United Community Banks, Inc.
Q2 2017 Earnings Call Transcript

Published: 26 Jul 2017

[Operator:]

Good morning and welcome to United Community Banks Second Quarter Earnings Call. Hosting our call today our Chairman and Chief Executive Officer, Jimmy Tallent; President and Chief Operating Officer, Lynn Harton; Chief Financial Officer, Jefferson Harralson; Chief Credit Officer, Rob Edwards. United's presentation today includes references to operating earnings, pretax, 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 this morning 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 2016 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 will turn the call over to Jimmy Tallent.

[Jimmy Tallent:]

Good morning and thank you for joining our second quarter earnings call. We had a good solid second quarter with double digit growth in operating earnings per share and meaningful improvement in a number of other key financial performance measures. Overall, we’re very pleased with our results. I will start with some highlights. Net income was $28.3 million, or $0.39 per diluted share, included in those results were merger related and executive retirement charges totaling $1.1 million after tax or $0.02 per share. Excluding the merger-related and other charges, net operating income was $29.4 million, or $0.41 per diluted share, representing a strong 14% increase over the second quarter of 2016. Our return on assets on an operating basis was 1.10%, up 3 basis points from both a year ago and the first quarter. Our operating return on tangible common equity was 12.2%, up 63 basis points from last year. Our net interest margin grows 12 basis points from a year ago and was up 2 basis points from first quarter, slightly better than our expectations from last quarter. Our higher margin and disciplined expense management combined to lower our operating efficiency ratio excluding merger-related and other charges to 56.2%, our best in more than a decade. All of our capital ratios remained strong and at $13.74 our tangible book value increased $0.44 from first quarter. We recently announced a strategic partnership with Four Oaks Bank & Trust Company that will extend our footprint into the Raleigh area. We're very excited to partner with Four Oaks and we look forward to growing in that market. I'll have more to say about that in just a moment. Now, I will ask Lynn to share the details of the first quarter.

[Lynn Harton:]

Thanks Jimmy. As you can see on Page 8 of the investor presentation pre-tax, pre-credit earnings were $47.4 million, up $2.5 million from the first quarter and up $5.9 million from a year ago. Note that our year-over-year variances were also impacted by the Tidelands acquisition. Our net interest revenue increased during the quarter in part due to an increase in our margin. As outlined on Page 8 of the investor deck, our margin increased 2 basis points in the quarter, primarily due to the impact of rising short-term interest rates. Deposit pricing remains relatively flat with cost of deposits moving up just 3 basis points versus last quarter. We've not changed deposit pricing generally, but we have run some limited CD specials and we have selectively adjusted non-maturity deposit rates. To date those adjustments have been very limited and we aren't seeing significant pressure on deposit rates. Turning to Slide 10, our second quarter loan production was strong with an 8% increase from the first quarter. We funded $667 million in new loans in the second quarter compared with $615 million in the first quarter. Approximately $461 million of that was produced by our community banks, Atlanta and South Carolina led this production consistent with the past two quarters. The specialized lending areas now referred to as commercial banking solutions, as I will explain in a moment, produced $166 million loans. At quarter end, loans totaled $7.04 billion, an increase of $76 million over the first quarter or an annualized rate of 4%. Production increased nicely in the latter part of the quarter. And as we look forward, we expect findings from our Senior Care Group and our new renewable energy lending initiative led by Clayton Summers to continue to push our loan growth rate up from the second quarter level. That said we are also making a strategic decision to discontinue the purchase of indirect auto loans at the current premium levels. Absent new purchases, our indirect portfolio will run off by $45 million to $50 million each quarter. This will reduce our reported loan growth rate by about 2% to 3% but will not impact our earnings expectations. I should point out that this was not a credit decision, but a return decision. With average FICOs of 747, we are pleased with the credit quality of this portfolio and has performed well for us. As I mentioned earlier, this quarter we have renamed what we formally called our specialized lending unit. It will now be called simply commercial banking solutions. You will remember that the unit includes income property lending, asset-based lending, senior care, SBA, middle market, builder finance and now renewable energy. All of which we view as commercial areas that a regional bank should have. True to our strategy of delivering small bank service with large bank products and resources, our local commercial bankers will continue to drive business with our customers and bring Rich Bradshaw's team into those relationships that need larger bank services. There's no realignment occurring, Rich Bradshaw continues to lead the unit. This is just a name change that is more descriptive of the full services we provide. Turning to credit quality on Slide 14, our trends remain very favorable and stable, net charge-offs were 9 basis points for the second quarter, non-performing assets to total assets was 24 basis points, Our provision for losses was $800,000, which was the same as in the first quarter. And while our credit quality does remain stable and strong, we expect the provision to move higher with loan growth over the next few quarters. Fee revenue details are outlined on Page 8. Fee revenue totaled $23.7 million in the second quarter, up $1.6 million from the first quarter. Mortgage fees were up $387,000 from the first quarter. In the second quarter, we closed a record $204 million in loans compared with $182 million in the second quarter of 2016, 69% of the second quarter 2017 production was for home purchases. This is the first quarter we have exceeded $200 million in originations, which compares to our $274 million full-year origination level in 2014 when we began investing heavily in our mortgage business. Turning to our SBA business, gains from sales of SBA loans totaled $2.6 million in the second quarter compared with $2 million last quarter. We closed $32 million in SBA loan commitments in the second quarter, funded $35 million in balances and sold $30 million in guaranteed loans. We continue to manage expenses effectively. Total expenses were $63.2 million, up $403,000 from the first quarter. Excluding merger and other non-operating charges, operating expenses were $61.4 million, up $627,000 from the first quarter. These increases were mostly due to the cost of annual salary increases that went into effect April 1st. That linked quarter increase in the other expense category and the decrease in professional fees generally offset each other. As outlined on Slide 16, our operating efficiency ratio continues to improve. It was 56.2% in the second quarter compared with 57.8% a year ago and 57.3% in the first quarter. Income tax expense for the second quarter was $16.5 million reflecting an effective tax rate of 36.9%. As a reminder, we have included a reconciliation of operating expenses to GAAP expenses on Pages 36 and 37. And with that Jimmy, I'd like to turn the call back over to you.

[Jimmy Tallent:]

Thank you, Lynn. This was a very solid quarter for United with a number of significant achievements. I'd like to comment on two items in particular. First, this was our 12th consecutive quarter of double-digit earnings per share growth. That is a tremendous accomplishment for our bankers. Second, our 56.2% operating efficiency ratio was our best in more than a decade. This was in and of itself a great achievement, but when at the same time you earn the J.D. Power award for top customer satisfaction in the southeast for the 4th consecutive year. It is truly remarkable and again total credit to our great team of bankers. Also in the second quarter, we announced two acquisitions that will allow us to expand our presence in the fast growing Myrtle Beach MSA and entered the Raleigh MSA. In April, we announced a partnership with Horry County State Bank in the Myrtle Beach area with $375 million in assets and a presence in one of the strongest MSAs in the country. We expect to close at the end of July and complete systems integration in November. This is a win on two fronts. Horry County and greater Myrtle Beach is a mark in which we want to expand and Horry County State Bank is a solid cultural fit with United with the same customer service emphasis for which we were both known. Then on June the 27th, we announced the acquisition of Four Oaks Bank, EUR105 community bank with ten branches and two LPOs in the Raleigh North Carolina MSA and branches in Dunn and Wallace in Eastern North Carolina. Four Oaks has a very strong deposit base and low cost of funds, and over time has been locating mortgage branches in and around the Raleigh area to take advantage of growth opportunities. Like Horry County State Bank, Four Oaks has a strong service calls are very similar to United’s and we're very excited to partner with them. With this location in the Raleigh market over the past decade and with our history and business model, we believe we have a good opportunity to add additional bankers that will complement our expansion. While extending our footprint into the attractive Raleigh area, Four Oaks will serve as the springboard for a larger expansion strategy. We have long sought to be in this market and believed we have found the perfect partner there in Four Oaks Bank. We're in the process of obtaining regulatory approvals for the Four Oaks acquisition and our targeting closing the transaction in the fourth quarter was systems conversion likely to occur early in the second quarter of 2018. When fully converted, this transaction should yield an additional $0.03 to $0.04 of annual EPS accretion and adjust $0.10 dilutive to tangible book value. As a reminder, beginning in the third quarter, we will see our first impacts from the Durbin amendment. While lower interchange fees and large bank FDIC assessments will impact the quarter, we estimate this will cost about $0.25 per share per quarter moving forward. We're optimistic about the positive momentum that continues to build our underlying performance. Though we don't typically give guidance, we expect continued improvement in our business and believe most analyst estimates have properly accounted for the Durbin impact. We believe our third quarter loan growth will be in the mid single digit range including the 2% to 3% impact of shrinking the indirect portfolio that Lynn mentioned earlier. In short, we are comfortable with the consensus estimates for the third quarter. Now, we'll be glad to answer any questions.

[Operator:]

Thank you, ladies and gentlemen. [Operator Instructions] And our first question is coming from the line of Jennifer Demba with SunTrust Robinson. Your line is open.

[Jennifer Demba:]

Thank you. Good morning.

[Jimmy Tallent:]

Hi, Jennifer.

[Lynn Harton:]

Hi.

[Jennifer Demba:]

Hi. The renewable energy lender you've hired, what kind of potential do you see for a portfolio in that segment?

[Lynn Harton:]

Hi, Jennifer. This is Lynn. We're really focusing on solar farms there, typically backed by take or pay contracts, typical project size, $7 million to $15 million. We’ve had some experience with that with a couple of existing customers and also one of our existing middle market bankers and whose kind of how we got interested in it. It’s not going to be a game changer, but we think over the next eighteen months $150 million somewhere in that range would be a reasonable target for us to be able to book.

[Jennifer Demba:]

Okay. And any other new lending lines you're looking at right now or evaluating Lynn?

[Lynn Harton:]

Not right at the moment. We're really focusing in on Raleigh, very excited about recruiting there and getting some great interest. And so that's kind of I guess in a way our newest lending area as the present.

[Jennifer Demba:]

Okay. And do you need any additional branches in Raleigh to be where you want to be in terms of a footprint standpoint there?

[Lynn Harton:]

We certainly will over time. The Four Oaks team, which I've been very impressed with by the way, already has loan production office there. So our focus would be to continue to build that out, add to the mortgage area, which we think is a huge opportunity in Raleigh. And then selectively look at perhaps one to two branches over time once that revenue is in place.

[Jennifer Demba:]

Great, thank you so much.

[Operator:]

Thank you. Our next question is from the line of Catherine Mealor of KBW. Your line is open.

[Catherine Mealor:]

Thanks. Good morning.

[Jimmy Tallent:]

Good morning, Catherine.

[Catherine Mealor:]

Lynn, you mentioned in your comments that you expect about a 2% to 3% reduction in the growth rate from the run up of the indirect auto portfolio, but you don't expect an impact to the bottom line. Can you walk us through some of the offsets that you expect?

[Jefferson Harralson:]

This is Jeff. So, I think, Catherine, I can talk about that.

[Catherine Mealor:]

Great. Hey, Jefferson.

[Jefferson Harralson:]

When we start talking about the indirect auto piece of it, when I came in here we started looking at the various relative of attractiveness of various investments including that one and in a rising rate environment we're also looking at the lowest yielding assets. And as we start thinking about it, it just made business sense to let it run-off. It’s really not hard to replace the earnings with just the typical securities that we are buying now. So from a yield perspective relatively easy to replace, we can also replace it in a capital efficient manner. Optically, it’s going to make our loan growth a little bit lower, but financially it makes all the sense in the world to replace that earning asset with a similar one and with less capital treatment on it.

[Catherine Mealor:]

Got it. So basically the offset is going to be in the securities book versus the loan book near-term.

[Jefferson Harralson:]

That's correct. That's correct.

[Catherine Mealor:]

All right, I like them. And then do you also have the amount of the accelerated discount this quarter.

[Jefferson Harralson:]

Yes, $1.4 million.

[Catherine Mealor:]

Okay, great. And then one last one on the Four Oaks deal. Can you talk a little bit about some of your assumptions in your EPS accretion there, effective cost savings and expected growth rate of that portfolio and how much of that growth rate should come from additional hires over time?

[Jefferson Harralson:]

Yeah, I could take that one too. So recall we have $0.04 of EPS accretion in our model. We're adding a mortgage originator there and we have about 5% of balance sheet growth there, so think about that as the revenue growth. 35% cost savings, of that 30% is salary and benefits, 40% is lower OREO costs and other professional fees and 38 – or a lot of small as I will just put in the other category. We actually have two models for Four Oaks that get us to $0.04 for this year. One is our base case of with the assumption I’ve laid out. The second one is a higher growth model in which we lift out teams, which we’re optimistic that we can possibly do, but with the extra expenses and the extra growth you still get to the $0.04 in 2018 either way, but if we’re able to achieve a lift out and bring some people in then it starts looking different in the out years, so 2020 looks a lot more accretive if we’re able to do some of the hiring we think we might be able to do.

[Catherine Mealor:]

Right, great, super helpful. Thank you.

[Operator:]

Thank you. And our next question comes from the line of Michael Rose of Raymond James. And your line is open.

[Michael Rose:]

Hey, guys. Good morning. How are you?

[Jimmy Tallent:]

Hey, Michael. Good morning.

[Michael Rose:]

Hey, just wanted to follow-up on the loan growth question. So it seems like you'll have headwind from the indirect auto runoff, which makes sense. But then you hired the energy lender. Can you talk about $150 million book over the next eighteen months or so? I would expect obviously some of the other markets that continue to grow. So when do you think we get back to kind of that previous guidance range of mid to high single digits, understanding that obviously the near-term is going to be impacted by that run-off?

[Lynn Harton:]

Michael, this is Lynn. It’s a little hard to say and if you look at the production slide on Page 10 part of the difference is in our investor real estate book and we've consciously as we talked about kind of step back from that we're not seeing any deterioration there, we're not underwriting still strong, but it just felt right from a kind of prudence perspective to back off of that and let some of the current construction in the whole market get absorbed. It's a market we can get back into very easily. So we're looking at our senior care. We've added also a new middle market lender, you mentioned the solar farms, a renewable energy piece, to kind of pick up the growth, but the other muted piece is the much slower growth rate investor real estate for now.

[Michael Rose:]

Okay, so maybe a mid single-digit rate is kind of more and more appropriate as we think about 2018, Lynn.

[Lynn Harton:]

Yeah, other than in 2018, we will also Raleigh come in on and again we're very comfortable with that market, both Rob and I know that market. Well, we've got long relationships there. We’re, as Jefferson mentioned, very optimistic about our ability to pull teams in there. So you'll have that piece coming in 2018. We feel strongly about.

[Michael Rose:]

Okay. And then just as a separate follow up, you guys mentioned that you’re comfortable with the consensus estimate for the third quarter I think that’s $0.40. Looks like the way you would get there obviously is some additional reserve release which probably continues in the back half of the year – or in the fourth quarter obviously credit is good and the outlook is good there as you mentioned. So is that the right way to kind of think about how you bridge that gap.

[Lynn Harton:]

Yeah, I would think about is slightly different from that because we do have a higher provision to our model going forward. We do think we'll have we have some positive seasonality helping us out in the back half of the year with SBA generally increasing in the back half. We've had some good operating leverage in the first half of the year. We think the core piece of that will continue to improve in the second half of the year. We also get some cost savings from Horry that that helps out. So the provision piece is going to increase, but we still think we can generate some operating leverage to help offset much of that Durbin impact.

[Michael Rose:]

Got it. Okay, that that clears it up. Thanks guys. I appreciate it.

[Operator:]

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

[Christopher Marinac:]

Thanks. Good morning, guys. I just want to follow up on the excess liquidity that you have. If we look out a year and just don't factor any M&A into it. Do you think that you will have made a material sort of dense in the excess liquidity? I’m just curious kind of where you think that will look out a few quarters from now.

[Lynn Harton:]

Probably, Chris, are you thinking about the loan to deposit ratios kind of what you're thinking about there?

[Christopher Marinac:]

Correct and just does how securities come down and impact the margin et cetera.

[Lynn Harton:]

Yep. So, let’s talk about that a little bit. So we have an 81% loan to deposit ratio now did move up a little bit this quarter. It is a very flexible loan to deposit ratio with rates moving higher. We get a little more flexibility also I think with the indirect portfolio shrinking a little bit. We do think that margin can increase a little bit. One reason is what you're talking about is the mix change from securities to loans as we slowly increase that loan to deposit ratio here. We may have a little bit of margin expansion still to come from the last rate hike. We also did call some senior debt that is going to help a little bit in the third quarter and some in the fourth. Our deposit base have been relatively low as well. We do think that deposit costs are going to increase a little bit. So all things equal, we think we have a balance sheet that’s pretty conservatively – conservative is very liquid as you note and we think that we can translate that into the higher earnings over time.

[Christopher Marinac:]

Great, that's helpful. Thanks for all that background. I guess my follow up separately has to do with M&A. And as you build out Raleigh and perhaps if you’re successful to get a team or two, does that make the next acquisition you do more accretive incrementally? Is that part of the thought process as you kind of take a careful approach on this Four Oaks?

[Jimmy Tallent:]

Well, certainly, it would be advantageous, Chris. The opportunity we see particularly with the relationships that Lynn and Rob and others have in that market could be we believe significant over time that's not to lessen the importance, value and contribution of the Four Oaks Bank. They have tremendous deposit base, core deposits, fabulous customer loyalty, a number of their customers only because of their size that they aren’t able to bank at the level that their customers need. So when you add all that together, we see that expansion that partnership, the quality of the bank, the springboard opportunity to be really significant for United in the short, medium and long-term.

[Christopher Marinac:]

Great, Jimmy. Thank you for that. I appreciate it guys.

[Jimmy Tallent:]

Sure.

[Operator:]

Thank you. And our next question is from the line of Tyler Stafford of Stephens. Your line is open.

[Tyler Stafford:]

Hey, good morning everyone.

[Jimmy Tallent:]

Hi, Tyler.

[Tyler Stafford:]

Hi. I just wanted follow up on the allowance question earlier in the comment and the press release about the allowance ratio to total loans slightly declining from here. Is that inclusive of the fair value marks from Horry County and Four Oaks acquisition?

[Rob Edwards:]

So, Tyler, this is Rob. I think the short answer is yes. So the way that we're thinking about the allowance today I know the published number is 84 bps. When we add in the existing marks, we've got 25 million, it comes out to 1.20 coverage on loans. And then, of course, both the Horry County and the – so on the Horry County we’ve got a little bit over a 6% credit mark and then on the Four Oaks one we've got just under a 4% mark. And so those come into the portfolio and that will drive down the allowance ratio that gets published because right out of the gate those loans are covered by the purchase mark.

[Tyler Stafford:]

Yeah, but you are referring to GAAP reserves not GAAP with the discount.

[Rob Edwards:]

Right.

[Tyler Stafford:]

Okay. Oh, do you happen to have what the accelerated accretion was on the securities yield that the slide deck referenced?

[Rob Edwards:]

Yes, added up 2 basis points for this quarter.

[Tyler Stafford:]

Okay and still expect margin to expand next quarter absent that benefit this quarter.

[Rob Edwards:]

That's correct. We may get one more quarter of impact from ABS prepayments, absent that we do believe we get slight expansion to.

[Tyler Stafford:]

Okay. And then just lastly for me is on SBA and you referenced stronger back half of the year out of the SBA business. And it looks like the last couple quarters you’re seeing better pricing out of the SBA sales. I guess one is that accurate and then any inside into – to what’s driving that better pricing and expectations for gain on sale out of the SBA business going forward?

[Rob Edwards:]

Yeah, so they've really been fairly stable. It's just the mix. So depending on whether they're longer-term loans or shorter-term loans is kind of what drives the actual recorded margin. So we see and being stable in the third quarter, they could – margins could come down very slightly in the fourth quarter due to some pooling changes and how SBA securities are sold, but fourth quarter is also our seasonably highest quarter. So we don't anticipate a significant impact from that.

[Tyler Stafford:]

Okay, very helpful. Thank you guys. Operator Thank you. And at this time, I am showing no further questions. I would like to turn the call back over Mr. Jimmy Tallent.

[Jimmy Tallent:]

Thank you operator and certainly I want to thank everyone on the call today. Any follow up question, don't hesitate to reach out to any of us. I do want to recognize and compliment once again our senior management team, our full team throughout our footprint for the superb job that they do day in and day out. Thanks so much for being on the call. I look forward to talking with you soon.

[Operator:]

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. You may now disconnect. Everybody have a great day.