United Community Banks, Inc.
Q3 2013 Earnings Call Transcript

Published: 24 Oct 2013

[Operator:]

Good morning, and welcome to United Community Banks' Third 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 of these are included on the website at ucbi.com. Copies of today's earnings release and investor presentation for the third 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. I'll begin by saying that we are pleased with third quarter results and this tremendous progress that we've made. It's good to be able to report what I would consider a normal quarter without any significant unusual items or elevated credit costs. We made considerable headway on a number of strategic priorities [ph] during the third quarter, and I will share that with you in a moment. First, let me note some highlights. We earned net income of $15.5 million, or $0.21 per share. We grew loans by $78 million or 7% annualized. We increased core transaction deposits by $94 million or 11% annualized. Our provision for loan losses was $3 million and our net charge-offs were $4.5 million. Nonperforming assets were down $1.2 million from the second quarter, which is equal to 42 basis points of assets. Our classified asset ratio is now at 26% compared with 27% last quarter. Midway through the third quarter, we issued $40 million in senior notes at 6%. And at quarter end, we used the proceeds to call our $35 million in subordinated debt, which had been 7.5% at quarter end. I'm particularly proud that our efficiency ratio significantly improved from 68.9% to 58.5% this quarter. And all of our capital ratios continued to strengthen. Now I'll review the drivers of these results and discuss our plans going forward. Our core pre-tax, pre-credit earnings were $28.9 million for the third quarter, up approximately $2.4 million from the second quarter. You can see this on Page 13 of the investor presentation. The increase was driven by lower core operating expenses, and that's good news. As expected, our net interest margin was down from the second quarter by 5 basis points. This caused net interest revenue to decrease by $224,000. The net interest margin decline was partially due to the pre-funding of our subordinated debt. On August 12, we issued $40 million in senior notes at 6%, and on September 30, we used the proceeds to repay our $35 million in subordinated debt, which had been at 7.5%. The incremental cost of having both the instruments outstanding for 49 days was approximately $350,000 and accounted for 2 basis points of the margin decline. Without the overlap, net interest revenue would have been up approximately $125,000 in the third quarter. I've mentioned in previous calls that we are promoting a home equity line with a below market rate of 1% for the first year. We have been offering this product more than a year now, and the balances are beginning to reset at prime plus. Approximately $45 million reset during the third quarter with another $40 million expected to follow suit in the fourth quarter. We anticipate more benefit going forward as this product matures. The other driver of the margin decline is pricing pressure, home loans and securities. This is likely to remain the case in the near term, making loan growth critical to increasing net interest revenues. We do expect the rate resets on our HELOC product and the lower-cost owner debt to slow further margin decline. I'm very pleased to report third quarter net loan growth of $78 million this quarter. Our new loan production is shown on Page 21. While we had net new loan growth in the Atlanta, Coastal Georgia, and South Carolina regions, we also saw solid production across the rest of our footprint with $71 million in North Georgia and $38 million in Western North Carolina. Our new healthcare group in Nashville added $6 million in balances to the $18 million they produced in the second quarter. We saw solid increase in C&I lending in the third quarter, following a steady increasing trend over the prior 5 quarters. Our new South Carolina and Nashville loan production offices are producing solid growth, and we're seeing more demand in other markets as well, particularly Atlanta and the Georgia coast. We also saw healthy third quarter increases in both owner-occupied and income-producing commercial real estate. On the retail side, solid growth continues with the in-house mortgage product we rolled out in January and with our home equity line of credit. During the third quarter, we funded $73 million in balances under these programs. In regards to our securities portfolio, we continue to reinvest most of the cash flows into floating-rate securities, where available, to counter the effect on interest sensitivity of fixed rate loans. Floating-rate instruments now account for 39% of the portfolio. This has cost us a mule, but has helped maintain a slightly asset-sensitive balance sheet. And now to core fee revenue. You'll find the trends on Page 13 of our investor presentation. Third quarter core fee revenue was $14 million, down slightly from the second quarter due to the slowdown in mortgage refinancing activity resulting in a decline in mortgage fees of $449,000. In the third quarter, we closed $77 million in mortgage loans compared with $95 million in the second quarter and $108 million in the third quarter of 2012. The volume of new purchases this quarter was 59% compared to 49% last quarter. We have continued to see a pickup of new purchase volumes over the past 5 quarters. While refinancing activity has slowed, we're seeing growth in the purchase money business, which is where we're focused. We still see a great opportunity to increase our share of the mortgage business, particularly in our newer and more metropolitan markets. And keeping with that vision, I'm pleased to report that Mike Davies has joined us as President of United Community Mortgage Services. Mike comes to united with more than 28 years of experience in the mortgage banking industry. With his leadership, we plan on making our mortgage product an even stronger part of our relationship banking strategy. Although mortgage fees dipped a bit in the third quarter, our bankers did an outstanding job of filling the gap with solid increases in all other fee revenue components. Deposit service charges increased by $484,000 and brokers fees grew by $211,000. As I've mentioned on earlier calls, we see a great opportunity to grow the brokerage business within our footprint and are especially encouraged by the results of the past 2 quarters. We have excluded a number of non-core items from core fee revenue that are shown on Page 16 in the investor presentation. Core operating expenses are presented on Page 14. They totaled $39.3 million in the third quarter, a decrease of $2.7 million from the second quarter and $1.2 million from 1 year ago. This is a credit to the disciplined efforts of our bankers to reduce cost and improve efficiency. I want to point out that these core expense reductions come at the same time that we are making significant strategic investments in business heads, commercial relationship lenders, new markets and back-office capabilities. In the past year, we have made 25 strategic hires in the front and back office to support our initiatives and position us for long-term growth. To cite a few examples, we entered new markets in South Carolina and Nashville by attracting several bankers who have specialized expertise that we can leverage across our footprint. To support our retail banking focus and to help centralize our consumer underwriting, we added a senior retail credit officer, Chuck Valerio. Chuck has over 30 years of experience in consumer credit and underwriting. We also hired 4 other highly skilled members of his team to support our retail banking focus. As I mentioned earlier, we added a new President of our mortgage business to increase market share in this key area. We have also added key leaders and managers with years of experience to strengthen our loan operations area and added additional leadership to focus on growing fee revenue. These investments in talent, together with our outstanding existing team, will drive our future growth and success. We are already seeing encouraging results. Third quarter core operating expenses decreased in every category with the exception of professional fees, where there was a small increase. The decreases are the results of ongoing efficiency initiatives from which we will continue to reap benefits going forward. A key benefit of our cleaner balance sheet is the reduction in costs associated with managing and maintaining problem loans and foreclosed properties. These reductions have come in nearly every expense category, from salaries and benefits for workout personnel to other support costs for appraisals on classified loans and foreclosed properties. Let me cover a couple of specific expense categories as shown on Page 14. Core staff cost in the third quarter were $22.5 million, which is down $617,000 from the second quarter. About 1/3 of this decrease was in core salaries, mostly related to positions eliminated late in the second quarter. On September 30, we had 1,496 employees. That compares with 1,500 at the end of the second quarter and 1,592 a year ago. Keep in mind that these decreases in staff and related costs include bringing on the 25 new strategic hires. We will see some fluctuation in personnel expense as we continue to add skilled revenue producers who can help us grow. The other 2/3 of the decrease in staff expenses relates to lower payroll taxes and lower mortgage commissions due to the decline in fee revenue. The other expense category was down $1.6 million from the second quarter. About $300,000 of the decrease came from lower ATM network maintenance cost, following our switch to a new debit card processing service provider. Accounting for most of the remaining other expense decreases were lower appraisal and other costs associated with managing and maintaining a reduced classified loan balance. Those costs were elevated in the second quarter as a result of the asset sale. Our third quarter core operating expenses excludes several items that we consider to be non-core. The excluded items are shown on Page 16 of our investor presentation. The larger side on this quarter was $405,000 in severance charges. The third quarter reduction in total expenses allowed us to bring our efficiency ratio down to 58.5%. The last time our ratio was at that level was in 2007, prior to the financial crisis. To put this in perspective, in 2007, our net interest margin was about 50 basis points higher than today. To return the efficiency ratio to the 58% range has required significant expense reduction and added fee revenue. Our bankers have done a tremendous job of not only executing the strategy to achieve this objective, but doing so while maintaining a customer satisfaction score of 95%. Because we no longer have a full valuation allowance on our deferred tax asset, we're back to showing a normal income tax provision. Income tax expense for the third quarter was $9.5 million. Our effective tax rate for the quarter was elevated from 35% to 38% by the net effect of 2 unusual items. In July, the state of North Carolina adopted legislation to reduce its corporate tax rate from 6.9% to 6% next year and 5% in 2015. This rate reduction resulted in a $1 million impairment charge to reduce our deferred tax asset and an increase tax expense for the quarter. That impact was partially offset by $400,000 tax credit related to the release of previously established reserves for unserved tax positions that primarily relate to state tax returns where the statute had expired. Before we open the call for your questions, I want to make a few closing comments. Our lower efficiency ratio demonstrates that we are successfully reducing overhead cost and increasing fee revenue. At the same time, we are focused on building and growing our business for the long term. To that end, as I've shown, we continue to invest in exceptional talent in targeted areas. These investments come in the near-term cost, but with significant promise for long-term benefit. We are committed to growing and maximizing shareholder returns, and that means reinvesting in our business. Banking is changing rapidly as you know, and we are positioning ourselves, not just to keep pace with, but to thrive in the new environment. We're doing this with new products and services tailored to specific needs and deliver professionally, efficiently and with unmatched customer service. I mentioned earlier our 95% customer satisfaction rating. It reflects we are one of the best in service throughout the country. Whatever else changes, service still matters, and always will, as service is a strong competitive advantage for United. The low interest rate environment continues to put pressure on our margin, and we could see more of this in the near term, but at a slower pace. When rates finally do begin to rise, we expect the asset sensitive positioning of our balance sheet to lift our margin and increase net interest revenue. On our last call, I discussed our goal of a 1% return on assets by the fourth quarter of 2014, as shown on Page 11. That goal would also drive the growth in earnings per share. With our accelerated disposition of classified assets in OREO in the second quarter, we have executed Phase 1 of our plan to achieve the goal. Our significantly lower third quarter credit cost reflect the positive impact. The loan loss provision of $3 million compares to $15.5 million in the third quarter of 2012, and our foreclosed property cost to $200,000 compares to $3.7 million 1 year ago. Now, Phase II begins with lowering our holding company debt and equity cost. Our successful third quarter senior notes offering allowed us to replace $35 million in subordinated debt at 7.5% with $40 million in senior notes at 6%. Not only did this lower our debt cost, it also improved the holding company's liquidity position by $5 million, as well as extending the maturity if we elect to do so by 3 years. And it improved future access to lower funding cost from the retail and institutional markets. A very important part of our strategy to reduce debt and equity cost is reestablishing regular dividends from the bank to the holding company, which will allow us to pay down our preferred stock. This would have a very favorable impact on increasing earnings per share. Our plans are still being developed, and we expect them to be finalized in the fourth quarter. We will share those updated plans during our next earnings call. That brings me to the status of our regulatory examination, which is now complete. We have had our preliminary review of the results and expect the final written report within 45 days. I can't say more at this time, other than we are pleased with the preliminary results and believe the regulators are pleased as well with our progress. Those are my prepared remarks. Now, Lynn, Rex, David and I will be pleased to answer any questions.

[Operator:]

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

[Michael Rose:]

Rex, maybe this one's for you. Just wanted to get a sense for some of the actions that you took this quarter. How will that impact the NIM in the fourth quarter going into next year, and then how should we think about the reset of the remarketed TARP funds going from 5% to 9% is moving to next year? And is that, I would assume, is obviously a priority for you to get paid down, any thoughts there would be helpful.

[Rex S. Schuette:]

So first, on the, as Jimmy indicated, on the senior notes, that have a positive impact, again there's about $350,000 just a net interest revenue run rate. That was additional in Q3 that will go away in Q4. The overall affect of the senior debt and the sub-debt is about equal when you look at the different rate differentials on the $40 million versus $35 million, so the cost is about the same per quarter, but we have the incremental carry cost in the third quarter. As I provided last quarter and Jimmy noted, that we still expect some margin compression driven primarily by a loan repricing, competitive pricing in a market. That still continues. And again, we talked last quarter in the 3 to 5 basis points, and we expect that to be higher to lower part of that range still going forward and that probably continues into '14 also, with pricing compression going forward. So we still see that impacting us on a run rate, but again, with loan volume picking up, we hope it'll be able to offset. I think the key item for the quarter is that net interest revenue for the first time in many quarters actually increased when you take out the double count of the senior notes that were issued. So net interest revenue is kind of flat increasing and we'd like to see that continue. But again, we continue to fight some of the pressures.

[Michael Rose:]

So do you think you can actually continue to grow NII from here?

[Rex S. Schuette:]

I believe we can. I think we will see fourth quarter increase and, again, going into next year, we can see that holding or continuing. And a lot really just, again, its driven by the loan growth underneath it and pricing compression. Again, that being at the lower end of the range, we could see that continue to grow.

[Michael Rose:]

Okay, and then just secondarily, as it relates to credit related cost, obviously the foreclosed property expense came down, the appraisal fees were lower. Should we consider those kind of a run rate or base or new kind of a base going forward?

[Rex S. Schuette:]

David, do you want to comment? I think it is, but I...

[David P. Shearrow:]

Yes, I think that you can feel pretty good about that as a relative run rate rather than that same range that we were in this quarter. We feel comfortable where we are now.

[Operator:]

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

[Kevin Fitzsimmons:]

I just want to clarify that the -- Michael's question from just before was on the pace of OREO cost, David?

[David P. Shearrow:]

Yes. Our OREO cost this past quarter, about $200,000. And my response to that was I think 1 year that kind of a run rate is a reasonable estimate for next several quarters based on what we're seeing right now.

[Kevin Fitzsimmons:]

Okay. I just wanted to double check that. And then x OREO cost, I guess from what -- it seems like the pace of this quarter was about $39.3 million in expenses, core expenses. And Jimmy, I kind of heard there's more efficiency effort to come, going forward, but there's also strategic investments going forward. So should we kind of think of that as a run rate -- stable run rate going forward or should we think of that net amount per quarter going down even further on expenses?

[Jimmy C. Tallent:]

Kevin, I think right now, I would just look at that as somewhat of a run rate. There will be a little bit of fluctuation. We have other initiatives in place where we will see expense contract some more. But we will also be opportunistic in being able to take advantage of new hires, new revenue producers. We have been on a real focused march and recalibrating the expense base of the company for various reasons and obvious reasons. But also, 2, we have an equal focus today in growing and expanding the revenue side of that. So I think for your purposes, I would probably leave it somewhere where Q3 is at, but understand there could be a little bit of up and down over the next couple of quarters.

[Kevin Fitzsimmons:]

Okay, great. And just a quick follow-up on -- you addressed the pricing competition and pressure that's out there on the loan front, and at the same time, that's affecting the margin, but you're very intent to grow the loan book to offset that. And we've heard some banks talk about that some of this pressure that's out there is just other banks that are so focused on growing loans that they're growing them regardless of if it's profitable or economic growth. And so I'm just wanted to get a sense how you're weighing that? Are there certain loan buckets you're really staying away from because it's too fierce competitively right now and are there certain loan buckets or geographies where you feel you have an advantage and the pricing is not as competitive?

[Jimmy C. Tallent:]

Kevin, Lynn is going to take that question.

[Lynn Harton:]

We continue to feel very good about our $500 million goal by the end of next year is achievable. It is, as you mentioned, a very competitive environment. And we have walked away from several deals. But we didn't feel like we're priced right. But if you come break down that $500 million, the way we look at it, we got $78 million of that this quarter, that leaves about $422 million. We've already got built in funding in Greenville coming out of our income property division of about $70 million. So even if we didn't do anything new there, that would fund up over the next year. That takes us to $350 million remaining of our goal. I'd be very disappointed if we didn't do $100 million over the next 5 quarters in our healthcare and corporate banking area. That continues to go well. We just hired an additional healthcare lender in Nashville that we haven't announced officially but has just accepted, so we think that's variable. That gets us at $250 million. We think we probably grow the indirect business about another $50 million, so that gives us down to $200 million over the next 5 quarters that we need to get out of the core bank and this past quarter, the core bank grew $31 million. So that's about a $40 million a quarter run rate that we need. We did $31 million. We think that's very doable, most of that is coming out of retail, home equity, small business, mortgage and coming out of areas where we've got a great franchise and brand. So it's certainly not easy, but we feel confident that we get at least close to it.

[Operator:]

Our next question is from Matt Olney of Stephens.

[Matt Olney:]

Good overall improvements in expense phase, I think Jimmy hit on those -- these, in the prepared remarks. The FDIC assessment expense still looks pretty elevated compared to your overall dramatic improvement in your credit quality. Any reason that this hasn't come down yet?

[Jimmy C. Tallent:]

Well, Matt, we would hope to see that come down in the near term.

[Matt Olney:]

Okay. And on that Slide 11, that 1% ROA goal, it looks like you're assuming some benefit from kind of lowering the debt and equity cost of the holding company. Can you give us any more detail as to what you're assuming in that slide?

[Jimmy C. Tallent:]

Well, the slide -- let me kind of go over that, Matt, to give a little better understanding. That's our path, our goal to get to the 1% ROA run rate by Q4 for '14. That's where we put our flag. Of course, it includes the loan growth, expense reduction, fee revenue and the lowering of our debt equity cost. The key, though, the key is EPS growth, I think that drives the value, as we all know. If you look at the components of the loan growth it experience the fees, those are being executed every day. Their strategies around each one of those that will continue to move those in the right direction as we move forward. Doesn't mean that each one of those will be absolute, there could be more or less in 1 category or the other, but we at least we have the roadmap and we know which lever to fill. Now Phase 2 of our plan is, of course, lowering our debt equity cost. Simply stated, the old TARP and the Elm Ridge preferred, of course those are the two that's most expensive. Our plan is to pay these down substantially without any kind of a common raise. Now, of course, we must have approval to do them from the bank to the holding company. Our capital is very solid today, it's growing at a very strong pace with the earnings, as well as the DTA recapture. Those plans will be finalized in the fourth quarter. We have clear understanding of the cost, $0.05 a quarter today of the debt equity of those 2. It would be $0.08 a quarter when it reprices. So Phase 2 of our plan will have significant impact on the -- on driving our EPS. This quarter, fourth quarter, is when that plan will be finalized.

[Matt Olney:]

And thanks for that detail, Jimmy. It seems to me that you could upstream some capital potentially in the fourth quarter given the profitability last year, and you could start to pay down 1 of those higher costs instruments. Am I thinking about this the right way, that is possible?

[Jimmy C. Tallent:]

Yes, you are.

[Operator:]

Our next question is from Jennifer Demba of SunTrust Robinson Humphrey.

[Jennifer H. Demba:]

Acquisitions, Jimmy, I think in the last couple of quarters, you've talked more about interest in those in the coming quarters. Can you just give us some detail on what you're thinking at this point?

[Jimmy C. Tallent:]

I'm sorry, I didn't understand that, Jennifer.

[Jennifer H. Demba:]

Oh, I'm sorry. Looking at banking acquisitions, I think you've indicated in the last 6 months or so that you'd be open to looking at those sometime in the foreseeable future, just wondering how you're thinking about that right now.

[Jimmy C. Tallent:]

Yes, we are. Our existing organic business, our phases internally, are continuing to be executed. So I don't want to take the focus off of that because there's significant value creation with the existing plans. Now assuming that is executed in over the course of time, the M&A is part of our long-term strategy. Those basically need to fit into 3 categories. One is strategically; second is going to be financially compelling; and third, we would certainly want it to be low-risk. Whatever we do and when we do it would need to support our plan, our financial plan, the ROA component, in a way that it still meets the criteria or it could possibly accelerate that. We do think M&A is part of our overall strategy. There is a lot of interest there, out there, to -- and a lot of talk, and certainly is very important to us.

[Operator:]

Our next question is from Taylor Brodarick of Guggenheim Securities.

[Taylor Brodarick:]

I just had a question about the reserves. Looks like you have pretty ample reserve at this point. Let me just remind us, how you think about that going forward or any type of targets for that?

[David P. Shearrow:]

Sure, this is David. Well, as you might suspect, as our credit costs continue to decline, our methodology will lead to continued lowering of our reserve, and we would expect some under provisioning much like this quarter going forward here for the next few quarters. So what we've said, and still continue to believe is that, the reserve will gradually probably come down more in the range of kind of maybe in the 1.5% on loans over the longer range. I think while the credit costs are dropping and that's driving points towards reductions, at the same time, we're building our business in some newer areas that do require reserve. And so with the combination of those 2, we think a gradual reduction will continue to occur in probably land in that mid-1% range.

[Operator:]

Our next question is from Christopher Marinac of FIG Partners.

[Christopher W. Marinac:]

Jimmy, I was wondering if you could give us little more color on some of the impact, even if it's just a small stages on new hires in Middle Tennessee plus any other bankers you been hiring in South Carolina and North Carolina, et cetera?

[Jimmy C. Tallent:]

Sure. We do have the very skilled team there in Nashville, in the healthcare arena. Lynn alluded to the one that has just committed to come. Certainly, our Greenville team, we have continued to add to that. We've had other people that we're still in conversation with. I also mentioned some key people on the, as far as business heads, more into the operational aspect because we really want to continue to build this company in a very scalable fashion and also a strong focus on the fee revenue aspect. As you know, our fee revenue runs about 50% of our peers. And so that's very important to us to build that. Mechon, the new president of our mortgage operation. We have, for decades, done exceptionally well in our legacy markets on the mortgage business. We have not done well in our metropolitan markets. So we think, with Mike's skill and experience, that certainly could be a huge addition there. We also now have someone that's helping to drive the fee revenue piece. Their full job is every day focused on that, on the product line, improving it, adding penetration and certainly the end results is getting more revenue from that. So it's kind of across the board, Chris. We've added, what I call, pure revenue producers in these markets. But we also have strengthened some key areas we felt necessary in today's environment, but also will add that additional strength as we continue to move the balance sheet forward.

[Christopher W. Marinac:]

Okay, and I guess my follow-up just was how to do with what sort of what you're seeing on both house prices and land prices, whether it's in North Georgia or other parts of the footprint. Are you seeing continued recovery there and I guess, is there opportunity for that to go further into 2014?

[Jimmy C. Tallent:]

David, do you want to?

[David P. Shearrow:]

Yes, sure. I'll give a shot at that. We have seen a lot of stabilization and improved pricing, certainly in some of the metro areas like Atlanta. In fact, in some pockets, it's interesting there -- we're hearing a lot of multiple bids on house and that type of thing some other real desirable areas in Atlanta. You move outside to more rural markets, clearly, I think we've stabilized. I don't know that we're seeing a lot of appreciation there in most of those markets yet. The land has stabilized, and I do believe actually has shown some recovery in some of these markets, although I will call it fairly nominal recovery at this point in time. Going -- looking forward, I do think we're going to see continued improvement in all of these markets on values, but I don't expect it to be a big pickup. I think it'll be fairly nominal increases in value. That's my opinion, for what's it worth.

[Operator:]

I'm not showing any further questions in the queue. I'd like to turn the call back over to management for any further remarks.

[Jimmy C. Tallent:]

Thank you, operator. Let me just say first, thank you for being on the call. Thank you for your continued interest in United Community Banks. Also want to, once again, thank our team members, the people that really drive this company every single day, I know some of you are probably on the line. I just want to say, and once again, thank you for your support and the execution of this plan as we continue to see really, really strong results. Look forward to speaking with you at the next conference call, and hope all of you have a great day.

[Operator:]

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