Earnings Call: Q2 2019

Jul 24, 2019

Good morning, and welcome to United Community Bank's Second Quarter 2019 Earnings Call. Hosting our call today are Chairman and Chief Executive Officer, Lynn Harton Chief Financial Officer, Jefferson Harrelson Chief Banking Officer, Rich Bradshaw and Chief Risk Officer, Rob Edwards. United's presentation today includes references to operating earnings, pre tax, pre credit earnings and other non GAAP financial information. For these non GAAP financial measures, United has provided a reconciliation to the corresponding GAAP financial measure in the Financial Highlights section of the earnings release, as well as at the end of the investor presentation and both of these are included on the website atucbi.com. Copies of the 2nd quarter's earnings release and investor presentation were filed last night on Form 8 ks with the SEC, and a replay of this call will be available in the Investor Relations section of the company's website atucbi.com. Please be aware that during this call, forward looking statements may be made by representatives of United. Any forward looking statements should be considered in light of risks and uncertainties described on Page 4 of the company's 2018 Form 10 ks as well as other information provided by the company in its filings with the SEC and included on its website. At this time, I'll turn the call over to Lynn Harton. Good morning and thank you for joining our call. We appreciate your interest in United and we look forward to our conversation today. Our Q2 results represent a continuation of great execution by our teams across the company. We reached an operating return on assets of 150 basis points, the best in our history. Our operating EPS was $0.59 an increase of 11% year over year. Our net interest margin increased slightly quarter over quarter. Both loan and deposit growth were on target with expectations and our First Madison partnership continues to be on track. Our markets continue to perform well economically and our credit results reflect that sound economic foundation. Here in Greenville, we sit in the middle of some important international supply chains, and so we are aware of the uncertainty that global growth and trade frictions can have on local companies' decisions to invest for the future. It's unclear today how those uncertainties will develop. However, we believe that we have positioned the company to be able to perform well in any normal economic cycle. Over the past several years, we have entered into several new business lines to diversify our revenue sources and leverage our strong brand and local relationships. We have grown historically strong lines of business and expanded our footprint and brand into several new fast growing markets. These initiatives have enabled us to exit less profitable areas like purchased indirect auto loans and improve the strength of both our core earnings and our balance sheet. We are a much stronger and more profitable organization and one less dependent on traditional community bank lending alone. We have continued to enhance our credit culture through process improvements, improved talent and disciplined concentration management by product type, relationship size and geography. Our funding base continues to be one of the strongest in the South as our service based culture continues to deliver high quality core deposit growth, giving us ample liquidity and low cost funding. We've continued to keep pace in technology investments, both in digital solutions for our customers and operational improvements for our employees. But most importantly, we have maintained our focus on the fact that this is a people business. We have an outstanding team that works together to produce great results. We are also able to attract great bankers to join our team and they are drawn in large part to the same attributes that our customers value in us. We're small enough that individuals matter, large enough to have the products and services to compete and forward thinking enough to have a promising future. We're excited about the path that we're on and we appreciate you being here with us. So Jefferson, why don't you give us more details on the results for the quarter? Sure, Lynn. Thank you. I'll begin on Page 6 to discuss our net interest income and margin trends. Our net interest income increased 7.4% annualized versus last quarter and increased 9% year over year. Spread income growth did benefit from 2 months of First Madison in the numbers. Our net interest margin increased by 2 basis points to 4.12% in the quarter, of which 1 basis point came from slightly higher accretable yield versus last quarter. Last quarter, I mentioned on the call that about 3 basis points of 1st quarter accretable yield would not repeat. In the Q2, these 3 basis points in fact did not repeat, but were replaced with some of the initial accretion from First Madison. Turning to Page 7, we take a look at our deposit base. We are very proud of our core deposit base with a 33% contribution from demand deposits. Our cost of deposits were only up 3 basis points versus last quarter and we continue to be well ahead of our peers in deposit cost. On Page 8, we were also pleased with the growth in our core transaction deposits so far this year. Core transaction deposits were up 8% annualized year to date with $302,000,000 of growth, which more than fully funded all of our loan growth this year. On Page 9, you can see our loan portfolio breakout, which is very diversified. We were pleased to grow loans excluding First Madison and indirect auto loans at a 9% annualized pace versus last quarter. On Page 10, we look at non interest income, which was up $3,500,000 versus last quarter and up $1,200,000 versus last year. We experienced good growth in fees across the board with a record mortgage production quarter and higher SBA brokerage and other fees as well. Expenses on Page 11 were in line with or slightly better than our expectations. Our increase in expenses came mainly from merit increases and higher mortgage commissions. Our operating efficiency ratio came in at 54.4%, which is a new low for our company. Credit quality on Page 12 was stable with improved net charge offs versus last quarter. We recorded a $3,200,000 provision that more than covered the $2,400,000 in net charge offs. Our reserve percentage did decline to 70 basis points with the addition of the First Madison loan book. I'll finish up on Page 13 with capital. Our risk based capital ratios came in as expected the all cash First Madison deal, while our leverage ratio and TCE ratio saw slight improvement as we continue to shrink our securities book, which offsets the impact of the deal. We had no buybacks in the quarter and we will look to be opportunistic with the $42,000,000 remaining on our authorization. And with that, Lynn, I'll pass it back to you. Thanks, Jefferson. We are pleased with these results and I'd like to close my comments by once again recognizing and thanking the United team. It takes great people to deliver great performance. For those of you that are listening in, I am proud to work alongside of each one of you and I thank you all for what you do every day. And now we'll be glad to answer any questions that you might have. Thank And our first question comes from Catherine Mealor from KBW. Your line is open. Thanks. Good morning. Good morning. Good morning. Really great quarter. But I thought I'd just start with the margin. You've seen some really nice margin expansion and a lot of it's been from mix shift, but also your asset sensitivity. So just wanted to get an update on how you're thinking about your margin outlook if the Fed does cut later this month or again this year? All right. Thanks, Catherine. If we get a rate cut, we do have 53% of our loans that are floating. Of that, 62% are tied to LIBOR, dollars 2,900,000,000 38% of those are tied to prime, which is $1,500,000,000 So, we have had some of the impact on our LIBOR loans already and then you'll get a more full impact on LIBOR and prime with a cut. I think that the margin, think of it because we'll still have some positive mix change occurring. We still have flexibility with our lower loan to deposit ratio. I think of it as down on a rate cut down 7 to 10 basis points on our margin offset by some 2 to 3 basis points of continued mix benefit over time each quarter. So that's 7 to 10 bps per quarter per cut? That's right. Okay, got it. And then how you mentioned your loan to deposit ratio. I mean, how aggressive do you feel like you could get on lowering deposit costs and then bringing that loan to deposit ratio higher when the Fed cuts? Right. So on this part of that question, I might have to ask you to redo that. Do want to say that when you mentioned 7 to 10 basis points per quarter for each cut, I would make sure you do the offset each quarter for the remix as it continues to occur. Yes, yes. So 7% to 10% on a core basis offset by the mix. So you're kind of like 5 bps per cut roughly? That's right. Okay. Okay, that makes sense. And then my other question was just how aggressive you think you could be on bringing your loan to deposit ratio higher as you push deposit costs down in a rate cut? Right. So we do have a nice loan to deposit ratio. We do have a great core deposit base. We have customers. We want to we do want to grow our customers. We can be a little more conservative. We already have lowered our CD rates. We have seen some other competitors do that as well. We have lowered some other rates. We're going to take another look at deposit rates if we do get a cut on the 31st. So we do look to be, I guess, I'll use the description aggressive in our deposit rate cuts. So we think we do have the flexibility to do that. And we're not looking to shrink our deposit base. We're still looking to grow our deposit base, but we think we do have flexibility with the loan to deposit ratio and do plan to be relatively aggressive in cutting pricing on some deposit types. Okay. That's great. I think one other one on just growth. I mean growth is fantastic this quarter. Any update on the back half of this year? And how much of that you think will come from your core businesses versus the Navitas growth? All right. Rich, do you want to start with that or I can jump on that too? You want me to start on how we feel about Q3? Yes. Sure. So, Catherine, good morning. Our branch delivered another strong production quarter. Pipelines for loans and bankers looks good for Q3. However, we have seen lower payoffs in Q1 and Q2 and anticipate more normalized payoffs in Q3, but expect to still be at mid single digit growth for the quarter. Okay. Great. And how and do you think the percentage of Navitas versus kind of your core bank should stay about where it is? Or do you see that mix shift changing over time? Thanks. So we are around 7.5% of our loans being Navitas loans currently. They have been a good source of growth for us. We're very happy and pleased where that deal is. Now we have imposed a limit of having Navitas loan to total loans of being around 10%. I think we mentioned last quarter that we are planning on in the Q3 to begin selling Navitas loans. So I think that you're going to see the because of the selling of certain Navitas loans, you're going to see the percentage of growth coming from Navitas decline and you're going to see the percentage of Navitas loan to total loans stay more stable and less than the 10% limit. Great. All right. Awesome. Thank you so much. I'll pop out. All right. Thanks. Thank you. Our next question comes from Brad Milsaps from Sandler O'Neill. Your line is open. Hey, good morning. This is actually Peter Reese on for Brad. Hello, Peter. Hello. So maybe just following up on the NIM, could you maybe give a little bit of color on maybe the specific impact from Navitas, just on the loan yield side with each rate cut and what that kind of looks like? So the I would not expect a from the loan yield side, a big move from the VITUS loans. They're longer term in nature when they are made. They sort of I would not expect a decline in the VITUS loans as rates decline. There is some pricing competition in the business, but from the rate cut itself, I don't expect a lot of change there. Got it. Okay. And maybe just on expenses, I mean, you guys maybe came in just a bit below your previous guidance for this quarter. But what are you kind of expecting here as we go into the back half with First Madison kind of integrated and what kind of the run rate looks like going forward? Yes. Thanks for the question there. So on Navitas or on the expenses, we do have a full quarter of First Madison to come in. We have core growth and we've also had some relatively significant hires over the last quarter and we expect more of those to occur. So if you combine the 3 of those, I think the I put a number out there of maybe 79.5 for Q3 and then more of a core low single digit growth rate off of there. Got it. Makes sense. Thanks so much. Thank you. Our next question comes from Tyler Stafford from Stephens. Your line is open. Hey, good morning guys. Good morning. Hey, I just wanted to start on fee income and congrats on a nice quarter by the way. But on fee income, can you just give us the mortgage production that you saw this quarter and then the SBA production you saw this quarter? Yes. So the mortgage production in the form of applications was $410,000,000 and the SBA production in terms of originations was $31,000,000 Got it. Okay. Thanks. I guess one for me just on Navitas and obviously credit hasn't started to percolate on at least from what we can tell there on that portfolio. I'm just curious if you're starting to see kind of any signs of weakening specifically on the Navitas portfolio or if everything is still pretty clean? Yes. So this is Rob Edwards. Hey, Tyler. I would say we have not seen really any change. Really our Q1 of owning Navitas was Q1 of 2018 and it's now it does the losses do change from quarter to quarter, but it's been right in line with our expectations. In fact, on the loss side, it's been, I would say, a little bit better than expectations here recently. And then we do they do have a fairly robust portfolio management process where they're refreshing external scores on the portfolio on a monthly basis and those continue to look very consistent as well. Good. Okay. And then just lastly for me, the SNC balances that you guys provided in the deck, those declined, call it, 25% from last quarter. I'm just wondering, I guess, what drove that decline if it was more of an intentional exit based on kind of what you're seeing on those underlying credits or if that was just normal pay down activity that took those balances down and if there are any more kind of planned exits over the near term? So I wouldn't define it as planned exits, but I would just say we have been saying that we're sort of lukewarm, maybe I should say cool in the leverage loan portfolio. A lot of that portfolio is done through the Shared National Credit Avenue. And so I would just say, I think we're comfortable where we are there. When we're in SNCs, generally, they're with local companies where we're close to and know the management team. And so that's the majority of what that book is. And I would expect it to be stable, but not see a lot of growth there. Okay. And maybe just last one for me, just going back to Navitas. Do you have what the average yields were this quarter? I think I do, Tyler. Let's see what I have here. I do not. They're relatively stable, but I'll get back to you. Okay. Okay, great. Nice quarter, guys. Thanks. Thanks. Thank you. Our next question comes from Jennifer Demba from SunTrust. Your line is open. Good morning. Good morning. Question, wondering if you can give us an update on your Atlanta progress, specifically with new hires or loan production and maybe talk about any other hires that you'd want to highlight across the other markets? Thanks a lot. Yes, sure, Rich. Hi, Jennifer. In Atlanta, in Q2, we hired a new Market President in Buckhead, Sharon Thompson, who has brought on another lender in Q2 and another lender just started this past Monday. I will tell you that we are looking at additional hiring there and feel very good about that. In addition, I wanted to highlight Charlotte. We opened up the community banking market there with a new market President, Charlie Curtis and he has brought on an additional commercial lender and this is adding to our Charlotte presence of asset based lending, builder finance, SBA, renewable energy and mortgage. And then lastly, in Columbia, South Carolina, we executed a lift out late in June. The new market President is Shannon Stevens and he brought 2 commercial lenders with him. Thanks so much. Thank you. And our next question comes from Christopher Marinac from Janney Montgomery. Your line is open. Thanks. Good morning. I want to delve into credit a little bit more with Rich on the specialty C and I front and just get a sense of behind the numbers that we saw, which are very good this quarter. Any other trends that you see both inside your portfolio as well as sort of your loans that you see as opportunities for the future just terms of general trends on credit? So, Christopher, hey, this is Rob. Maybe I'll answer the first part of that question just in terms of credit trends and then if Rich wants to chime in on opportunities on the C and I side in the future, that'd be fine as well. I would say economically speaking, it just feels like there's a lot of mixed signals out there so we're aware of that and we're watching the portfolio closely. We do have, I would say, relatively conservative project limits at $20,000,000 and relationship hold limits at $35,000,000 So we don't it's a fairly conservative portfolio from that aspect. When we look at our criticized and classified, we're basically flat year over year. So there will be some ups and downs quarter to quarter, but we feel good about we are. Chris, this is Rich. In terms of C and I, we still are very positive on that asset class and putting a lot of effort and a lot of our hiring is very focused on that. Okay, great. And then I guess just follow-up for either you, Rob, or others is, there's a scarcity of banks now in Carolina. And I'm curious, does that help you on the conversation as United is coming into these markets and ramping up with your production team and of course continuing to hire as you outlined? Is that sort of scarcity of competition incrementally helping you? I would say the answer is yes. In the last as you all are aware, in the last 2 years, there's been a lot of M and A activity in North Carolina and that it always creates opportunity at both the customer and the banking level and we're probably seeing that same thing in Atlanta as well. Great. Thanks very much guys. Appreciate the color. You bet. Thank you, Chris. Thank you. And our next question comes from Michael Rose from Raymond James. Your line is open. Hey, guys. Just wanted to get some color on efforts and if you think that we're at or near peak for costs. Thanks. I'll give a start. This is Jeff for sale on the deposit growth. A lot of it has just been blocking and tackling and new hires in the new markets and the efforts over the last few years, we have been very pleased with that. We have our deposit pricing in the middle of the peers right now and our growth rate has been very strong. On the brokered side, there has been an intentional decision to shrink brokered and FHLB and offset that with securities shrinkage. That's been a strategy. I do think that Q3, we have lowered some deposit pricing, but we also have probably a 3 or 4 months of CDs repricing higher. So I think the net of that is going to be a cost of funds that's right around here or maybe a basis point or 2 higher next quarter and then improved for the Q4. So I think we're right at the apex of deposit pricing in Q3. Okay. That's helpful. And then just one separate question for me on capital. Obviously, it was down a little bit because of the deal, but still very healthy. How do you guys think about the buyback at this point? Right. So if you think about capital for us, number 1, we want to use it for growth. We have been we have had higher growth recently. So we think that use is increasing. Deals, we like to use it in deals. This is the number 2 use of capital for us and we like to use cash at deals when we can. 2 years ago, we were able to put $84,000,000 of cash into the Navitas deal and we're able to put $53,000,000 of cash in the First Madison deal, which has helped. We do have some optimism on our pipeline that we'll be able to use cash in deals over time as well. And then maybe 3rd is buyback. So we are going to be managers of our capital. We do have $42,000,000 of authorization left. So depending on the first two, we would look to be opportunistic and perhaps aggressive on the buyback. Okay, that's helpful. And then actually just one more for me. Just as it relates to CECL, any sort of update there? And as we go through it, any thoughts around potentially changing any portion of the loan mix, just given some of the longer dated consumer stuff is hurt a little bit more through that process? Thanks. So Michael, this is Rob. I would just say we're on track for CECL. We've run our models against the portfolio 2 quarters in a row now and are increasingly confident with the modeling and the results of those and the looking forward to continuing to build a robustness there of that process. And I would say the answer to your second question is that we have not yet really made any decisions around remix based on CECL results. Okay. Thanks for taking my questions. Thank you. And I am showing no further questions from our phone lines. I'd now like to turn the conference back over to Lynn Harton for any closing remarks. Well, great. And thank you all for being on the call and for the questions, great questions. And we are very excited about where we are and look forward to seeing you next quarter. So have a great day. Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone, have a wonderful day.