United Community Banks, Inc.
Q3 2018 Earnings Call Transcript

Published: 24 Oct 2018

[Operator:]

Good morning, and welcome to United Community Banks’ Third Quarter 2018 Earnings Call. Hosting the call today are President and Chief Executive Officer, Lynn Harton; Chief Financial Officer, Jefferson Harralson; and Chief Credit Officer, Rob Edwards. United’s presentation today includes references to operating earnings, pre-tax, pre-credit earnings and other non-GAAP financial information. For these non-GAAP financial measures, United has provided a reconciliation to the corresponding GAAP financial measure in the Financial Highlights section of the earnings release as well as at the end of the investor presentation. Both are included on the website at ucbi.com. Copies of the second quarter’s earnings release and investor presentation were filed last night on Form 8-K with the SEC, and a replay of this call will be available in the Investor Relations section of the company’s website at ucbi.com. Please be aware that during this call, forward-looking statements may be made by representatives of United. Any forward-looking statements should be considered in light of risks and uncertainties described on Page 4 of the company’s 2017 Form 10-K as well as other information provided by the company in its filings with the SEC and included on its website. At this time, I’ll turn the call over to Lynn Harton.

[Lynn Harton:]

Good morning, and thank you all for joining our third quarter earnings call. I am pleased to report another quarter of strong results. Core deposits grew at a 6.5 % annualized rate. Our net interest margin improved and we exceeded our return on assets goal posting an ROA of 1.42% on an operating basis. Our asset quality remains outstanding and it continues to be a cornerstone of our performance goals. Our operating earnings per share reached $0.55 which is up $0.02 or 4% from last quarter and $0.14 or 34% from last year's third quarter. During the third quarter, we were also pleased to declare a dividend of $0.15 per common share to shareholders of record on September 15, 2018. This is equal to last quarter's, but it represents a 50% increase over last year and continues to reflect our strong profitability and our positive outlook. I will now turn the call over to Jefferson for more details on our performance in the third quarter.

[Jefferson Harralson:]

Thank you, Lynn. We’re pleased with the performance of the quarter and having exceeded a key profitability goal of 1.40% ROA. If you'd like to follow along with me, I am starting on Page 5 of the investor deck. On Page 5, you'll see we have $112.1 million in net interest income in the third quarter, up 13% annualized from Q2. The spread growth we generated got a boost from a continued increase on our net margin. After a 10 basis point increase last quarter, the net interest margin was up another 5 basis points this quarter and up 41 basis points from a year ago. A normalization of accretable yield versus last quarter contributed to the quarter-to-quarter increase. On Slide 6, the stability and growth of our core deposit base remains a key strength to our company and a driver in our margin performance as rates have risen. We were particularly pleased with our core deposit growth in Q3, up nearly $70 million and in customer deposits we were up nearly $156 million. Our cost of deposits, on Page 7, in the third quarter was 42 basis points, up 9 basis points linked-quarter and our loan-to-deposit ratio was stable at 82%. Turning to loans on Page 8, end of period loans were relatively flat in the quarter and up 2% annualized, excluding our strategic indirect portfolio runoff. Our loan production in the quarter was strong at $778 million albeit down from last quarter's record and up 26% over the same period last year. We had $44 million of loan growth at Navitas as our investments in the business appear to be pushing the growth rate higher than our original expectations. The Navitas growth more than offset $41 million in indirect auto runoff and at quarter end we had $242 million remaining at indirect auto loans. Moving to Page 10, fee revenue in the third quarter was $24.2 million, up by $900,000 from last quarter and up $3.7 million versus last year. SBA gains increased to $200,000 versus last quarter due to higher loan sales, although at lower gain on sale margins as the market pricing has decreased on these guarantee loans due to increased prepayment speeds. Our SBA construction loan backlog increased to $91 million at September 30th. Our mortgage business also continues to perform well and mortgage fee income is up $1.1 million or 26% above last year. In the third quarter, we had closed mortgage loans totaling $237 million compared with $192 million last year. This is a 23.5% year-over-year increase in mortgage loans closed. Turning to Slide 11, operating expenses were up $3.1 million in the quarter versus Q2. The lion’s share of the increase comes in the salaries line with increases in incentives as a driver as well as investments in our Navitas and other businesses. On Slide 12, we are also pleased to be able to report outstanding credit results again this quarter. Net charge offs was very low at 7 basis points, flat versus last quarter. Non-performing assets came in at 19 basis points, a slight improvement over last quarter and last year. We also have a new slide in the deck on Page 22 that I’ll highlight very briefly that looks at our core ROA and core pre-tax pre-provision earnings versus peers, with and without accretable yield and compares us to our regional peers based on second quarter results. With that, Lynn I’d like to turn the call back over to you.

[Lynn Harton:]

Thanks, Jefferson. We are once again proud of our performance as we continue to execute on our strategy of having great bankers, who deliver best-in-class service. We were also glad this quarter to be recognized as one of the best banks to work for in the United States by the American Banker for the second consecutive year. For our team members listening in, thank you for making this a great place to work, a great place to build relationships and a great place to build a career. None of this would be possible without you. One of the people that has long been responsible for making United great is our President of Community Banking, Bill Gilbert. Late last month, we announced that Bill will retire effective February 2019, after what will be 19 years with United and 42 years in banking. Bill's passion and commitment to our company and to our customers has been a cornerstone of this company. He has been an integral part of shaping United into the bank it is today. So, congratulations Bill and thank you for all you have done for this company and for me personally. I am also proud to announce that Rich Bradshaw, formerly President of Commercial Banking Solutions will add Community Banking to his responsibilities when Bill retires. Rich has done a phenomenal job of building and growing our commercial bank and creating an unusual partnership between our commercial specialties and our community teams. I am confident in our continued growth and success under his leadership. Now, we will be glad to answer any questions.

[Operator:]

[Operator Instructions]. And our first question comes from the line of Brad Milsaps of Sandler O’Neill. Your line is now open.

[Brad Milsaps:]

Jefferson, maybe I want to start with the margin. I just wanted to see if you could maybe give us a little bit more color on kind of how you’re thinking about it over the next couple of quarters, maybe specifically I would have thought you would have had a little more growth in core loan yields, given the mix change with more Navitas loans and fewer indirect loans? And as a follow-up to that, on the deposit side, you guys talked about a lot of the good core deposit growth but it also looks like you’re also growing brokered time a fair amount, both on average and period end. Just kind of curious of the strategy behind that, is that more of a little bit of a leverage strata, I assume your people would -- you can't pay them in margin, you got to pay them in NII. So is that kind of the driver behind that, I am just kind of curious how big you’re planning to take that brokered piece?

[Jefferson Harralson:]

Yes, thanks. Great questions, Brad. Let’s start with the brokered piece of it, the -- you’ve just seen increase in broker deposits this quarter that was mostly offset by shrinkage in the FHLB book. We think of those as being I guess interchangeable. And what we saw is the -- just more attractive rates in brokered CDs versus FHLB, especially for anything that has some term with it. So you’ll see that. If you think about those together, we didn't really add a lot of levers this quarter. It kind of looked like -- if you look just at the brokered CDs but the FHLB mainly offsets that. On the margins we did have nice margin expansion this quarter, some of that, a lot of that was accretable yield. We do think that the -- I guess for forecasted margin I think flat is probably a decent forecast for the margin going forward. We have had a nice 13 basis points of margin expansion over the last couple of quarters. We do have some have some tailwinds from the remix towards Navitas and we do think we did become a more liquid bank this quarter with the strong deposit growth that we had and we do think over time we should have a lower deposit beta versus peers, and I think that we have some flexibility that a lot of banks -- versus other banks there. So I do -- for fourth quarter I think it’s relatively flat and I do think there’s a positive story in the margin over time. I think there was another part of your question that I might not have got into.

[Brad Milsaps:]

Yes. Just the mix -- you said the mix change is more Navitas loans coming on and how that impacted the loan yield during the quarter?

[Jefferson Harralson:]

So the loan was up -- loan yield was up by 17 basis points in the quarter of that 17, 8 was the accretable yield increase and 9 was core. So I don’t have the breakout of exactly how much of that 9 core was Navitas, but a good bit of that 9 basis points of core would be Navitas.

[Brad Milsaps:]

Okay. So otherwise kind of loan yields kind of staying fairly stable outside of the growth in Navitas?

[Jefferson Harralson:]

Yes maybe up 2 or 3 basis points there.

[Operator:]

And our next question comes from the line of Catherine Mealor of KBW. Your line is now open.

[Catherine Mealor:]

And so the total loan growth has been a little bit soft the past couple of quarters. What do you say would be the drivers of this improving moving forward or is the low single-digit growth rate kind of more appropriate at this stage of the game? Thanks.

[Lynn Harton:]

Hi, Catherine. This is Lynn. I think for the next two or three quarters probably the same kind of rate is probably appropriate. And a couple of reasons. One is our credit appetite. We have talked about commercial real estate and our appetite in some of the products that we think are a little overheated. And honestly I think commercial real estate is going to slowdown overall anyway, when you look at rate increases, materials inflation, labor inflation, I think that'll slow for the industry about naturally. The other place that we could get a lot of growth that we decided that we’ve chosen not to is in leverage lending and again in a rising rate environment. I don't know that it makes sense to lean in there. So some of it is our credit appetite, part of it is though we’re addressing. So we've been laser-focused on our new acquisitions. So we've invested heavily in South Carolina with the acquisitions there, in new relationship managers. We’ve invested heavily in North Carolina, in the Raleigh market with our acquisitions there and we are -- we've invested heavily in Navitas. We’re actually up a lot of -- a several producers in Navitas. And that's been positive and good. And if you look at our numbers those are the areas that are growing, now what we have not done and this has been my mistake is we haven't shown the same attention to recruiting in our legacy growth markets, we’re actually down one RM year-over-year in Atlanta, that doesn’t makes sense, I shouldn’t have let that happen. We are down one RM in Savanna year-over-year. So one of Rich’s new mandates is to kind of restart recruiting engine in those markets, Charlotte as well. We are actively just began a pretty big recruiting effort in Atlanta as we speak. But that’ll take a few quarters to kick off. I am confident that we will be successful. We've always had great success recruiting. But all that pulled altogether I would say for the next two or three quarters is probably the kind of growth that we’re going to -- we’re expecting.

[Catherine Mealor:]

And on the buyback can you remind us what your current authorization is and how -- and if the buyback is something that you’re considering now as the pull back on your stock?

[Lynn Harton:]

Yes. Thanks, Catherine. We’ve authorization of little less than $30 million remaining to buy. We haven’t bought shares in 2018 or 2017. We are growing capital at a good pace. As you can see in our deck, we do think that it is possible that an acquisition could come up maybe that we can put some cash into. I think if we are unsuccessful in acquisitions through 2019, perhaps we will take a stronger look at the buyback. So the buyback is out there, it is a lever that we can pull to increase earnings, but we think that we can most likely use a more efficient way in 2019.

[Catherine Mealor:]

Okay. So if I am hearing right, it does sound like you’ll be active, just upcoming quarter just given where your stock is?

[Lynn Harton:]

I don’t think we’ll be active this quarter.

[Operator:]

And our next question comes from the line of Jennifer Demba of SunTrust. Your line is now open.

[Jennifer Demba:]

On the recruiting side, Lynn, you said you wanted to reignite some efforts in Atlanta and Savanna, what would be your goals in terms of number of RMs you want to pick up over the next year or so?

[Lynn Harton:]

Yes, so I don’t want to put a number out there, yes, I have shocked Rich with a number so he is absorbed in that. But first step is we are recruiting a new overall leader for Atlanta, we’re very excited about that and kicking that off and so we’re scoping that as we’re going through the budget now in terms of investment versus pay off. And so I am not ready to put a specific number on there but it is a focus of us, of the company for as we going into ‘19.

[Jennifer Demba:]

Okay. And follow-up on the last question buyback, M&A that topic. What are you seeing -- I mean it’s not been too long since the stocks have been behaving so poorly in this sector but what are you hearing from the M&A targets right now and their willingness to talk in this environment?

[Lynn Harton:]

Yes, it’s a great question. So to me I would break it into kind of a long view and a short view. For the long-term if you think over the next three, five years, all the elements have pushed a lot of consolidation are still in place and are still going on. And so we're having conversations with the companies that would add capabilities whether they’re private banking, wealth management or geographies that move us into faster growth areas or consolidation opportunities. We’ve got active conversations going on with companies that fit all three of those pieces looking -- building those relationships to be ready over the -- over that timeframe. So I think we will participate over the long-term. Look, the reality is in the short view though at these prices it is very difficult to make anything work unless it's a very small deal that potentially could do for all cash and it might just be a fill in cost savings exercise. So I think the conversations are going on, but I don't think a lot of things of significance are going to happen at these prices or they shouldn’t.

[Operator:]

And our next question comes from the line of Michael Rose of Raymond James. Your line is now open.

[Michael Rose:]

Hey. Just wanted to touch on profitability, you guys have hit your target and obviously environment is getting a little more challenging here as you played out from a growth perspective. I did hear the NIM is going to be flat. But should we think about you guys being able to at least sustain the ROA around the target that you just hit, and I guess what are the levers you have both on the revenue expense side to maybe help improve that as we move through the next couple of quarters? Thanks.

[Lynn Harton:]

Yes, great question. And we do feel confident in being able to sustain that. We’re committed to that and believe we can, I might let Jefferson give a little more color to that.

[Jefferson Harralson:]

Yes. So we’re not backing off our ability to maintain returns, we’re not backing off our ability to have operating leverage in 2019. If we don't see the revenue we’d like we will pull the expense lever to get there. We are in the budget process of 2019, it’s not the easiest budget year for us or I think a lot of banks, but we do think we can maintain profitability going to next year. We’re not putting out our guidance for ROA or ROE for 2019 I don’t believe or in the next quarter. We do want to be in the top quartile versus peers, and that's what we are focused on every day as to be a top quartile profitability bank.

[Michael Rose:]

So maybe just a follow-up. So I assume you guys -- and you laid out your -- you’ve some hiring goals, I assume that you would want those hires that go forward regardless. So I guess what I am trying to figure out is what other areas could be either reduced investment or cut costs and I assume some of those branches et cetera. But if you could just give a little more color that’d be great?

[Lynn Harton:]

Yes. We’re looking at all those areas, so branches, other back office areas where we’ve been on a pretty good tier on the M&A side and our focus has been on converting those correctly, getting them in the house correctly if you will. And so we’ve got a fair number of efficiency opportunities we think to take advantage of as we go into ‘19.

[Jefferson Harralson:]

We’re looking every non-comp expense very hard with this budget going into ‘19 as well.

[Operator:]

And our next question comes from the line of Tyler Stafford of Stephens Incorporated. Your line is now open.

[Tyler Stafford:]

I just want to start on the margin just a follow-up, what’s the normal amount of scheduled accretion that you would expect to see on a quarterly basis?

[Jefferson Harralson:]

So it’s right in this range here. If you think about accretable yield that will have to come through, in total it’s about $28 million. We had $2.2 million this quarter. So we had a -- and if you look at the marks that we’ve taken in the past, we’re comfortably below the loss rates that those marks would anticipate. So I think this level seems like a good level and possibly could go up over time for the near-term and there is -- again there’s $28 million left to go through in total.

[Tyler Stafford:]

Okay. So to clarify the comment about the flattish margin in the fourth quarter, I guess that if the accretion is running constant, that would imply to both GAAP and core margin?

[Jefferson Harralson:]

That’s correct.

[Tyler Stafford:]

On the marks, what’s the remaining mark on the Navitas portfolio at this point and how should we be thinking about the associated charge-offs and provisioning impacts going forward as a result?

[Rob Edwards:]

So Tyler, it’s Rob. There is -- it's just shy of $2 million marks remaining there. We did charge-off just shy of $500,000 independent of the mark. So as we go forward we’re transitioning away from the credit marks. The marks that we’ve of course are on specific loans. So that's where the accounting works there. So I would anticipate we’ve kind of -- what they have run historically is just shy of a 1% loss rate and that's kind of the way we’re thinking about it going forward.

[Jefferson Harralson:]

And I might add -- in this quarter -- and fill in Rob is that we were flat quarter-to-quarter on that charge-offs but there was a mix change a little bit where you saw some Navitas charge offs coming in a little bit and you saw our core legacy net charge-offs improve and netted out the flat quarter-to-quarter.

[Rob Edwards:]

Yes. So last quarter we were completely covered in the Navitas charge-off by the credit marks so we had no Navitas charge-offs in the $1.4 million charge-off last quarter. This quarter’s $1.5 million included the $480,000 Navitas charge off. So what Jefferson is saying is right, our core bank charge offs asset quality is just very strong.

[Tyler Stafford:]

So if the mark is largely gone and the -- I guess core credit -- or the credit profile of the core bank remains very, very strong here, what’s the net I guess impact to the provisioning that we should be thinking about?

[Rob Edwards:]

Yes. So the provision is going to go up of course as the mark goes away, right. So if you say you got a $500 million portfolio and just for round numbers we’re using 1%, that's 5 million provision next year to cover charge-offs and so you deal probably 5 million to cover charge-offs and some loan growth. And then on the core bank just from -- maybe just because I am a credit guy it feels awkward to budget less than 10% in charge-offs -- I am sorry, 10 basis points. So, but we’ve had 7 basis points losses the last two years running. So kind of it’d be the combination of those two things. You’ve got to -- I will just remind you to keep in mind, and I know I keep saying it but the allowance is a function of three things. It's asset quality, which is of course very strong. We just talked about what we expect there but also loan growth, which we’re saying is low single-digits and then also it's the portfolio mix, right. So we were -- land loans were down $20 million in the quarter. That's a high reserve rate in the model and replacing it with other -- even Navitas is lower than land loans, and so there’s a little bit of a pickup you get in the shifting mix of the portfolio that is small but it's sort of -- it continues on.

[Jefferson Harralson:]

Tyler, I’ll just layer into on the Navitas in total. We originally said when we bought it we thought we’d have $30 million to $35 million of quarterly growth. We’ve been investing in that business as you’ve seen some on the expense line. We had $44 million growth this quarter and we think that number can increase as we go through 2019 as well.

[Tyler Stafford:]

And then just last one, just around the SBA business, and with the pricing pressure that the industry is seeing, I am just curious how you guys are thinking about that volume going forward?

[Jefferson Harralson:]

Yes. So we’re -- we have seen decreases in the gain on sale as everyone has on gain on sale at SBA. We've been very happy with our investment in the business and the increase in originations over time, and we do have this really nice construction backlog at $91 million that should help our ability to sell loans over time. The gain on sale of the 10 year piece which is about half of what we do has fallen from the 110 range to the kind of 108, 108.5 range, and so we absorbed that this quarter. If you think about our loans sold this quarter, we’re up about 25% and our gain on loans sold was up only about $200,000 versus last quarter. So we do have -- there is some changes with the expectation and the actuality of higher prepayments in that business and prepayments reached 20% for the industry there and that has translated into lower gain on sale. So as we go into next year we do think we will have higher originations next year, the gain on sale could be lower if current market conditions exist. I know we’ve talked and I think we’ve talked with you too is with the yields on these loans now around what call it 7%, 7.5% and a gain on sale around 8%, 8.5%, you could choose to keep some of these loans on balance sheet and not really lose a lot of income on that half of your production because you earn it back very quickly. So if the market conditions remain the same as we go into 2019 we could take a piece of our originations holding on balance sheet, help loan growth, at a great quality asset with the 7.5% yield and kind of the breakeven in a very short period of time given the yield versus the gain on sale.

[Operator:]

And our next question comes from the line of Christopher Marinac of FIG Partners. Your line is now open.

[Christopher Marinac:]

I had a question on the allowance and credit trends and Rob partially talked about it a few minutes ago but just kind of want to get deeper, which is if the economy were to slow or you would see some negativity on credit trends, what has to happen to really kick in the reserve from the credit piece? I understand the loan -- I mean the growth and the mix components as Rob described. I just want to get drilled down on the first piece which is what has to happen to really make a material shift in reserve policy?

[Rob Edwards:]

So we track lots of metrics that drive our view of expectations around credit quality. So risk rating migration or upticks in non-accruals or changes in substandard assets, I mean I -- quite honestly, I think our credit metrics are unusually low at the moment as an institution, I think probably somewhere in 2016 was more of what I would call a normalized expectation just from our institutions performance. So I could see some of our metrics, kind of climbing up a little bit and that would still be a very normal view. So I think maybe the answer to your question is it would have to be a pretty sizable sort of recognizable shift in performance versus just kind of a minor fluctuation.

[Jefferson Harralson:]

Chris I’ll layer this thing, we’ve our reserve percentage that you see, but we also have a pretty healthy mark on loans that we’ve bought over time and I think that if you add together the mark plus reserve on total loans it’s 1 …

[Rob Edwards:]

1.08.

[Jefferson Harralson:]

1.08.

[Rob Edwards:]

That’s I guess 74 and 34.

[Jefferson Harralson:]

There’s some additional cushion that you don't see there on the -- in the press release. And we do think that we have built this bank to withstand the next credit cycle in a very strong way. I’d also just add in there that you have complete new models for credit losses coming in at the end of next year as well in the form of CECL, so that’ll be running that parallel internally for 2019 and of course have the new accounting standards hit us at the end of the year.

[Christopher Marinac:]

That’s very helpful. But -- and again the trends that would have to deteriorate, have even begun to deteriorate? That was one of the points I wanted to just kind of reaffirm, I think when we see the Q, it will reaffirm that in a couple of weeks.

[Lynn Harton:]

Yes, they have not.

[Operator:]

And our next question comes from the line of Kevin Swanson of The Hovde Group. Your line is open.

[Kevin Swanson:]

So I just had maybe a follow-up question on credit costs -- excuse me, on just credit in general. I mean I guess just given some of the announcements from past few quarters and maybe especially one or two this quarter around the industry, what appears to be I guess one-off credit sort of right now? Just curious on more of a higher level, what are you thinking in terms of where we are in the credit cycle and anything specific that’s starting to cause concern? Thanks.

[Rob Edwards:]

So the short answer is, I am truly not seeing anything from our perspective that’s causing any concern, certainly not in our portfolio, and really not economically. I do think we sort of are watching something -- in fact, I met with our credit team yesterday and we talked about being sure that we’re paying close attention to increasing interest rates in our underwriting and approval processes and so we’re not seeing anything from that today, so there's no signs of it. But if you were to say if you look out in the future, I think everybody is saying and it’s appropriate to be contemplating increasing interest rates in your underwriting processes, but we continue to do -- we’ve not revised our like Lynn said it earlier, and it's true and probably worth restating because of the credit questions but our risk appetite has remained consistent. We continue to get strong equity in our deals. We started four years ago transitioning a land portfolio into a true vertical residential construction portfolio. We've accomplished that. We’ve very-very granular exposure across the portfolio. We got project limits of no more than $18 million on any single project. Our largest A&D project is $4 million. So we just have very granular and we’ve used the last four years to really position the portfolio and we stuck to our underwriting and I think it's been very effective. So I'm not concerned about our portfolio, we’re not seeing any trends, I just feel like we’re very well positioned for whatever may come. But we’re not seeing more sort of globally. We’re not seeing any signs of weakening in any specific portfolio.

[Lynn Harton:]

I would echo that, and just to pick up on what Rob said about rates. So if there's anything that could happen just because of the strength of the economy I think we're on the cusp of a historically tight labor market, may be beyond that, so wage pressures -- our customers are telling us about material price increases. So you could see rates increase may be faster or go further than the market might expect and look when rates go up asset prices go down. So I mean you could have a slowdown caused by rates moving a little faster than people think but we're very cognizant of that looking at that and all of our underwriting and feel really good about how we’re positioned.

[Operator:]

And our next question comes from the line of Tyler Stafford of Stephens. Your line is now open.

[Tyler Stafford:]

Hey, sorry. Just one more from me on expenses. Jefferson I think you said in your prepared remarks, there was some incentive expenses in the third quarter. I am just trying to figure out if there’s anything that should fall out of this expense run rate or if there’s a good kind of starting point going into fourth quarter?

[Jefferson Harralson:]

Thanks, Tyler. So think it is a good starting point from this quarter. I do expect the expense line to be relatively flat versus last quarter. If you kind of look through the expenses of this quarter, I do see some -- a lot of incentive in there, a lot of that -- some of that -- a good share of it is Navitas being ahead of expectations and their incentive plan kicking in. You have -- I see other incentives here, I see bonus, I see also we had lower deferred costs this quarter with slower volume. So I think if you add it all together, I think about the expense line being relatively flat in Q4.

[Operator:]

And I am showing no further questions at this time. I would now like to turn the call back to Lynn Harton for closing remarks.

[Lynn Harton:]

Great. Thank you all for your interest, great questions. And look forward to next quarter. Thank you.

[Operator:]

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.