United Community Banks, Inc.
Q2 2015 Earnings Call Transcript

Published: 22 Jul 2015

[Operator:]

Good morning and welcome to United Community Banks Second Quarter Conference Call. Hosting our call today are 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, 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 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 statement 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 Tallent:]

Good morning and thank you for joining us for our second quarter earnings call. We had another strong quarter both financially and strategically. Our financial results were solid by every measure and I’ll talk more about that in a moment. On the strategic side, we completed our merger with MoneyTree Corporation and its subsidiary, First National Bank, and we announced a planned merger with Palmetto Bancshares. Both of these banks enhance and expand our footprint in very desirable markets and it will be hard to find partners that more closely fit our community and service oriented culture or provide better opportunities for growth. I’ll talk more about where we are with both mergers and then I’ll wrap up with our outlook. First, let me start with some highlights. Our call today will focus on performance measures presented on an operating basis, which excludes the impact of merger-related charges. Net operating income was $20 million or $0.32 per share, up 19% from a year ago. Reported net income was $17.8 million, or $0.28 per share. Return on assets on an operating basis was 1%, up from 94 basis points last quarter and from 88 basis points a year ago. Our operating return on common equity was 9.9% compared to 9% a year ago. Total revenue excluding the provision was $78.6 million, up $9.5 million or 14% from a year ago. At 3.30%, our margin was about the same as first quarter and was up 9 basis points from the second quarter of 2014. We had solid loan production of $518 million, with net loan growth of $142 million or 12% annualized. Our provision for credit losses was $900,000, half the amount from the first quarter. Unusually high recoveries drove net charge-offs down to $978,000, resulting in a lower provision. Our reported allowance ratio was 1.36%, down from 1.46% last quarter. The addition of the acquired First National Bank loans which had a purchase discount rather than an allowance lowered this ratio by 6 basis points. The non-performing assets to total assets ratio was 26 basis points, unchanged from the first quarter. Fee revenue was up $1.6 million from the first quarter or 40% annualized. The increase was driven mostly by strong mortgage production and SBA lending growth. Finally, all of our capital ratios remained very strong. Now, I’ll share some details of the quarter and also cover the mergers and our outlook for the remainder of 2015. As you can see on page 5 of the investor presentation, core pre-tax, pre-credit earnings were $33.4 million, up $2.9 million from the first quarter, and up $4.6 million from a year ago. Although First National Bank’s earnings account for approximately $700,000 of the increase, most of the increase was from growth in our core businesses. We held our net interest margin steady for the past two quarters, lower by only 1 basis point at 3.30%. This allowed our strong loan growth to drive the increase in net interest revenue. We grew loans by $142 million or 12% annualized during the quarter. This excludes the $244 million in loans acquired in the First National merger. The growth was driven by new loan production of $526 million in the second quarter as shown on page 7 of the investor presentation. With the exception of the commercial construction category, production exceeded the first quarter in every market and every category. Consistent with the first quarter, about 60% of the loan production or $296 million was driven by our community banks. Specialized lending added $130 million. Also similar to the first quarter, more than half of the production was in our C&I and CRE portfolios, reflecting our investment in key leaders and talent in this area. This investment continues to be both a strategic and a financial win. Looking at loan growth by categories, in the second quarter, we generated $300 million in commercial loan production and increased outstanding balances by $116 million. Our funding costs were lower in the second quarter due to our actions taken in the first quarter. You may recall that we repaid the remaining $6 million balance of our structured repurchase agreement, for which we paid interest at a rate of 4% and we redeemed $15.5 million in trust preferred securities that had an average interest rate of 11%. In addition, during the third quarter, we plan to redeem $32.3 million of trust preferred securities that have an average interest rate of 8.5%. At quarter end, our balance sheet remains asset sensitive. If there were a 200 basis points ramp up in interest rates over the next year, we would expect to improve net interest revenue by 1.6%. We still hold a large balance of floating rate securities to assist us in managing our exposure to rising interest rates. At the end of the second quarter, 30% of our investment portfolio was in floating rate securities. Loan pricing pressures will continue and we expect that to compress our margin slightly through the remainder of 2015. With only a modest decline, we also expect loan growth to drive increases in net interest revenue going forward. Before we move onto fee revenue, I want to speak briefly about our provision for credit losses. We saw a decline in the provision in the second quarter as a result of higher recoveries of previously charged-off loans. Our expectation is that net charge-off will return to a level both consistent with the previous two quarters. You’ll find the trends on core fee revenue on page 5 of our investor presentation. Second quarter core fee revenue was $17.2 million, up $2.1 million from the first quarter. The increase was spread among several categories with our mortgage business leading the growth. Mortgage fees were up $952,000 from the first quarter and $1.8 million from a year ago. The increases from both quarters reflect an increase in refinancing activity and our strategic focus on growing the mortgage business by adding lenders in metro markets. We closed $128 million in mortgage loans in the second quarter, up from $88 million in the first quarter and $69 million a year ago. 54% of the second quarter mortgage production was purchases and 46% was refinancing activity. We also saw strong growth in our interchange fee revenue following a slight dip in the first quarter. Interchange fees were up $582,000 from the first quarter and $244,000 from a year ago. During the second quarter, we funded $31 million in SBA USDA guaranteed loans and sold $15 million. Our SBA lending business produced $1.5 million in fee revenue from loan sales. That is up 30% from the first quarter. Sales of a portion of our SBA loan production and the resulting gains in fee revenue will remain a core part of our SBA business strategy. We expect continued growth in this area. Other fee revenue was up $354,000 from the first quarter. Increased customer derivative activity was the largest contributor as commercial customers sought to lock-in low fixed rates on their loans. As I mentioned before, growing our fee revenue generating businesses has been a key strategic focus as we worked to broaden our business mix. I’m very pleased with the progress we are making in this area. Core operating expenses are on page 5 of the investor presentation. As a reminder, our presentation of core operating expenses excludes market value adjustments to our deferred compensation plan liability, severance charges, foreclosed property costs and this quarter $3.170 million in merger related charges. The merger related charges are mostly severance, systems conversion and professional cost specifically related to merger activity. In the first quarter, we also excluded a charge of $690,000 to close out our loss-sharing agreement with the FDIC. We have included a reconciliation of core operating expense on page 5 of our second quarter investor presentation. Core operating expenses of $45.1 million reflected a $2.9 million increase from the first quarter. Accounting for $1.7 million of this increase was First National Bank’s operating expenses for the three months following the merger. The remaining $1.2 million increase was mostly in salaries and benefits, although professional fees and advertising and public relations expense were also up. All other expense categories were flat or down from the first quarter, excluding First National Bank’s expenses. The increase in salaries and benefits excluding the expenses of First National Bank was approximately $660,000, mostly due to higher incentives related to the increase at loan production and growth in fee revenues. At quarter end, we had 1644 employees, up 92 from the first quarter. 77 of the 92 were added through our acquisition of First National Bank. The increase in advertising and public relations expense reflects the cost of our annual customer appreciation day as well as other advertising and marketing campaigns. The increase in professional fees reflects the cost of corporate initiatives. Our operating efficiency ratio for the second quarter was 57.6%, which improved from the first quarter of 59.2%. Now, I would take a moment to talk about our acquisitions. As I mentioned earlier, we completed our acquisition of First National Bank on May 1 and their earnings were included in our results from that date forward. We continued to [outright] First National as a separate bank charter with 10 banking offices through the systems conversion, which was successfully completed last weekend. Following the conversion, all of First National banking offices are operating under the United Community Banks brand. We have completed all of the necessary training and First National Bank is now fully a part of United. Because this was an in-market merger with significant branch overlap, we will be consolidating six bank offices

[Operator:]

[Operator Instructions] Our first question comes from the line of Michael Rose from Raymond James.

[Michael Rose:]

Jimmy and Rex, can you hear me?

[Jimmy Tallent:]

Yes, I can hear you, Michael.

[Michael Rose:]

Good, sorry about that, I had the microphone on mute. I missed some of your prepared remarks, but I wanted to talk – now that you guys have hit kind of 1% return on assets and have the deal closing here soon, how should we think about profitability as we get into next year and beyond?

[Jimmy Tallent:]

Well, from the 1% ROA, Michael, which has been a goal of our company and our team now for a while, I am very proud that our bankers have achieved that. I would say a 10% improvement, a 1.10% ROA would be our next milestone, but I think that’s certainly achievable as long as we continue to execute at the current pace and I think also added to that will be the closing of the Palmetto. Once that is integrated and all of the efficiencies realized, so I think that’s where we will be.

[Michael Rose:]

Okay, that’s helpful. And then can you – maybe this one for Rex, can you just talk about how you expect the margin with the deals to trend here over the next couple of quarters may be on a core basis and then with the equation from the deals? Thanks.

[Rex Schuette:]

Sure. Michael, I think there are a couple of things with it. When you look at their cost base with Palmetto coming in, as Jimmy indicated, to close September 1, their deposit costs are averaging about 5 basis points, we are averaging around 17 basis points. So there is a benefit there. But keep in mind, their cost per quarter is about $130,000 and in effect were to come up to our rate, that’s $260,000 a quarter. So it shouldn’t have too much of a negative impact, but it could have, as we look at adjusting rates for Palmetto back to ours, we’re bringing ours down a little bit in comparison. When we blended it in and looked at their loans and deposits in our forecasts, we see our margin holding in pretty close to coming down 1 to 2 basis points, Michael. I don’t see it dropping down much more in that on a run rate, on a linked quarter basis. And then going out to 2016, we see it holding. And again, part of this is on loan growth assumptions we have built in, as Jimmy indicated before, in the high single digits. So we see the margin expanding a little in a flat rate environment slightly in 2016.

[Michael Rose:]

And that would have to be in the loan side from some of your specialty businesses with higher yields?

[Rex Schuette:]

Yes. And again, we’re seeing more of a mix come in and then we could have this. But we are seeing more of a mix come in with respect to floating rates in the specialized lending area. So again, if rates do move up and as Jimmy indicated, we’re asset sensitive as you look at a 200 basis point ramp just under 2%, but again our expectations, I think like the Street, is that you probably have one increase and it holds for a while and then maybe another increase in 2016. But it’s not a ramp every quarter. The ramps are built on consecutive quarter increases of 25 when you look at it.

[Michael Rose:]

Okay, great. Thanks for taking my questions.

[Operator:]

Our next question comes from the line of Kevin Fitzsimmons from Hovde Group.

[Kevin Fitzsimmons:]

You guys touched on this when you talked about the outlook in the margin about the yield pressure. Can you dig into that just a little more? We’ve heard from a couple banks over the past couple of days about how it’s gotten noticeably more competitive, the pricing pressure, just over the past few months. And so if you can just give us a sense on where you’re seeing the most pressure either by market or by loan type, that’d be helpful. Thanks.

[Rex Schuette:]

Let me make, Kevin, a couple of comments and have Lynn comment on the business side of it. As we indicated last quarter, we did redeem some TruPS and repurchase agreements. That helped us to offset some of the lower yields that we had on the loan portfolio, dropping down 4 basis points. So we held steady at 3.30% compared to 3.31% benefited from some of the lower debt costs that we had. We anticipate redeeming another $32 million late this quarter in TruPS that will have a benefit of two or three basis points on a run rate, but that would be next quarter because it will be late before we do that. But again, we still have the pressures, Lynn can talk about in a second just on competitive loan pricing, but this might offset some of that on a linked quarter basis as we go forward. Lynn?

[Lynn Harton:]

Kevin, clearly it’s highly competitive on variable rate loans, we are continuing to see probably another 5 basis point compression this quarter over last. But one positive thing is we aren’t seeing less in long-term fixed rates, we were seeing a lot of that even from larger banks. That has moderated. And in fact, if I look at our funds transfer pricing yield quarter over quarter which would take into effect fixed and term, we’re actually slightly better this quarter than last. So it’s clearly very competitive, I wouldn’t really say anything else, but I don’t see it dramatically accelerating from here.

[Kevin Fitzsimmons:]

Okay. And Jimmy, just a follow-up for you, you mentioned how you guys would still be able to be open to a small deal while going through Palmetto and going through the integrating of it, can you talk about – I would assume that it would have to be the right market, the right situation, what kind of markets would really be high on your priority list if something did come out? Thanks.

[Jimmy Tallent:]

Sure. Really, Kevin, it’s the same markets that we have talked about for some time. Certainly, our bias is in the metro markets today. When I did mention at the last earnings call that we have put a self-imposed time-out that was due to the fact that the FNB and Palmetto just come on board, what we really wanted to do is to first close FNB and obviously that’s complete. Second, and very important, was to get that integrated into the United system. And as of last week end, that is complete and has been successful. Now, of course, our attention will focus over on the integration of Palmetto and certainly the close. It would need to be a very compelling transaction, needs to be the right bank in the right market, financially compelling, low-risk, one that would not take our eye of a ball with Palmetto, with the bias toward the metro markets.

[Kevin Fitzsimmons:]

And when would Palmetto– I know it’s going to close 9/1, when would the conversion take place?

[Jimmy Tallent:]

The integration should have occurred at least early in Q1. Could it come earlier than that? That’s a possibility. That will be firmed up over the next 60 days.

[Operator:]

Our next question comes from the line of Jennifer Demba from SunTrust.

[Jennifer Demba:]

Can you give us a little more detail on the growth trajectory you’re expecting in some of these fee income line items like mortgage and SBA? And also Rex, just wondering what you’re thinking about in terms of tax rate going forward?

[Jimmy Tallent:]

Lynn?

[Lynn Harton:]

Jennifer, on mortgage, we’ve continued to invest in producers as we talked about. So obviously that paid off big this past quarter. It’s been hard to get visibility in the mortgage business beyond about one quarter and so I would say we feel very good about the third quarter and again we have new producers that are just coming on line. So we would expect to continue to see some growth beyond that. In the fourth quarter, we would expect to be not as hot just because it’s a normal seasonal slowdown, but again – so we feel very good about that. On the SBA side, as you noticed, as Jimmy mentioned, we did not sell as much of our production this quarter as we did in the prior quarter, which has been part of our strategy. Fundings were up pretty significantly, right online with our plan and budget and so we would expect to see the same kind of growth in the third quarter that we showed this past quarter. So again, feel very good about that. Brokerage, it looks like it’s down, it was down quarter over quarter, but we had a large campaign in the first quarter and so we had really outsized performance in the first quarter and we’ve just started adding some additional producers in brokerage and so we would expect that to start paying off probably in the fourth quarter. So again, we would expect continuing same kind of growth we’re showing because of the investments we’ve made.

[Rex Schuette:]

And probably just the other comment, Lynn, on fee revenue than the tax rate. Fee revenue and other fee revenue, you’ll see that up on a linked quarter basis and that is primarily driven by our customer swap program that we have with our commercial loan customers out there, it’s about $0.5 million in the quarter. So it’s about up about $300,000 on a linked quarter. So very solid performance for that. On the effective tax rate for the quarter, it’s slightly over 38%, 38.2%. That’s really driven again by the mix of some of the merger charges coming in, some detectable, but on a prospective basis, we’ve been averaging around 37.8%, 38%, 37.8% to 38%. We should be in that same range prospectively and we might have some other adjustments in Q3 because of merger charges coming in on that. But that’s kind of the run rate, Jennifer.

[Jennifer Demba:]

Thank you very much.

[Operator:]

Our next question comes from the line of Jefferson Harralson from KBW.

[Jefferson Harralson:]

I’m going to follow up on Jenny’s questions on the SBA specifically. You got to $34 million on SBA loans originated and you think that – I guess, when will we get to a full ramp here, is it at $40 million, at $45 million, at $50 million? With the investments you’ve made, what can you say about what kind of run rate originations that you expect to get to?

[Jimmy Tallent:]

So the third quarter we would expect to be up from where we were in the second quarter by an equivalent amount of our growth in the first quarter. And as we look at fourth quarter, historically fourth quarter is a strong quarter for SBA and so a little additional growth in the fourth quarter. We’re pretty much at a full complement of staffing, so again we feel very good about the team and very good about their ability to put those numbers up.

[Operator:]

Our next question comes from the line of Nancy Bush from NAB Research.

[Nancy Bush:]

I have two questions for you. The first one, Synovus had some very positive comments about the Atlanta market yesterday, both the demand side there, but also were very cautious about the competitive side. They said that competition has fought back in. And I wanted to just get your view of the market, how you are competing there, are there any segments where you think you are moving market share and are there any segments where you’ve just decided that competition has become too crazy?

[Lynn Harton:]

We also like the Atlanta market. As we mentioned earlier in the year, we opened actually up a new region in that kind of middle Atlanta area and we continue to add to the team there. Yes, it is very competitive; every market we are in is extremely competitive. We are very focused on the small end of the commercial side, also we have some specialized lenders there in Atlanta that work up team together with the branches, specifically in SBA and commercial real estate. So in our mind, it is a very attractive market. We don’t see the competition there any more drastic than in Savannah or Knoxville or Greenville, and we’re just trying to compete with hiring the best. I mean, it sounds straight, but the best bankers that we can and let them bring the relationships over and that’s kind of what we’re focused on.

[Nancy Bush:]

Are you big enough there yet to really be moving any market share that you can see or is that yet to come?

[Lynn Harton:]

That’s really hard to say in terms of we are growing there. In terms of picking up dramatic market share, I don’t know that we are going to – we are large enough to move dramatic market share, but we are clearly growing there and we feel very good about continuing to grow. Jimmy, I don’t know if you got any additional comments.

[Jimmy Tallent:]

Sure. Well, the beauty of that is certainly a little bit of market share growth there has a significant impact on our company. I would say that the opportunities that we are seeing today are significantly more there than just a few quarters ago. I think Atlanta particularly was a little slower with getting traction in our economy. Though, I think that is making a mass progress. It’s still a very dynamic market, very large corporation, we continue to see expansions. New companies moving in, I’ve seen more cranes in Atlanta today than I have in years, so we are very optimistic about the market. Our goal today is to slash off a little piece of that dynamics there and I think that will have a significant benefit to the growth and we’ve been able to continue to add to a very capable team. So that would be my comments, Nancy.

[Nancy Bush:]

Secondly, as you approach the $10 billion, sort of the magic $10 billion mark, I mean as you say, you probably will be under at year end, but I mean inevitably you’re going to cross it and maybe cross it significantly. So how are you thinking about that change from under to over $10 billion, how do you have to ramp up for that? Do your compliance cost then after $10 million sort of go up exponentially and what do we expect as you guys grow I guess is the bigger question?

[Jimmy Tallent:]

Sure, Nancy. Let me give you a little bit of color and maybe some of our thinking in regards to that $10 billion. Once again, we will not cross the $10 billion in 2015. Today, I do believe there is a good probability that that would occur in 2016. But suffice it to say that we still have some flexibility with our securities portfolio in helping to manage ourselves underneath that. But here is what we do know specifically. After the Palmetto closes, the Durbin impact is going to be somewhere in the $8 million to $9 million range. The FDIC insurance assessment will be in the $1 million to $2 million range. So we know that absolute. Again, we will not exceed that in 2015. Now, assuming that we do cross that landmark in 2016, our Durbin effect will not go into force until 7/1/2017. Of course, by the end of 2017, the [DFAS] also gets ramped up. We have been adding to the compliance arena for some time, we probably will add a few more but not a significant cost because we’ve been investing in that now for almost 2 years. Currently, we are working on plans to have offset this additional cost. It includes cost saves, it includes revenue enhancements, it includes acquisitions. Now, in regard to the acquisitions, would it take the shape of three or four banks in that 18 to 24 month period that [indiscernible] save $500 million to $1 million, that’s a possibility or a bank of $2 billion or $3 billion in sales that would have to cross that in a more meaningful way. Today, I can’t answer that specifically on the M&A because we have very specific criteria that we will not deviate from, but clearly we understand who we are, the cost associated with it and where we need to go. Did that help?

[Nancy Bush:]

Yes, there is a plan there. Alright, thank you very much.

[Operator:]

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

[Matt Olney:]

Within operating expenses, I believe in your prepared remarks you said what the contribution of the recent acquisition was. Can you repeat what that was in the second quarter?

[Jimmy Tallent:]

The contribution, Rex, of FNB transaction?

[Rex Schuette:]

You’re asking on the revenue side, is that?

[Matt Olney:]

No, I’m sorry. Just on the expense side?

[Rex Schuette:]

Expense side, it’s roughly about $1.7 million of expenses with FNB in the quarter, for two months. And that’s pretty much the run rate we anticipated. If you go back early, you have to go to their call reports, they’ve been running about $900,000 a month in Q1. So the run rate has come down a little. And again, as we have indicated, we expect to get 35%, 40% savings by Q4 in that run rate by going into Q4 with the conversion completed as well as going through the balancing everything and consolidating six offices in August.

[Matt Olney:]

So as we look to fully integrate that in the third quarter along with partial impact of Palmetto, any range you can give us in terms of what we should be expecting for operating expenses in 3Q?

[Rex Schuette:]

If you look at – they just released this morning, Palmetto did, and again on a monthly basis, they’re about $3.2 million or roughly $9.5 million a quarter to $10 million is their run rate right now and they just released this morning. So you have about one-third of that hitting in the third quarter, Matt, because again with conversion, we won’t get the savings until we get closer to conversion. And that run rate will continue in the fourth quarter as far as the expense line is concerned.

[Matt Olney:]

And then just the legacy bank, any material change in expenses in the third quarter?

[Rex Schuette:]

Not any material changes on the run rate, it’d be fairly consistent. There are some little ups and downs when you look at it on run rate, advertising aside because of customer appreciation, professional was little high with some initiatives, some of those will move around coming into Q3, but not a significant move.

[Operator:]

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

[Christopher Marinac:]

Jimmy, just to get back to your point about 2017, so if you cross over $10 billion and there is no financial impact in 2016, it’s all beginning in the second half of 2017? Just want to clarify that.

[Jimmy Tallent:]

That’s correct.

[Christopher Marinac:]

And my original question was on the refi business in the mortgage side, should that percentage change much as the third and fourth quarter develop and will the purchase number naturally grow as you continue to execute there?

[Jimmy Tallent:]

Yeah, we would expect – the purchase business has continued to grow as a percentage and we expect to continue to see that happening.

[Christopher Marinac:]

And then back to the SBA business, would you expect any changes from the program, I mean, as you get deeper in this business, would there be any shifts in terms of where FSS comes from Congress or would [indiscernible] the program in general?

[Jimmy Tallent:]

So there is a possibility just because it’s tied to overall government funding that there could be a time out in September potentially. All of our information dealing with contacts on the heels, there is no doubt that it will be funded, but there may be a 30-day hide. Yes, we’ve gone through that many times before. We’re executing a plan now to go ahead and get our approval numbers before August. Right now, it’s fully funded through the end of August. So we don’t think it’s going to have any impact on our business and we don’t see any significant changes in our program, it’s got a lot of support on the heel. And again, we feel very good about where it’s going in the business itself.

[Christopher Marinac:]

Is it a fact that you didn’t sell certain loans this quarter, did that flexibility give you an option if that scenario occurs?

[Jimmy Tallent:]

It does.

[Operator:]

This does conclude the question-and-answer session of today’s program. I’d like to hand the program back to Jimmy Tallent for any further remarks.

[Jimmy Tallent:]

Thank you, operator, and let me say thank you all for being on the call today as well as your interest in United Community Banks. As a reminder, the Investor Day that’s scheduled for October 8 in Atlanta, we hope that you’re able to take advantage of that and hope to see you there. And also to our team, our United team, once again, just a huge thank you for your continued support and execution in driving this company to a level that we all desire. Thank you for your continued support. With that, I hope all of you have a great day and look forward to talking to you at the end of the third quarter.

[Operator:]

Thank you, ladies and gentlemen, for your participation in today’s conference. This does conclude the program. You may now disconnect. Good day.