United Community Banks, Inc.
Q4 2012 Earnings Call Transcript

Published: 24 Jan 2013

[Operator:]

Good morning, and welcome to United Community Banks' Fourth Quarter Conference Call. Hosting our call today are President and Chief Executive Officer, Jimmy Tallent; Chief Operating Officer, Lynn Harton; Chief Financial Officer, Rex Schuette; and Chief Risk Officer, David Shearrow. United's presentation today includes references to core pretax, pre-credit earnings and other non-GAAP financial information. For each of these non-GAAP financial measures, United has provided reconciliation to GAAP in the Financial Highlights section of the news release and at the end of the investor presentation. Both are included on the website at ucbi.com. Copies of today's earnings release and investor presentation for the fourth quarter were filed this morning on Form 8-K with the SEC, and a replay of this call will be available on the company's Investor Relations page at ucbi.com. Please be aware that during this call, forward-looking statements may be made by United Community Banks. Any forward-looking statements should be considered in light of risks and uncertainties described on Page 4 of the company's Form 10-K, and other information provided by the company in its filings with the SEC and included on its website. And at this time, we will begin our conference call with Jimmy Tallent.

[Jimmy C. Tallent:]

Good morning, everyone, and thank you for joining us for our fourth quarter earnings call. Overall, I'm pleased with the results of our fourth quarter. We have had our fifth consecutive profitable quarter and the sixth profitable quarter of the last 7. We continue to make significant progress on a number of strategic fronts that I will share in just a moment. But first, let me cover some of the highlights from the quarter. Our core pretax, pre-credit earnings were $29.1 million, down $761,000 from the third quarter of 2012 and up $2.4 million from the fourth quarter of 2011. Net income was $9.3 million or $0.11 per share. Severance charges, which are excluded from our core earnings, decreased net income by about $600,000 or $0.01 per share. Our core operating expenses were up about $1 million from the third quarter, mostly in legal expense and higher commissions and incentives related to loan and revenue growth. For the second consecutive quarter, loans were up both linked-quarter and year-to-date. Our provision for loan losses was $14 million, down $1.5 million from the third quarter and level with the year ago. Net charge-offs were down $6.1 million from the third quarter to $14.5 million. That is the lowest level since the second quarter of 2008. Our allowance for loan losses remains strong at 2.57% of loans. Non-performing assets at quarter-end were $128 million, down $13.8 million or 10% from the third quarter, and represented 1.88% of total assets. Core transaction deposits grew by $75 million for the quarter and by $311 million for the full year. The annualized growth rate was 10% for the quarter and 11% for the full year. Our net interest margin was 3.44%, down 16 basis points from the third quarter and 7 basis points from a year ago. I mentioned in last quarter's call that we expected our margin to fall to the mid-3.40% range. This expectation was due mostly to the overlap of our sub debt refinancing and the scheduled repricing of approximately $90 million in corporate bond holdings from a fixed to floating rate. And all of our capital ratios remained solid at quarter-end. Those were the highlights. Now, I want to get more into the drivers of the fourth quarter results and also talk about strategic initiatives to improve performance and grow earnings. Interest rates remain at record low levels, creating pricing headwinds and natural margin compression. As long as this is the case, loan growth will be the key to growing net interest revenue. Our focus on growing owner-occupied commercial real estate and small business loans continues to produce favorable results. Much of this growth is due to our ongoing investment in new lenders in key markets. We also continue to broaden our retail product offerings and have been successful growing consumer and residential mortgage loans. We have been running a very popular home equity line of credit promotion that is helping us to achieve a more favorable balance in our overall business mix. This new HELOC product has brought many new relationships to United with very strong credit metrics. The average FICO score on this new product is 759, and the average LTVs are in the mid-50s, 60% of these are first mortgages. Last quarter, I mentioned that we hired a lender in Greenville, South Carolina. In the fourth quarter, we opened a loan production office in Greenville, and we'll see loan production beginning in the first quarter. We'll also be adding more lenders there throughout the year. This is exciting news to us because we've long sought to expand our footprint in South Carolina, and under Lynn's leadership, we have an outstanding opportunity. While this loan growth is positive, pricing pressure will continue to put further stress on our margin, as I noted earlier, but not to the extent that we saw in the fourth quarter. Also, as I noted earlier, 5 basis points of the 16 basis points linked-quarter margin decline was due to the overlap in the replacement of our maturing sub debt. Another 5 basis points was due to the scheduled repricing of certain corporate bonds from a fixed rate to a floating rate. These floating-rate securities were part of a planned strategy to maintain a neutral to slightly asset sensitive interest rate position. The success of our home equity line of credit campaign has also contributed to the margin decline. Now that might sound counterintuitive, but the product has an introductory rate of 1% for the first year and will begin to reset to prime plus beginning in mid-2013. At year-end, we had $100 million in loans under the new lines of credit that were accruing at the introductory rate. We have intentionally avoided going out on the curve to chase yield in our securities portfolio. We have also given up some yield by putting 38% of the portfolio in floating-rate instruments to maintain a more neutral to slightly asset sensitive balance sheet. We believe our balance sheet is properly positioned in this interest rate environment. Now turning to credit quality. I'm pleased with the continued improvement in our credit metrics. In fact, all of the key measures had meaningful improvement during the quarter. Our non-performing assets of $128 million were down 10%, which included a 4% decrease in non-accrual loans and a 32% decrease in OREO due to strong sales activity. The inflow of new non-performing loans fell to $20 million, the lowest level since the credit cycle began. Loans past due 30 to 90 days were 65 basis points. Accruing TDRs were down 11% from last quarter to $123 million. This was the second consecutive quarter that we have shown a decrease. Fourth quarter net charge-offs were $14.5 million, the lowest level since the second quarter of 2008. And performing classified loans were down $21 million in the fourth quarter. As you will recall, in the third quarter, we began to gain significant traction with a $41 million decrease in performing classified loans. That improvement continued into the fourth quarter with another $21 million decrease, leading to the lowest level of net charge-offs and new non-performing loans since the credit cycle began. We began 2012 with a 67% classified asset ratio. At year-end, that ratio stood at 50%. Clearly, we have made significant progress in improving credit quality in the past year. The trend is moving in the right direction and at a healthy pace. And the lower levels of performing classified and non-performing loans will translate into lower charge-offs and provision levels for 2013. And now, the core fee revenue. You will find the trends on Page 28 of our investor presentation. We had solid core fee revenue growth in the fourth quarter compared to both the third quarter and a year ago. Mortgage fees were the main contributor. We closed $100 million in loans in the fourth quarter compared with $79 million a year ago. Refinancing activities helped boost fee revenue. Deposit service charges are up from last year and last quarter, mostly due to higher interchange fees and transaction volume. Also, the increase in deposit service charges from a year ago reflects new service fees rolled out at the beginning of 2012. Our core operating expenses are presented on Page 29 of our investor presentation. They increased slightly in the fourth quarter, but declined $2.3 million from a year ago. As I noted earlier, the slight increase from the third quarter was due primarily to legal fees and commissions and incentives. Our personnel costs continue to decline. For the full year of 2012, core personnel costs were down $8.1 million from 2011 as shown on Page 35 of the investor presentation. We continue to look for ways to operate more efficiently and consolidate or eliminate staff positions. As a result, staff headcount was down by 7 from the third quarter and down 164 from a year ago. We've been focused on operating efficiencies for several years now and are down 430 positions from the beginning of the credit cycle. At the beginning of 2012, we committed to improve our core pretax, pre-credit earnings run rate by $10 million annually by the fourth quarter, primarily in expense savings and fee revenue growth. We set as our base the fourth quarter of 2011. As a result of our efforts, our annual run rate in core operating expenses was reduced by $9.4 million, and our annual core fee revenue run rate increased by $12.4 million. Unfortunately, margin compression offset half of these positive results. Our bankers did a phenomenal job growing their businesses and finding every opportunity to reduce cost. Their efforts have put us on a solid path going forward. Overall, I applaud their efforts and I commend them on a job well done for 2012. And now, we look forward to the opportunities that lie ahead in 2013. We know that challenges remain as well. The sluggish economy is expected to continue and rates are expected to remain at record lows. This environment will continue to put pressure on our margin and make loan growth challenging. In fact, we see margin compression continuing in the range of 2 to 4 basis points per quarter. We also know we must continue to become more efficient and do so in a way that preserves our unique culture of superior service. Those are our challenges. We expect the trend of improving credit metrics to continue, and this will translate into lower levels of charge-offs and provisioning. We see opportunities to grow our mortgage and advisory service businesses, and we will look to expand both. We also believe we can grow our loan portfolio in the mid-single-digit range. We will accomplish this by continuing to add lenders in key markets. We're setting a new goal for ourselves, very similar to the one we set in 2012. We will seek to increase our annual run rate for core pretax, pre-credit earnings by $10 million, using the fourth quarter of 2012 as our benchmark. We will accomplish this goal by continuing our focus on revenue growth, loan and core deposit growth, and operating efficiency. A number of projects are underway to reduce costs and increase efficiency, and they will be completed as we move through 2013. Our bankers are up to the challenge, and I am confident they will continue to produce outstanding results. Our determination to improve operations and deliver superior financial results has led us to look at every aspect of our business, to find ways to deliver the highest level of service in the most cost-efficient way. Our fourth quarter results and ongoing credit quality improvement continue to build the case for a reversal of our deferred tax asset valuation allowance. As I mentioned last quarter, our expectation is that this could occur mid to late 2013. At the end of the quarter, the deferred tax asset valuation allowance was $271 million. That represents about $4.69 per share. The reversal of the valuation allowance would also increase our year-end tangible common ratio from 5.7% to 9.3%. Those are my prepared remarks. And now, Lynn, Rex, David and I, will be pleased to answer any questions.

[Operator:]

[Operator Instructions] Our first question comes from the line of Jefferson Harralson with KBW.

[Jefferson Harralson:]

I was just going to ask about the composition of that 8% pretax, pre-provision guidance you guys have given us, it's very nice. Are you expecting to be kind of flatfish revenue and make up the most -- and make up the rest in expenses or can revenue be positive?

[Jimmy C. Tallent:]

Yes, it will be a combination -- similar to what we saw in 2012. Certainly, the efficiency projects will create opportunities to reduce some expense. Certainly, this year, some of that expense reduction will be reinvested into other revenue opportunities. Also, too, on the fee side, we believe there's opportunity there to grow that as well, and certainly, achieving a positive loan growth in our portfolio will help that number a great deal. So it's a combination similar to 2012, a little bit of that, of the savings to be redirected to revenue generating opportunities.

[Jefferson Harralson:]

My follow-up is on the Greenville LPO. How many lenders did you -- are you putting in there, and with the investment you've made so far, where do you think loan balances can be in the next, I don't know, 3 to 5 years?

[Jimmy C. Tallent:]

Jefferson, we're very excited about the expansion there in Greenville. And I think it would just be appropriate to ask Lynn to respond to that.

[Lynn H. Harton:]

Sure. Thanks, Jefferson. Right now, we've got 2 lenders in Greenville. We're off to a good start. We want to, of course, get the right people and go at it slow. I wouldn't want to project 3 to 5 years out, but we think we'll do really well this year and you'll be pleased with what you'll see at the end of '13.

[Operator:]

Our next question comes from the line of Kevin Fitzsimmons with Sandler O'Neill.

[Kevin Fitzsimmons:]

I was wondering a couple of things. First, on the heels of your comments on the DTA allowance reversal, Jim, if you could comment on what that means for TARP repayment and how you see you all going about what you're going to use as sources for that TARP repayment. So I would assume there is some cash at the parent level that you'd be able to part with and I'd assume at a certain point, you would be requesting approval to dividend up from the bank, and would there be any incremental source you would need to go after beyond those levels? And then secondly, if you guys could just comment on the pace of reserve releasing, it seems like the allowance to loan ratio is still pretty healthy. There wasn't a whole lot of reserve released this quarter. Is that something we should bake in over the next several quarters?

[Jimmy C. Tallent:]

Kevin, on the repayment of the TARP, I think, maybe Rex will be the appropriate one to respond, and then David can respond back to the reserve release.

[Rex S. Schuette:]

There's probably a couple of items on the TARP when you look at it and take it into consideration. Obviously, it's Tier 1. The rate does go up to 9% at year end, so we're focused. I'm looking at to reduce our not only our equity costs, but our debt costs at the same time. I think the point, in reference to Jimmy on the DTA recovery, is a key element of that, that adds to our regulatory capital in the forward 4 quarters when it comes in. I think additionally, any flexibility with the remarketing of TARP in the first half of the year will give us more flexibility, looking at that in the second half and going forward. As we look at it, the cash at the parent company is about $54 million. We have 2.5 years of debt service coverage. The debt service -- net debt service coverage this year is about $16 million. So we have cash -- ample cash at the parent company, which is really a key component of this also of what we're looking to do to pay down TARP or trust preferred. And so we have opportunities to look at a retail note program. All the banks have done that to add a little more liquidity at the parent company. With us continuing that improvement in earnings, I think that will help also to put us in a better position in the second half of the year to look at our remarketing opportunities or refinancing opportunities to drive down lower costs at the parent company for our debt and equity. And again, I think we're going to continue to look at that. And again, I would see us doing this more, as we talked before, Kevin, on an installment basis, looking at the cash and excess cash we have at the parent. We have $24 million of dividend capacity this year based on last year's earnings, if TARP does come back in, that will add to earnings for '14 to give more flexibility in '14 for payment back up through the bank to the parent company. So we have all these items focused, looking at it in our capital planning model, Kevin. So there are a lot of alternatives. We do look at reducing the costs. We don't look to dilute shareholders further and would weigh that it in, again, in the context, especially if the TARP is remarketed.

[David P. Shearrow:]

On your reserve question, Kevin, this is David. As you know, as you correctly stated, we've been fairly conservative on under-providing at this point in the cycle. Although, as Jimmy stated in his opening comments, our credit metrics really are showing some significant improvement, and we're encouraged by that. So I would expect the level of reserve release will probably be at this level or greater as we go through the coming year. And if I was guiding you, I would probably tell you, we'd see some gradual step down, but maybe getting to the 80 to 100 basis point range by the end of the year, by the end of '13. Any given quarter on the charge-off side, there could be a little bit of volatility, just because of the way things time there, but I think from our reserve perspective, you'll see that tick down nicely. And I think longer-term, targeting a level of reserve, maybe in the 2% range. So hopefully, that's helpful.

[Kevin Fitzsimmons:]

So getting down to a 2% range over 1 year or 2 years, you're thinking?

[David P. Shearrow:]

Yes, 1 to 2 years, hitting the 2%. But I think if you're looking at quarterly provision, probably targeting down to an 80 to 100 basis-point-range by the end of '13.

[Operator:]

Our next question comes from the line of Christopher Marinac with FIG Partners.

[Christopher W. Marinac:]

David, Jimmy, Rex and Larry, I guess I just want to continue on Kevin's line of questioning, which is, just back to charge-offs then. If you provide 80 to 100, would that direct that charge-offs could approach that level not necessarily the next 2 quarters, but just as we get into kind of later in '13 and early '14?

[David P. Shearrow:]

Are you saying would charge-offs approach the level of provisions, is that -- what's your comment?

[Christopher W. Marinac:]

Correct.

[David P. Shearrow:]

Yes, and I think, yes, and I think in a given quarter, I mean, I think we will be under-providing, so I think the level of charge-offs would exceed that provision guidance that I was giving just as we -- the tail of this continues goes through. But given what's going on with the loss rates, given what's going on in the overall level of classified, et cetera, certainly, it would argue for a reserve release over the course of this year.

[Christopher W. Marinac:]

Okay. But I realize we're a long ways away from a normal, but normal still, at least in the context of '13, is still above 100 basis points of loss, that's what I want to verify.

[David P. Shearrow:]

Yes, I think that's right. I think that's a reasonable estimate.

[Christopher W. Marinac:]

Okay. And then Jimmy, can you talk about sort of your new production in your markets. Not just from yourself but from other banks. What are you seeing competitively and how is that varying from Tennessee and other parts of the footprint?

[Jimmy C. Tallent:]

Chris, we're seeing opportunities in production really across the footprint. If we go back and look all the way through 2012, though we did have positive loan growth this year, which we're very pleased about, but sometimes it gets a little bit overshadowed by just the final number such as -- I think maybe, the HELOC kind of stands out. But backing up through over -- throughout 2012, we saw a nice addition in our commercial, owner-occupied real estate lending. I think it was $150 million underneath that. We saw a nice improvement on the investor property. We saw a nice improvement in our residential mortgage. And really, it's across the footprint. Typically, we're seeing Atlanta, North Georgia from a quarter-to-quarter base, kind of be somewhat tied, in as far as most production for that quarter. We saw a really a nice increase in outstandings out of our Savannah base. So it's really reasonably broad across the footprint, not any one specific area that is just trumping everything else. So it's fairly uniform.

[Christopher W. Marinac:]

Okay. And then Rex, just one quick question for you. Whenever the DTA allowance comes back in, do you have a gauge at this point of how much would be disallowed or would that number be shrinking as time passes?

[Rex S. Schuette:]

It would be shrinking. Obviously, the earnings every quarter and tax benefit bring down the DTA. From our $271 million, there will probably be maybe $10 million or $15 million that may be reserved for state taxes, that we'd still keep on the balance sheet, so that net amount would be the amount reversing back. And then for regulatory capital, in your models you're going to look at the same way that the forward 4 quarters, when we bring it back, basically, that tax benefit would benefit Tier 1 capital as you look at the ratio on a pro forma basis.

[Operator:]

Our next question comes from the line of Matt Olney with Stephens.

[Matt Olney:]

Good to see the improvement on the performing classified loans. It sounds like you guys have good momentum to bring this down. So as you look into 2013, should we expect continued momentum in bringing down this performing classified loans or is there anything that kind of gives you pause to think that, that momentum could slow the next few quarters?

[Jimmy C. Tallent:]

David, you want to...

[David P. Shearrow:]

Sure, yes. Matt, I think -- let me tell you that the credit improvement has been pretty significant these last 2 quarters, and frankly, better than what I had -- would have -- I had anticipated prior to that time. So as we look at it, looking at whether or not we have the exact same pace this third -- and looking out first, second quarter as what we experienced instead of fourth, I would probably, more on, from a more conservative standpoint, think that it may not be quite as rapid as that, but again, I've been surprised the last 2. So I guess I'm hopeful it will continue the same pace, but conservatively, I'll probably tell you, it might be at a little bit less rapid pace over the next couple of quarters, but continuing to improve, that's certainly, yes.

[Matt Olney:]

Sure. Sure. Okay, and then secondly, it sounds like the potential for bulk loan sales has not been your strategy. Is that still the case and should we expect a similar pace of dispositions in '13 compared to the last few quarters?

[David P. Shearrow:]

Yes that's -- that's something we always look at and continue to evaluate. I think, again, if we're getting the kinds of traction that we had in the third and fourth quarter, the probability is probably a little less of doing a bulk sale. We'd probably look at it more deeply if the pace were to slow more. So I'm not answering your questions directly, but I would tell you that we continue to look at it, evaluate that as an option. But if we're getting good headwind on retail, we tend to get better realization rates on retail if we can do that. So that's kind of how we think about it.

[Jimmy C. Tallent:]

Matt, this is Jimmy, just an add-on to that as well. The classified ratio is very important to us, and again, very good results in 2012, at the 50% percent level now, and that's something too, that we really want to keep pushing down into the 30s. So assuming we continue to have the type of momentum, we will be headed in that direction fairly rapidly, but certainly, that's one of the areas that we have a focus on.

[Operator:]

Thank you. I'm not showing any further questions at this time. I'd like to turn the call back to Mr. Jimmy Tallent for closing remarks.

[Jimmy C. Tallent:]

Thank you, operator. And again, I want to thank everyone for being on the line, and thank you for your questions. Certainly, if you have additional questions, don't hesitate to call us. Once again, I want to thank all of our United employees for their continued support, their dedication, the executing of the results that we're able to share today. So thank you, everyone, again, and have a great day.

[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.