. That compares well with the $94 million of net originations in the linked quarter and continuing much higher than last year’s average originations.
The lack of growth during the quarter largely reflects the $37 million or 42% of originations that were from unfunded commercial real estate construction loans, which will fund as construction ramps up.
Payoffs are also still running a bit higher than typical due to some sales of customer businesses as asset prices remain high. We still have a healthy commercial loan pipeline of $73 million and we expect that to generate commercial loan growth as payoffs and refinances continue to normalize.
Our credit metrics remain sound despite a modest increase in non-performing loans which reflected the addition of one commercial real estate loan that is well collateralized.
Total deposits of $1.97 billion decreased 1% from the sequential first quarter due to the seasonality in municipal client balances. Excluding municipal deposits, total deposits were up $18 million during the quarter, mostly in demand deposits. On a year-over-year basis, total deposits were up $85 million or 4% and reflected growth across all deposit categories with the exception of time deposits.
At this point, assuming no further Fed rate hikes we expect to see further expansion in our net interest margin of approximately 20 basis points in the third quarter. We have not seen competition for deposit rates begin to rise, but expect some movement in late third quarter. Any further increases by the Fed, including today’s increase would have a positive impact.
As a reminder, a 25 basis point move from the Fed, all other things held constant, would increase net interest income by $1 million annually or four basis points in total margin due to our variable rate portfolio.
With that, operator, we would now like to open the line for questions.
Question-and-Answer Session
Operator
And at this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Alexander Twerdahl with Piper Sandler. Please proceed with your question.
Alexander Twerdahl
Good afternoon.
David Nasca
Good afternoon, Alex.
John Connerton
Good afternoon, Alex.
Alexander Twerdahl
Just wanted to keep you going on that last set of comments on the NIM, John. I think you said 20 basis points expected in the third quarter, and that does not include the 75 basis point hike from today?
John Connerton
That’s correct.
Alexander Twerdahl
And the — what kind of expectation for average earning assets would that take into account? I mean, now that cash has kind of gotten closer to normalized levels, it looks like in the second quarter, — is there still some sort of asset transitioning that’s going to be done? Or do you think you’re going to have to actually grow the balance sheet to fund loan growth?
John Connerton
So I think, there’ll be some movement in our cash into interest-earning assets. I think what’s going to drive it is we do expect loan growth for the whole year to still be in the higher single digits between 7% and 9%. So that would — that’s really where we’re looking to grow our interest earning assets.
Alexander Twerdahl
Okay. But to fund the loan growth, would you need to actually expand the balance sheet just given sort of the liquidity position today? Or can it be done with cash and cash flows from securities?
John Connerton
It can be done with cash. We’re still sitting in on approximately $80 million in excess liquidity, and we plan on driving those — putting that into use.
Alexander Twerdahl
Great. And then the $1 million annually from each 25 basis points is that — do you think that — does that take into account deposit betas? Or do you think that kind of the 1 million–
John Connerton
Yeah. Sorry, Alex. Yeah, that’s — everything held constant. So we haven’t seen our betas move. We expect betas to start to move. So that would bring that $1 million down for every 25 basis points if and when — well, when betas start to move up.
Alexander Twerdahl
Okay.
John Connerton
We talked about it last time — I think we talked about last time our betas last cycle moved around between 30 and 40 basis points for the whole cycle. We expect with the excess liquidity that we have here, our strategy is going to be proactive with our core customers and adjust our rates to those particular customers. And with the excess liquidity that we do have as well as our deposit gathering that we’ve had recently, we feel we’ll be able to most likely do better than that? Or there should be some probability that we do better than that from the last cycle.
Alexander Twerdahl
Okay. That’s good color on that. And then just switching gears to the efficiency, the commercial efficiency process that you’re talking about, David, in your prepared remarks.
David Nasca
Yeah.
Alexander Twerdahl
Is the — I guess is the goal for that to reduce or to create operating leverage and reduce expenses? Or is it to drive more loan growth or kind of maybe talk to a little bit more sort of the higher-level rationale for putting this in place, is a catch-up on just getting the systems up to the 21st century? Or what’s — I mean, what’s kind of the higher-level thought process behind it?
David Nasca
Okay. I’ll do that. You asked about three questions, and I’m laughing, Alex, because it’s sort of all of those things. We’re not — we’re up to the 21st century. I mean, we’ve got good loan processes and systems, but we have been growing above trend for a long period of time. There is a need to address the continued scaling of that operation. It will provide efficiencies to the organization, but it will also allow us to effectively create some scale for the organization to grow and continue growing faster because it affects all areas.
It affects underwriting, operating, booking, portfolio management — and on top of that, what it will do is it will position us with maybe what you’d say is, it will enhance our controls as well in making sure that with this kind of volume we’re diligent around our control. So, I think it’s all three of those things. It’s efficiency, it’s scalability and it’s a control environment. So, we’re going to be — we’re making investments to get better and stronger and bigger.
Alexander Twerdahl
Great. And then just — can you just remind us with the branch efficiency program, the 750,000, have we started to see that? And I think you mentioned you started to see the very beginning of that in the second quarter. But when does that really sort of impacting the expense land [ph]?
John Connerton
It’s really occurring it will — the largest component of that is salaries Alex and that has already begun. But by the beginning of fourth quarter, all those expense saves which should start to be there from an annual perspective.
Alexander Twerdahl
Great. Thanks for taking my question.
John Connerton
Thanks, Alex.
Operator
[Operator Instructions]. Next question comes from the line of Chris O’Connell with KBW. Please proceed with your question.
Chris O’Connell
Hey, good afternoon. Wanted to start off with the origination yields coming on the books? I heard the pipeline numbers, but I may have missed it. But if you guys could just go through what the loan yields coming on are, that would be great?
John Connerton
Sure. The yields, we usually get anywhere between 200 and 250 off of our funding source, which yields anywhere between 5.5% and 6%
Chris O’Connell
And that’s funded on the whole portfolio?
John Connerton
Yes. No, I mean, 5.5% on the — that’s on new originations going forward.
Chris O’Connell
Yes, yes. Sorry. Got you. Okay. Great. And then for the efficiency initiatives as well as kind of the branch savings and putting it all together, how are you seeing bottom line kind of operating expense numbers flowing through into the back half of the year here?
John Connerton
So Chris, I think the only — I think the current run rate is a good run rate with the exception of, as we move through the quarters here towards the end of the year, we do look at our — what our bottom line is going to be and then how that’s going to impact our incentives, which we won’t — we usually don’t know until into the third quarter. So, if you look at prior year’s third quarters, you can see if we are doing well, we’ll adjust the incentive calculation then.
So that would be an impact to kind of bring up the current run rate going forward. But we haven’t really got to that point in the in the year yet where we’re comfortable booking that additional incentives if the performance — the full year performance part.
Chris O’Connell
Got it. And these — the technology and the outside of the branch plan, do these investments create a little bit of a higher expense growth run rate ahead into 2023? Or are there offsets there?
David Nasca
I think the answer to that is we’ll have some expense run rate into 2023, but we’re also managing other sides of that expense, whether it’s personnel, some other things. So we think the run rate that you’ve seen is appropriate going forward. You’re not going to see big bumps up or down. We think we’re at a good level here. So there’s going to be puts and takes there.
Chris O’Connell
Okay. Got it. And for the deposit flows this quarter, most of it being driven by the muni decline, how much of that do you think will come back in the third quarter?
David Nasca
Yes. It’s going to follow the seasonality that we’ve had in prior years. And usually, probably a good chunk of that. So we are high points somewhere in the first quarter and then again, it kind of meets that same high point at the end of third quarter, beginning of fourth quarter. So we would expect that we haven’t been — we’re not losing any customers, so we expect that those balances should come back on those high points.
John Connerton
Let me just add on to that, Chris. What you have here is obviously, in New York State, Texas School and property taxes, our February/March and then they’re kind of October for this school taxes. So they build — they get paid by the municipalities. They come out of their accounts coming at March, April time frame, and they come out of the accounts in the October, November time frame. But up to that point, they build back to those levels.
Chris O’Connell
Okay. That makes sense. And then I know you guys were eventually looking to build back TCE back to the 8% range. Obviously, difficult with the AOCI marks this quarter. How do you guys think about capital levels in terms of regulatory versus TCA and is there a goal or a time line that you guys want to get back towards the high 7s or 8%. Yes.
David Nasca
Well, I think with the AOCI impact there, we are kind of adjusting for that. And we think that where our capital ratios are at this point are sufficient, and we’ll manage if you adjust kind of excluding the AOCI at this point, we’re cognizant of it. But we — based on the makeup of our portfolio, our investment portfolio, we’re not significantly concerned around the impact from AOCI and where our capital levels are were pretty good from the perspective of where we want to be.
Chris O’Connell
Got it. And looking ahead, kind of piggyback on Alex’s questions, you guys grew the investment portfolio, just to touch this quarter again. Do you think that you’ll be keeping that more flat or moving the flows in the loans as they come off going forward? Or do you expect that to continue to grow?
John Connerton
We think, from here, we’re probably at a level that’s going to stay pretty consistent. We’ll utilize our excess cash that we do have, as Alex accepted for loan growth and any impacts from funding flowing out, because we’re staying disciplined on our deposit pricing.
Chris O’Connell
Okay, great. And then, lastly, I know it’s been there for a while, and you guys have the $54 million left on the criticized hospitality book. Any update there on how you see that progressing over the course of the tail end of this year?
John Connerton
Yes. It’s kind of consistent with what we’ve been saying for the last couple of quarters. Just seasonal business up here. Most of our properties are around — in our geographic area. And we’ll be — we’re going to look at it pretty hard at the end of third quarter, which will be kind of the end of the season to make the assessment on those assets. And so far, our understanding of the activity and their performance is headed in a positive direction.
David Nasca
Improving. Yes.
Chris O’Connell
Great. All right. Nice quarter. Thanks for taking my questions.
David Nasca
Thank you.
John Connerton
Thanks, Chris.
Operator
Our next question comes from the line of Erik Zwick with Hovde Group. Please proceed with your question.
Erik Zwick
Thanks. Good evening, guys.
David Nasca
Good evening.
John Connerton
Hi, Erik.
Erik Zwick
Just a question, I guess, on your commercial borrowers with variable rate loans and just trying to understanding the potential impact to them. We’ve got, I guess, 225 basis points of hikes under our belt now and future curve would suggest maybe another 75 by the end of the year.
As you underwrite these loans, are going to continue to monitor them ongoing, certainly, a lot of these borrowers still have a lot of cash on hand, maybe more than they did pre-pandemic. But as their debt service goes up, does it get to a point? Are there any bars that start to become a little bit more stressed? Or do you build in enough cushion that they can withstand this?
And I guess how often the cash flows for those borrowers updated? Are they seeing uptick in those cash flows that could help offset? Or just curious about the potential kind of like your credit developments that could result from the interest rate hiking cycle.
David Nasca
Okay. I’ll answer that first, Erik, this is Dave Nasca. Couple of things that you asked there that I’d like to address. One is, we — when we’re underwriting these borrowers, we stress them for increased levels. So we have several stressors that we put the loans through in underwriting.
So from a perspective of do we see them being damaged by the rates up, my terms, not ours. In terms of that, we see the industry challenged by the rising level of inflation certainly, but we have underwritten these loans to be able to stomach this. So you asked, is there a little bit of a cushion in there? I don’t know if I’d call it a cushion, but we certainly understand where they are with respect to stress.
Secondly, we do get and we look at these loans at regular intervals. And where we are concerned, we will certainly make sure that we get cash flow statements, and we’re in relationship with these borrowers. So we understand their businesses and where they are. I think that is the difference with us is a community institution that’s really relationship-focused. We are working with them if they do experience difficulties we’re usually first to know and working on that.
So we have not seen that level of, I’ll call it, damage yet, but there’s significant impactors here, certainly, but we don’t expect it — we hope that it’s not a tremendous continuing burden. And we’ve written strong collateral. We have guarantees. We have debt service coverage ratios that are on the reasonable, if not conservative side. So I think the question about, do you have cushions there, we believe we do.
Erik Zwick
That’s great. Thanks, Dave. I appreciate the detailed answer there. That’s all I had today. Thank you.
David Nasca
Awesome. Thanks there. All right. Are there any other questions there, Shamali?
Operator
No. That is all the questions for today.
David Nasca
All right. Well, I’d like to thank everybody for participating in the teleconference today. We really appreciate your continued interest and support. And please feel free to reach out to us at any time. We look forward to talking with all of you again when we report the third quarter 2022 results, and we hope you have a great day.
Operator
And this concludes today’s conference, and you may disconnect your lines at this time. Thank you for your participation.
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