United Community Banks, Inc.
Q2 2013 Earnings Call Transcript

Published: 25 Jul 2013

[Operator:]

Good morning, and welcome to United Community Banks' Second Quarter Conference Call. Hosting the 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 pre-tax, 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 www.ucbi.com. Copies of today's earnings release and investor presentation for the second 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. At this time, we will begin the conference call with Jimmy Tallent.

[Jimmy C. Tallent:]

Good morning, everyone, and thank you for joining us for our second quarter earnings call. As you know, from our pre-announcement, we have 2 very significant events late in the quarter. The accelerated sales of classified assets and the release of a deferred tax asset valuation allowance. Those 2 events significantly influenced second quarter results and will have a profound positive impact on our company going forward. For that reason, I want to cover those 2 items first and then discuss the rest of our second quarter results. I'll begin with a little background. Late last year, our management team developed a list of key 2013 goals, in addition to our financial goals for growth and expense reduction. It was a list we believe we must accomplish to achieve our longer-term strategic goals. It included settlement of a Fletcher matter, resolution of the SEC investigation, remarketing of the TARP preferred stock, reduction of our classified asset ratio below 30%, restoration of our deferred tax assets and the listing of our MOUs. By reversing the DTA valuation allowance and accelerating the classified asset sales, I'm pleased to report that, through the second quarter, we accomplish nearly everything on that list. I'm very proud of our people and all that they have achieved. The path is now clear for us to focus exclusively on the things that we do best, growing our business and earnings. The accelerated sale of $172 million of classified assets and the DTA valuation allowance release of $272 million had a significant impact on the numbers. So I will discuss them in further detail now. Both had been in the works for several quarters. Following our recapitalization in 2011, we had been making steady progress in reducing classified assets and cleaning up the remaining legacy problem credits from the financial crisis. Each quarter, since 2011, we saw meaningful improvement in our credit measures, especially in the last 4 quarters. However, our classified asset ratio and credit costs were not moving to an acceptable range at a pace that would allow us to pursue our strategic initiatives. We believe the time was right to accelerate that pace by selling classified assets. As we begin to model various disposition scenarios, we found we could significantly improve our credit measures with just a slight decrease in our capital ratios. Our accelerated sales during the second quarter included $151 million in classified loans and $21 million in OREO. Net charge-offs were $72 million. The loan-loss provision was $48.5 million, and OREO costs were $5.2 million. These sales place our credit measures in a much better position and allow us to devote full attention to executing our strategic plans and growing the business. Non-performing assets, which are made up of $28 million in non-performing loans and $4 million in OREO, now total $32 million or 44 basis points of total assets. That matches pre-crisis levels and currently ranks United as having one of the lowest ratios of all publicly-traded banks in the Southeast and all U.S. banks between $5 billion and $20 billion. As a result of the classified loan sales, our allowance for loan losses was reduced by $24 million from the first quarter. At 1.95% of loans, our allowance ratio remains strong, especially in light of our improved credit risk profile. At quarter end, our performing classified loans were $176 million. The classified asset ratio is 27%, down from 49% last quarter. As you know, this is a key measurement. And throughout the process, we have been in constant communication with the regulators. It goes without saying that we expect significant reductions in net charge-offs, loan-loss provisions and foreclosed property costs going forward. What may not be as obvious are other expected cost savings such as legal fees, appraisal costs and other workout-related expenses. This brings us to the release of the DTA valuation allowance, which we have been discussing with our auditors since early this year. Clearly, after several profitable quarters and steady improving credit measures, the weight of evidence had become more positive. The improved credit measures brought lower volatility to our credit cost, as net charge-offs became more predictable. The accelerated classified asset sales in the second quarter further reduced volatility by removing assets that were most likely to result in losses. With lower and more predictable future credit cost and the earnings performance, our positive objective evidence in the second quarter now outweighs the negative. Now I want to discuss the drivers of our second quarter results and talk about our plans from here. Our core pre-tax, pre-credit earnings were $26.6 million for the second quarter, up approximately $200,000 from the first quarter, as shown on Page 14 of the investor presentation. The increase was driven by higher core fee revenue that was mostly offset by a slight decline in net interest revenue and higher core expenses. I'll cover each of those, beginning with the decline in net interest revenue. The pricing pressures on both loans and securities are likely to remain in the near term. That makes loan growth critical to increasing net interest revenue. Although second quarter loans were down $5 million on a linked-quarter basis, this is a tremendous accomplishment, considering that we sold $151 million in loans during the quarter. People all across our footprint have done an exceptional job in growing the loan portfolio. We saw good loan growth across all of our footprint, the strongest that we have seen in quite some time. We continue to gain traction in our newest markets, which I want to comment on. In addition to growing within our existing footprint, we continue to add seasonal lenders in new markets with outstanding growth opportunities. Early in the quarter, we added a small, but experienced team of healthcare industry bankers in Nashville. By the end of the quarter, they had already funded $18 million in new loans, with several in the pipeline that had been approved and are pending closure. We see outstanding opportunities to grow this business throughout our markets. We also continue to gain traction in South Carolina, where we funded $15 million in new loan balances in the second quarter with more to come. With the initial success we've had in this market and the outstanding growth potential, we plan to apply for a full service branch in Greenville to serve all the banking needs of our new customers. On the retail side, we continue to experience solid growth with the in-house mortgage product that we rolled out in January and with our home equity line of credit. As you may recall, the home equity line has a 1% introductory rate for the first year and then converts to prime plus. We are approaching the 1-year anniversary and expect about $50 million of loans to adjust upward in the third quarter. During the second quarter, we added $67 million of new balances under these programs. During the quarter, we continued to purchase high-quality, indirect auto loans as we've had over the past 5 quarters. In the second quarter, we had a unique opportunity to purchase $102 million in indirect auto paper that partially offset the impact of the classified asset sales during the quarter. At quarter end, we had $152 million outstanding in indirect auto loans. Also impacting net interest revenue is our securities portfolio. We are managing it strategically, continuing to direct purchases toward floating-rate instruments. We have also been investing in fixed-rate bonds and swapping them to floating in order to improve interest sensitivity. Floating-rate instruments now account for 38% of the portfolio. We have given up some yield, but have also avoided exposure to rising interest rates while maintaining a neutral to slightly asset sensitive balance sheet. And now, to core fee revenue. You will find the trends on Page 14 of our investor presentation. Core fee revenue of $14.1 million was up $1.4 million from the first quarter with increases in every category. I'm especially pleased to report increases of $348,000 in our mortgage business and $296,000 in our advisory services business. As I've mentioned in previous quarters, we have an excellent opportunity to growth both of these businesses within our footprint and are working diligently to do so. We closed $95 million in mortgage loans in the second quarter. That compares to $70 million in the first quarter and $80 million in the second quarter of 2012. The positive service charges of $8 million were also up by $569,000 from the first quarter and by $156,000 from the second quarter a year ago, both reflecting higher levels of interchange fee revenue. The increase in other fee revenue from the first quarter, as noted on Page 14, reflects ongoing growth in our customer derivatives business, which totaled $488,000 in the second quarter. We continue to gain traction with this product among commercial customers who want fixed rate loans while we swap the loans to floating on our books. A number of non-core items that we have excluded from core fee revenue are shown on Page 16 of the investor presentation. Core operating expenses of $42.1 million are presented on Page 15 of the presentation. They increased by $1.2 million from the first quarter and by $755,000 from a year ago. The increases were primarily in communications and equipment expense and other expense category. The increase in communications and equipment expense reflects the higher cost of new technology we are using to improve our operating efficiency and our customer service. It also includes some transition items, and we expect the run rate to decline. The increases in other expenses from the first quarter and a year ago were mostly due to higher appraisal costs on substandard loans. We keep looking for ways to operate more efficiently and consolidate or reduce staff. During the second quarter, we reduced headcount by 40 positions, and we're down 114 from a year ago. We incurred $1.6 million in severance in the second quarter related to the eliminated positions. Severance charges and other non-core expense items are excluded from core expenses and are shown on Page 16 of the investor presentation. As we control and reduce expenses, including personnel, at the same time, we invest in people who will help us achieve our growth objectives. Before I conclude my prepared remarks and open the call for your questions, I want to comment on where we are going from here. I mentioned earlier that we started the year with some clearly defined goals that we wanted to accomplish in 2013. We're halfway through the year, and most of those goals have been achieved. Our people have worked hard and produced outstanding results. With credit quality now well under control, our attention is laser-focused on growing the business and improving earnings performance, a key financial goal, to which we are totally committed as a 1% return on assets. Lowering our credit-related cost was a critical phase to that end. The next key phase in the process is lowering holding company debt and equity costs. This phase is dependent on completing the classified asset sales and includes repaying or refinancing our holding company subordinated debt, trust preferred securities and preferred stock. A key step, and one we believe we are on track to accomplish, is reestablishing regular dividends from the bank to the holding company. Another key step that is important to lowering these costs is a bond rating. As you have probably seen, Crowe bond ratings agency announced last evening our published BBB rating. We're extremely pleased with the investment-grade rating, which reflects the significant progress that we have made over the past year to improve our overall credit quality, strength in capital and produce sustained profits. This fits well into our current plans. We are taking a methodical approach, one we believe is most advantageous to our common shareholders, to reducing debt and equity costs. Although specific plans are still being finalized, I want to be clear, they do not include a large dilutive common equity raise nor do we expect to be saddled indefinitely with a 9% preferred stock dividend. There are other options available that we are currently exploring, which include

[Operator:]

[Operator Instructions] Our first question is from Michael Rose from Raymond James.

[Michael Rose:]

I wanted to just get some color on a couple of clarifications that were in the slide deck. I think you said that you expected mid single digit loan growth this year. And I just want to make clear that, that assumes -- or that incorporates the bulk sales this quarter.

[Rex S. Schuette:]

Michael, this is Rex Schuette. If you think about the bulk sales included in the quarter, we had $151 million of loans that were sold, and we're down $5 million. And again, in the quarter, as Jimmy indicated, we have the opportunity to acquire another $104 million of indirect auto. So that leaves us roughly in the range of about $47 million, $48 million of net growth when you look at a linked-quarter basis, which is about 5% growth for the quarter. So we still expect to be in that range -- in the mid-single-digit range, Michael.

[Michael Rose:]

Okay. That's helpful. And then, I think you said the margin was going to be down 3 to 5 basis points. Now is that for the full year -- year-over-year? How do we read that 3 to 5 basis points that was on the slide deck?

[Rex S. Schuette:]

Yes. I think it's going to be in probably the upper end of that range, 4 to 5, Michael, over the next 2 quarters, but it should level out. After that, we do have, as Jimmy indicated, repricing of some of the HELOC coming in the second quarter. And part of it is really just to balance off of the new loan growth that we have coming on. And again, it's competitive, and that's really been -- 2/3 of the margin decrease from last quarter is primarily related to loan pricing and 1/3 of that -- the other 1/3 in round numbers is related to the securities portfolio, where again we're focused on putting on floating-rate securities versus extending and taking just a slightly lower yield. And we have a little bit of pickup offsetting that with respect to lower deposit costs down 3 basis points overall for interest-bearing deposits.

[Michael Rose:]

Okay. So the way to read that is, from the 3.31% you'd expect -- the 3.31% you'd expect another 3 to 5 basis points of compression in the back half of the year.

[Rex S. Schuette:]

I think in each of these next 2 quarters.

[Michael Rose:]

Okay. So that's per quarter? Okay.

[Rex S. Schuette:]

Then it's leveling off -- we see it leveling off.

[Michael Rose:]

Okay. That's helpful. And then, just 1 final question. Given the drop in classified this quarter, how should we think about the loan loss reserve level, where does it normalize and would you expect the kind of under provision here for a couple of more quarters?

[David P. Shearrow:]

Yes. Michael, it's David. Yes, we would expect that we'll continue to have some level of under provisioning over the next few quarters just as our loss rates will keep dropping and the de-risking of the balance sheet. I think, in the longer term, we'll probably end up somewhere in the mid-1s -- around a 1.5, and I think it will take a little while to get there. So somewhere between that and where we are today by the end of the year, would be a pretty good proxy.

[Operator:]

Our next question is from Kevin Fitzsimmons from Sandler O'Neill.

[Kevin Fitzsimmons:]

Just a couple of questions. First, 1 quick question on credit. I noticed that NPL inflows actually increased this quarter. And just if you can touch on that whether that's anything to be concerned about or what was driving that? And then, secondly, in terms of capital planning, Jimmy, if you could just give us any kind of sense for timing on when you might -- we might expect resolving former TARP. Whether it would happen all at once, whether it would happen in installments? And maybe if you can lay out for us, if possible, your funding sources like, for example, the cash you already have at the holding company, the amount of cash you would hope to dividend up from the bank? And then, what, if anything, is left over to look at using some of the alternatives like you mentioned?

[Jimmy C. Tallent:]

David, I'll take the last part of that, and then I'll also ask Rex if he would to help on clarification. Number one, it's been a series or phases that we have been working through and, of course, the first phase, getting our credit -- our legacy credit issues behind is very key. Certainly, at some point, as our MOU would be lifted, which, of course, will provide the dividend capacity back from the bank up to the holding company, which will play a key component in that process. We have been looking at the -- our equity and the cost of that now for several quarters. As I said a few moments ago, we don't have an absolute plan because each one of these components, we believe, play into restructuring and lowering the costs. Certainly, the Crowe rating last night will -- in our opinion, will help that process. But over the next 2 to 3 quarters, this plan not only will be designed but implemented during that period of time, some of the instruments, certainly, the more expensive, the one that we have coming due in February of next year, of course, that would be paid off. So there is just a number of components that we're looking at. Bottom line is we know that we will absolutely reduce the cost of the debt equity. That time period will occur over the next 2 to 3 quarters, and we strongly believe in the execution of that with these several million dollars of additional savings for the company. Rex?

[Rex S. Schuette:]

Yes. Let me just add that to that. Current cash at the parent company is just under $46 million. We have dividend capacity later in '13 of roughly $24 million from last year, 2012, which is 50% of earnings. We'd have dividend capacity in '14. We're, year-to-date, at $236 million. So conceptually, you'd have 1/2 of that or $118 million-plus remaining in the year -- in 2014. So we have capacity -- kind of the question you're driving at we have capacity from the bank to dividend up to the parent company later in this year and into the first quarter of next year. We're reviewing that with the regulators. So I do think, as Jimmy indicated, there's high cost of debt equity we have at the books. $48 million of our TruPS are averaging 9.27%. And as Jimmy indicated in his prepared remarks, the $180 million goes up to 9%. We think we can access the market and lower that or renegotiate. So we have a lot of opportunities that we're looking at, and we'll be working through that over the next few quarters.

[David P. Shearrow:]

I think there -- and there was 1 other question on the inflow. Yes, there was a little bit of a tick-up. We had about $10 million of inflow last quarter, and we are up about -- to about $13 million this quarter. When you look at the content there, most of the increase was in resi mortgage. I don't think there's any story there really other than there was a -- just an aberration in this quarter. I think, based on what I'm looking at from past dues and what I expect going forward, I would expect it to come back down more in line with what we've had in the prior couple of quarters. And we've seen a little bit of volatility quarter-to-quarter in the resi mortgage portfolio. Overall, inflow -- total inflow will drop. With the de-risking, I would expect our inflow over the next couple of quarters to be somewhere in the, say, $7 million to $8 million range.

[Operator:]

Our next question is from Matt Olney from Stephens.

[Matt Olney:]

Circling back on Kevin's question on the debt pay-down, can you talk a little bit more about the priorities of -- which debt structures, or trust preferred structures that you're hoping to redeem or refinance initially?

[Jimmy C. Tallent:]

Yes, let me take a stab at that. Of course, first is the overall troughs that -- it is the most expensive. We certainly would want to address that first. That's balanced off with the benefit of the Tier 1 capital treatment. That's balanced off with the part of the -- what I call, the old-bill TARP and the benefit of being able to pay that down at all at any point in time. That's also balanced off in the fact that the dividend capacity that we have this year and certainly next year relative to classified assets. So there's a number of components that we're looking at so that we make the right decision from a cost standpoint, but also a right decision from a capital standpoint.

[Rex S. Schuette:]

I guess, the only thing I would add, if you're looking at our trust preferred securities, is $48 million -- a little over $48 million that average over 9%. That, as Jimmy indicated, would be at the top of the list. We have flexibility. Those are callable, and most of them continuous, having flexibility -- and as Jimmy noted, having the optionality on the preferred, the $180 million, there's a lot of value to that and gives us a lot of flexibility of when we want to call it and the time period and, again, really trying to utilize cap position from the bank at the same time and balancing this off to lower our overall costs going forward in '14.

[Matt Olney:]

Okay. That's great color. And then, switching gears over on the other side, you mentioned the ROA goal of 1%. Can you talk more about that? And how much of that is -- of the anticipated improvement is based on revenue enhancement versus continued expense reductions? Because it sounds like you continue to hire new teams of lenders. So I'm guessing most of that improvement is going to have to be on the revenue side. Is that fair to say?

[Jimmy C. Tallent:]

That's fair to say. And though I don't have absolute percentages around each component -- but basically, the first phase, which we've just completed, is lowering our credit cost and, of course, the return to the DTA and the taxability of earnings going forward, which, in my view, kind of balances where we are today on the ROA component. The next phase, that we are laser-focused on is lowering the cost -- the debt costs within the holding company. Certainly, that will contribute a component of additional ROA strengthening. Another part of that, of course, is restoring our dividend capabilities from the bank to the holding company, which ultimately will determine the amount of contribution that, that will provide. But it will absolutely provide what we believe a fairly significant amount towards the 1% ROA. A third component is to continue to grow our loan portfolio. We've added the additional teams, the South Carolina team, the Nashville team, but also to -- we're beginning to see strengthening in the number of our existing markets. Certainly, the headwind there is the margin compression. But the truth is that we have to grow our loan book in a very prudent manner and grow interest revenue because the margin compression is going to remain in the near term. The other component that will play a significant component to that would be the growth of fee revenue piece. Now this is obviously the mortgage and the brokerage that we've talked about, whereby we actually are very close to bringing in senior leadership on the mortgage as we have already on the brokerage. But this is across the board, this is not just these 2 items, it includes debit cards, merchant services, treasury. Every one of these will be additive as we focused more accountability in each one of those areas. And then, the last component is continuing to control and reduce expenses and improve operating efficiency.

[Operator:]

Thank you. We have no more questions. Thank you. I'll turn the call over to Jimmy Tallent, President and CEO, for closing remarks.

[Jimmy C. Tallent:]

Thank you, operator. Let me thank everyone for being on the call. We sincerely appreciate your interest in the company. Please reach out to any of us today or later if additional questions arise. I also want to once again compliment our team of United bankers who every single day get up and suit up in a very successful way of commitment and execution and moving our company forward. Thanks again for being on the call. We look forward to speaking to you at the end of the third quarter. Hope you have a great day.

[Operator:]

Ladies and gentlemen, this does conclude today's conference. You may now disconnect. Everyone, have a great day.