United Community Banks, Inc.
Q4 2016 Earnings Call Transcript

Published: 25 Jan 2017

[Operator:]

Good morning. And welcome to United Community Banks Fourth 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 Rex Schuette; and 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 fourth 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 2015 Form 10-K as well as other information provided by the Company in its filings with the SEC and included on its website. And at this time I will turn the call over to Jimmy Tallent.

[Jimmy Tallent:]

Good morning. And thank you for joining our fourth quarter earnings call. 2016 was an outstanding year for United Community Banks and it ended with a solid fourth quarter performance. We head into 2017 with strong momentum. In November, we completed the systems conversion for Tidelands and have achieved all of the cost savings that we anticipated. A year ago we set an ambitious goal of achieving a 1.10 operating return on assets in the fourth quarter of 2016. I am proud to say that not have our bankers achieved that goal, but they've also delivered meaningful improvement in nearly every other measure of financial performance. I'll talk more in a moment about our fourth quarter and our outlook into 2017, but first let me cover some additional highlights. Fourth quarter net income was $27.2 million or $0.38 per diluted share. Included in those results were pretax merger-related charges of $1.14 million or $0.01 per share. Also included was a tax charge of $976,000 or $0.01 per share to write off a deferred tax asset on unexercised nonqualified stock options that were cancelled during the quarter. Excluding merger related charges and the tax charge, net operating income was $28.9 million, or $0.40 per diluted share. Our GAAP return on assets was 1.03 for the fourth quarter. On an operating basis, excluding that merger related and other charges, we met our goal of 1.10 ROA, up 2 basis points from the third quarter and 11 basis points from a year ago. Our operating return on tangible common equity was 12.5%, up slightly from a third quarter and up 1.6% from 10.9% a year ago. Our margin held steady with the third quarter at 3.34% that is also level with fourth quarter of 2015. We had strong loan growth in the fourth quarter of $196 million which is 12% annualized. Fourth quarter loan production was $747 million. After a negative provision for loan losses of $0.3 million in the third quarter we did not require a provision in the fourth quarter. Net loan charge-off for the quarter was $1.5 million, or nine basis points, that compares to $1.4 million for the third quarter and $1.3 million for the fourth quarter of 2015. Our allowance to loans ratio was 89 basis points compared with 94 basis points at the end of the third quarter. The revenue was down $1.1 million from the third quarter primarily due to lower customer derivatives and merchant service fees. Our mortgage and SBA businesses both had record quarter and all of our capital ratios remain very strong. Now I'll ask Lynn to share some details from the fourth quarter.

[Lynn Harton:]

Thank you, Jimmy. As you can see on page 13 of the investor presentation, pretax, pre-credit earnings were $46 million, up $1.5 million from the third quarter and up $7.3 million from a year ago. Please note that our year-over-year variances were also impacted by the Tidelands acquisition. On Page 16, our net interest margin was level with the third quarter. We were able to offset the effect of loan pricing competition with the more favorable funding mix, and we saw some benefit from rising short-term interest rates. The margin was also level from the same period a year ago. Turning to Slide 17. We ended 2016 with solid loan growth and production. Our loan production actually set a new record at $747 million. We were particularly pleased with our C&I production as that category alone with owner occupied real estate accounted for two thirds of our total commercial loan production in the quarter. Approximately $490 million was produced by our Community Banks led by Atlanta and South Carolina and $216 million came from our specialized lending areas. As a result of the strong production, our loan balances grew by $196 million during the fourth quarter, an annualized rate of 12%. I want to make you aware of some changes the way we classify loans for reporting purposes. In the fourth quarter, we re-class certain loan balances previously shown as retail loans to several commercial loan categories. We did this to better align our reporting with the business purpose of the loans rather than the collateral type. All periods presented on page 17 and 18 have been reclassified to conform to the fourth quarter classifications, as well as all other schedules in the deck in earnings release. The reclassification moved approximately $247 million in residential mortgages and home equity lines from the residential mortgage and HELOC categories to the owner occupied and income producing commercial real estate categories. So these loans were secured by 1 to 4 family residential properties, their purpose was commercial in nature. Reclassification included residential home rental property and business purpose loans secured by the borrower's primary residence. We also reclassified approximately $178 million in residential construction loans to the commercial construction category. These reclassified loans are to builders and developers of residential properties. Reclassifying these balances better align how we categorize loans with how we manage credit risks. In addition, historic charge-offs and recoveries have been reclassified. It is important to note that the reclassifications do not affect regulatory concentration limit and therefore have no impact on our regulatory reports. Turning to credit quality on slide 11. Our credit trends remain very favorable. Net charge-offs were 9 basis points for the fourth quarter and 11 basis points for the year. Nonperforming assets to total assets ended the year at 28 basis points. Due to the strong credit performance, we recorded no provision for credit losses in the fourth quarter. Fee revenue details are outlined on page 13 and 14. Our fee revenue businesses generated $25.2 million in the fourth quarter, down $1.13 million from the record setting total in the third quarter but still 19% greater than the same period a year ago. As mentioned earlier, the decline was primarily due to lower customer derivative activities and lower merchant services fees. Our customer derivative business generated $821,000 in fee revenue in the fourth quarter; this was down $625,000 from the record level in the third quarter but up $422,000 from a year ago. Our mortgage and SBA businesses both set records again in the fourth quarter. Mortgage fees were up $477,000 from the third quarter. Our pipeline remain strong, however we do expect a normal seasonal decline and some slowdown in refinance activity as we go into the first quarter. Turning to our SBA business, gains from sales of SBA loans totaled $3 million in the fourth quarter compared with $2.5 million in the third quarter and $2 million a year ago. We closed $57 million in SBA loan commitments in the fourth quarter, funded $55 million in balances and sold $41 million in guarantee loans. By comparison, in the third quarter, we closed $39 million in loan commitments, funded $37 million in balances and sold $32 million of guarantee loans. For the full year 2016, we funded $172 million in SBA loans compared to $130 million in 2015. That represented 225 loans closed in 2016 versus 130 loans in 2015. This was an outstanding year for our SBA group by all measures. We also continue to manage expenses effectively. Total expenses on page 13 including merger related charges were $61.3 million in the fourth quarter, down $2.7 million from the third quarter. Excluding merger charges, operating expenses were $60.2 million, down $691,000 from the third quarter. Most of the linked quarter decline in expenses was in salary cost and professional fees. The decrease in salaries and benefits were primarily due to lower equity compensation expense, lower group medical expense and lower FICA taxes. The $387,000 decrease in professional fees reflects year end accrual adjustments for legal and accounting services. We did have a $619,000 increase in the other expense category reflecting higher internet banking cost due to customer acceptance of our new owned line and mobile product and an increase in loan underwriting and miscellaneous lending cost due to our strong production levels. Our operating efficiency improved to 56.6% in the fourth quarter compared with 57.8% in the third quarter and 59.4% a year ago. On Page 38, we have included reconciliation of operating expenses to GAAP expenses. And with that I'd like to turn it back over to Jimmy for additional thoughts on 2016 and our outlook for 2017.

[Jimmy Tallent:]

Clearly 2016 was an outstanding year for United Community Banks. Our bankers excelled by every measure and drove exceptional performance which met or exceeded our goal. I could not be more pleased. During the year, we grew loans by $619 million or 10%, exceeding our target of half single digit. And that excludes the Tidelands acquisition. Funding nearly 80% of that loan growth this year was core transaction deposit growth of $489 million, or 9% again excluding Tidelands. By the end of the year, core deposits had risen to 93% of total customer deposits, a mix that we are very proud of. Operating earnings per share of $1.48 was up 17% from 2015. This was due to the strong loan and deposit growth, disciplined expense control and solid performances from our fee generating businesses. Our operating return on tangible common equity increased 162 basis points to 11.9% in 2016 from 10.2% in 2015. We ended the year with 12.5% reflecting a steady upper trend throughout the year. Our operating efficiency of 57.8%, an improvement of 73 basis points over 2015 also reflects solid performance and disciplined expense control. We ended the year with a fourth quarter operating efficiency of 56.6%, a new record for United. We expanded in new markets including those entered through the recent acquisitions of Tidelands, Palmetto and First National Bank. This expansion has moved us into additional dynamic market with attractive demographics. More than 80% of the United footprint is now within metropolitan statistical areas. I should point out that in 2016 we completed systems conversions for both Palmetto Bank and Tidelands. All three of our recent acquisitions have met or exceeded our strategic and financial performance objectives. We continue to expand our business and product offerings and delivered record performances by our mortgage and SBA lending businesses. And the performance measure I most proud of is achieving out goal of 1.10 operating return on assets in the fourth quarter. It follows a trend of steady, quarterly improvement all driven by our determined and truly outstanding bankers. Looking forward, we are excited about continuing to grow our business and improve our financial performance. Our expectation for 2017 is for loan growth in the upper single low double digit range. Our interest rate sensitivity position is neutral to slightly asset sensitive. Absent any additional rate increases, we expect slight margin improvement in the near term. This forecast reflects the recent rate increase and our expectation of minimal impact on deposit pricing as well as continued loan pricing pressures. We expect continued revenue growth in our SBA business, though we expect that mortgage growth will be tampered by rising long-term interest rates. We will continue to focus on controlling operating expenses with some year-over-year improvement expected in our operating efficiency ratio. 2017 is not without its challenges. We expect loan pricing competition to continue. In the second half of the year, our interchange fees will be reduced for the Durbin amendment becomes effective on July 1. Our deposit insurance assessment at that time will increase under the large bank assessment framework. And while we expect credit quality trends to remain favorable, we expect our provision for credit losses to increase with projected loan growth. We've been preparing for these challenges for a while now and our bankers are up to the task. We, therefore look forward to the year with optimism and an expectation that our return on assets for the full year will remain around the same level as 2016. I want to make one last comment before I'll open the call to your questions. A few weeks ago we announced that Rex will be retiring in 2017 following 16 years of dedicated service to United. I cannot overstake the value of Rex's service or how much he will be missed. We have retained an executive search firm to assist us in identifying and recruiting a successor and we expect the process to be completed in a few months. Rex has been a tremendous asset to United with his deep financial expertise and sound business judgment and has served us extremely well, in both challenging and prosperous times. Rex has graciously agreed to stay on as long as necessary to ensure an orderly and smooth transition. Now we'll be glad to answer your questions.

[Operator:]

[Operator Instructions] And our first question from Nick Grant with KBW. Your line is open.

[Nick Grant:]

Hey, good afternoon, guys. I'll start with M&A today. So your currency has gotten much stronger, especially post-election, but a lot of your potential targets are also up quite a bit. And then also we've had some recent deals in your targeted markets that have a potential to add competition for new deals. So how are you guys thinking about these dynamics? And has that changed the way you think about M&A in the near term?

[Jimmy Tallent:]

Thank you for the question, Nick. Let me just kind of give you our philosophy of the M&A world and really our business strategy. To begin with nothing has changed about our geographic vision or strategy within those four states or would be our primary focus the four states in which we operate in today. Criteria are the same, strategically, financially as well as low risk. I think any M&A that we would do probably would shape up kind of like this we are very interested in entering new markets of course for growth. We would also be interested in what I would call an overlap market whether it be good cost save as well as enhanced the growth profile. Size wise, still the same, our sweet spot $300 million or so up to probably the $2 billion. That's what we defined as sweet spot. Immediately accretive to earning per share and certainly any dilution to tangible book would be earned back within three years or so. So really our thinking our strategy has not changed and I don't suspect it will. Strong, strong focus everyday we come in, we are focused on growing the company organically but if and when an opportunity present itself that hits all of those dynamics then we would certainly be planning to move forward with it.

[Nick Grant:]

Okay, great. And then on to SBA. It's great to see you guys really ramping originations. At the same time, we've kind of consistently seen gains on say margins go down a bit. Do you think we are starting to get to a level where we are seeing these margins stabilize more? Or how are you thinking about that?

[Lynn Harton:]

Yes, Nick, so the margins -- the pricing in the market is really pretty stable now. We saw a slight decline but that was primarily coming from -- we had some fixed rate construction loans that finished out in the quarter, became available for sale and obviously rates had moved on those. That's not a product that we are offering today. They weren't long term fixed but they were fixed proportion. And that was really the primary impact on our margins, still very strong and at this point we don't see anything that we change that.

[Nick Grant:]

Okay. And then on the originations ramp, would you guys say that's more driven by, I don't know, some elevated confidence from small business in the economy? Or is that more driven by investments you are making in new lenders or potentially new verticals?

[Lynn Harton:]

Yes. It's really new lenders and new vertical so we are up year-over-year about 30% plus. We anticipate continue in that pace in 2017. We'll continue to add new producers and continue to look at new verticals. So it's primarily more on that side.

[Operator:]

And our next question comes from Michael Rose with Raymond James. Your line is open.

[Michael Rose:]

Hey, good morning, guys. How are you? Jimmy wanted to talk about the puts and takes of your loan growth outlook. Clearly you did a little bit better this quarter. Really strong loan production. Any businesses you are looking to expand, to accelerate, or keep that growth around these levels as we move into next year? And obviously you did a big SBA build-out. What areas or what product types are you looking to hire in to generate that type of growth? Thanks.

[Jimmy Tallent:]

Sure. Let me as Lynn to comment on that.

[Lynn Harton:]

Sure. Thanks Jimmy. And Michael so we do have really strong momentum right now particularly in the commercial book. If you look at commercial loan growth and outstandings annualized in the quarter was about 15%, our commitment growth actually was about 20%. Where that's coming from is some of the investments we've made. So senior living got a lot of unfunded commitments on the book so we continue to see growth out of asset based lending the same thing. Our middle market team has done very, very well. And it's the magic in it for us is really the cooperation and partnership between the Community Banks and specialized group. So we got these relationships on the community side and expertise on the specialty side. That's really driving that growth. So we feel very comfortable that it will continue. If you look back we said mid to single digit growth for 2016, we delivered 10%. We are saying now high single to low double, I feel very, very confident in that and hopefully we will do a little better may be.

[Michael Rose:]

That's helpful. And maybe one for Rex. Obviously a lot of talk around tax change and policy. How does that affect you guys? You guys have a pretty high tax rate and then you have the DTA, so how would that all work? What's the kind of sensitivity to a lower tax rate? What would be the earn-back on any charge you have to pay, things like that? Thanks.

[Rex Schuette:]

Right, Michael. There are two key areas that impact this. One is our DTA which includes timing differences also. And if you look at again our expectations are that any change would happen 1.1.2018, so if we had change effective 1.1.2018 and move to down 10% from 35% to 25%, we basically would have to write off about $20 million of DTA which would be equivalent to about $0.14 EPS. But at the same time we would get $0.12 accretion annually at the same time. So again we think we would earn it back fairly quickly but again that's pretty well prorated whether you look at 5% or 15% of those numbers, Michael should be fairly consistent.

[Michael Rose:]

Okay, so the earn-back would be a little over a year back to that, correct?

[Rex Schuette:]

Right.

[Michael Rose:]

All right. Then just one final one for me. You mentioned in the prepared comments that FDIC assessment costs would go up. Do you have a sense for what that delta will be? Thanks.

[Rex Schuette:]

Yes. We are going through that, earn expectations are with the risk weightings and the assessment rates that we move into which will be effective in the third quarter, Michael, would be probably in the $800,000 to $900,000 a quarter range, somewhere in that range that's what we would expect it to be additional assessment.

[Operator:]

And our next question comes from Jennifer Demba with SunTrust. Your line is open.

[Kevin Alloway:]

Hi, this is actually Kevin Alloway on for Jennifer this morning. Just a quick question. What is the out growth or the loan outlook look like in South Carolina with Sam Erwin having left? Is there anything different there?

[Lynn Harton:]

Yes, so we feel very good about what's going on in South Carolina, our Greenville team is doing very, very well. Our specialty group is largely based there. And so there is a lot of overlap and lot of share relationship is driving a lot of growth. And our Charleston team is doing extraordinarily well and we just added to our team in Myrtle Beach, that's doing very well. So we feel as you see in the production and in growth, the areas that you would expect to lead those were, and that was Atlanta and South Carolina and so we feel very good about it.

[Kevin Alloway:]

Perfect, thanks. [Technical Difficulty] Sorry? You mentioned that you've got some other employees there. You also lost [Technical Difficulty] could point out there?

[Lynn Harton:]

No. We have not.

[Operator:]

And our next question comes from Christopher Marinac with FIG Partners. Your line is open.

[Christopher Marinac:]

Thanks. Good morning, guys. I just want to drill back on the SBA business. How much opportunity do you see for additional kind of market share gains? I guess I'm just trying to think of the big picture of kind of where you are relative to not only the business plan, but more importantly, the opportunity that you guys saw several quarters ago when this began.

[Lynn Harton:]

Well, it's really just like any piece of the business. It is a people driven business. And so we continue to see solid recruiting activity. So it's really we believe very strongly in the growth that I mentioned earlier be very similar to what we experienced in 2016. If we the way to upsize that would be if we have the opportunity to bring even more teams on and we are talking to some and who knows if that happens or not but we've got group with a great reputation in the industry, the people want to come work for and so that's really would be the driver of any additional growth beyond of what we kind of got built- in at this point.

[Christopher Marinac:]

Okay, great. And then on the traditional bank side, Lynn, what do you see in terms of new hiring this year in terms of just organic teams, whether that be in existing markets or perhaps adding a de novo lending market this year?

[Lynn Harton:]

Yes. So we continue to recruit, we probably added in excess of 20 bankers on the commercial side this year. We don't have any markets at this point targeted for a loan production office; we are really focusing on, getting our latest one up to speed. I mentioned we just made some hires in Myrtle Beach for example. But we are always recruiting and we would anticipate be enable to do the same kind of additions in 2017 that we did in 2016.

[Christopher Marinac:]

Okay, great. Thanks for that. And Rex, just a quick one for you. The liquidity that you still have, does that give you a lot of pricing flexibility on deposits and therefore can that help you kind of lag on a deposit beta basis as rates change in the future?

[Rex Schuette:]

It does help us, again when you look at our overall sensitivity it and again it takes an all kinds of assumptions but all of our sensitivity analysis would have certain assumptions and core deposit rates going up and right now those betas would probably in 60% but again obviously we didn't have that with the last increase. So I think having the flexibility with our loan to deposit ratio at about 80% gives us some flexibility that we could delever and take pressure off, growing wholesale deposits going through 2017 with our outlook for very strong loan growth.

[Operator:]

[Operator Instructions] And our next question comes from Nancy Bush with NAB Research. Your line is open.

[Nancy Bush:]

Good morning. I want to go back -- can you hear me? We seem to have quite a bit of echo here. I want to go back to the first question on deals. And one of your large regional competitors made a comment this quarter on their earnings conference call that they believe that the industry had reached a tipping point with regard to the value of branches. And that they would not necessarily be looking at large branch deals, acknowledging the movement to digital, mobile, et cetera. Could you just give me your thoughts about that?

[Jimmy Tallent:]

Sure, Nancy. Certainly digital banking continues to grow and the customer preference as far as percentage of transactions at least in our company continued to trend in that direction. I think they are still, branches are still very, very important but here at United we are constantly viewing our branch structure. In fact, we will be consolidating five this quarter because it's just the right think to do. Lynn mentioned earlier about our investment into the new technology that we have made with the internet and mobile banking and so forth which we are very excited about. So you make those investments but you also have to understand how do you offset that cost and so I think as we go forward as an industry, the delivery channels probably will be tilted towards the mobile, that doesn't replace branches. I think they are still going to be very, very important, very critical in growing any business and from a customer usage standpoint but I think at least in our shop, certainly as far out as we can see it is a constant review and pruning and typically just good business.

[Nancy Bush:]

Okay. Yes, and secondly I would ask on the regulatory front. You mentioned that any change in taxes would probably not hit until 1.1.2018. But I'm hearing a lot about a change in the classification of Community Banks as far as asset size goes, rolling back Durbin, et cetera. Can you just tell us what your sources in Washington are saying to you and what you regard as likely changes in the regulatory outlook for Community Banks?

[Jimmy Tallent:]

Sure. Well, certainly there is a lot of talk, lot of optimism today relative to the potential changes in the regulatory world. Personally I think that has to be tampered, I do expect to see some changes, and I think those will take time. Certainly the Durbin and loss of the interchange revenue for those of us that are in that world, my personal view I would I guess sum it up in two words. One would be hope and two would be I doubt that there will be a great deal of change. But I think at the end of the day from the people that I talked with, with mid sized coalition group of banks as well as ABA and so forth, I think there will be very strong push for reform. I think over time we will see some changes but at this point I think we are going to look at it is business as usual and anything that comes in that is helpful is going to be additive.

[Nancy Bush:]

Okay. All right. Thank you.

[Rex Schuette:]

And Nancy if I could add one point, add back on one point when I talked about the tax rate changes to make sure I clarify the right numbers. So in dropping from 35% to 25%, that again will be reduction of our deferred tax assets of $20 million and that $20 million equates to $0.28 impact on tangible book value. And again the other side of it is from an EPS it is $0.24 of accretion an annualized basis. So whether you double that and go to sit down to 15% or you only have a 5% reduction it is pro rata basically on those numbers. Just want to clarify that.

[Operator:]

And I am showing no further questions. I'd now like to turn the call back to Jimmy Tallent for any further remarks.

[Jimmy Tallent:]

Thank you, operator. And thank all of you for being on the call this morning. I do want to conclude the call by recognizing our team of bankers over 2,000 folks that make up this great company, just a huge thank you for your continued efforts, the execution and making United Community Banks the best that it can be. Thank all of you and hope you have a great day.

[Operator:]

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