Earnings Call: Q3 2018

Oct 24, 2018

Good morning, and welcome to United Community Bank's Third Quarter 2018 Earnings Call. Hosting the call today are President and Chief Executive Lynne Harton Chief Financial Officer, Jefferson Haralson and Chief Credit 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 of the GAAP financial measure in the Financial Highlights section of the earnings release as well as at the end of the investor presentation. Both 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 on 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 2017 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 all for joining our Q3 earnings call. I'm pleased to report another quarter of strong results. Core deposits grew at a 6.5% annualized rate. Our net interest margin improved and we exceeded our return on assets goal, posting an ROA of $142 on an operating basis. Our asset quality remains outstanding and it continues to be a cornerstone of our performance goals. Our operating earnings per share reached $0.55 which is up $0.02 or 4% from last quarter and 0 point 14 Q3. During the Q3, we were also pleased to declare a dividend of $0.15 per common share to shareholders of record on September 15, 2018. This is equal to last quarter's, but it represents a 50% increase over last year and continues to reflect our strong profitability and our positive outlook. I'll now turn the call over to Jefferson for more details on our performance in the Q3. Thank you, Len. We are pleased with the performance of the quarter and having exceeded a key profitability goal of a 1.40 percent ROA. If you would like to follow along with me, I'm starting on Page 5 of the investor deck. On Page 5, you'll see we had $112,100,000 in net interest income in the 3rd quarter, up 13% annualized from Q2. The spread growth we generated got a boost from a continued increase in our net interest margin. After a 10 basis point increase last quarter, the net interest margin was up another 5 basis points this quarter and up 41 basis points from a year ago. A normalization of accretable yield versus last quarter contributed to the quarter to quarter increase. On Slide 6, the stability and growth of our core deposit base remains a key strength to our company and a driver in our margin performance as rates have risen. We were particularly pleased with our core deposit growth in Q3, up nearly $70,000,000 and in customer deposits, we were up nearly $156,000,000 Our cost of deposits on Page 7 in the 3rd quarter was 42 basis points, up 9 basis points linked quarter and our loan to deposit ratio was stable at 82%. Turning to loans on Page 8, end of period loans were relatively flat in the quarter and up 2% annualized excluding our strategic indirect portfolio runoff. Our loan production in the quarter was strong at $778,000,000 albeit down from last quarter's record and up 26% over the same period last year. We had $44,000,000 of loan growth at Navitas as our investments in the business appear to be pushing the growth rate higher than our original expectations. The Navitas growth more than offset $41,000,000 in indirect auto runoff and at quarter end we had $242,000,000 remaining in indirect auto loans. Moving to Page 10, fee revenue in the Q3 was $24,200,000 up by $900,000 from last quarter and up $3,700,000 versus last year. SBA gains increased $200,000 versus last quarter due to higher loan sales, although at lower gain on sale margins as market pricing has decreased on these guaranteed loans due to increased prepayment speeds. Our SBA construction loan backlog increased to $91,000,000 at September 30. Our mortgage business also continues to perform well and mortgage fee income is up $1,100,000 or 26% above last year. In the Q3, we had closed mortgage loans totaling $237,000,000 compared with $192,000,000 last year. This is a 23.5% year over year increase in mortgage loans closed. Turning to Slide 11, operating expenses were up $3,100,000 in the quarter versus Q2. The lion's share of the increase comes in the salaries line with increases in incentives as a driver as well as investments in our Navitas and other businesses. On Slide 12, we are also pleased to be able to report outstanding credit results again this quarter. Net charge offs were very low at 7 basis points, flat versus last quarter. Nonperforming assets came in at 19 basis points, a slight improvement over last quarter last year. We also have a new slide in the deck on Page 22 that I'll highlight very briefly that looks at our core ROA and core pretax pre provision earnings versus peers with and without accretable yield and compares us to our regional peers based on 2nd quarter results. With that, Len, I'd like to turn the call back over to you. Thanks, Jefferson. We are once again proud of our performance as we continue to execute on our strategy of having great bankers who deliver best in class service. We were also glad this quarter to be recognized as one of the best banks to work for in the United States by the American Banker for a 2nd consecutive year. For our team members listening in, thank you for making this a great place to work, a great place to build relationships and a great place to build a career. None of this would be possible without you. One of the people that has long been responsible for making United great is our President of Community Banking, Bill Gilbert. Late last month, we announced that Bill will retire effective February 2019 after what will be 19 years with United and 42 years in banking. Bill's passion and commitment to our company and to our customers has been a cornerstone of this company. He has been an integral part of shaping United into the bank it is today. So congratulations, Bill, and thank you for all you have done for this company and for me personally. I'm also proud to announce that Rich Bradshaw, formerly President of Commercial Banking Solutions will add community banking to his responsibilities when Bill retires. Rich has done a phenomenal job of building and growing our commercial bank and creating an unusual partnership between our commercial specialties and our community teams. I am confident in our continued growth and success under his leadership. Now we'll be glad to answer any questions. You. And our first question comes from the line of Brad Milsaps of Sandler O'Neill. Your line is now open. Hey, good morning guys. Good morning. Good morning. Jefferson, maybe I want to start with the margin. Just wanted to see if you could maybe give us a little more color on kind of how you're thinking about it over the next couple of quarters. Maybe specifically, I would have thought you would have had a little more growth in core loan yields given the mix change with more Navitas loans and fewer indirect loans. And as a follow-up to that, on the deposit side, you guys talked about a lot of the good core deposit growth, but it also looks like you're also growing brokered time, a fair amount, both on average and period end. Just kind of curious the strategy behind that. Is that more of a little bit of a leverage trade? I assume your people would you can't pay them in margin, you got to pay them in NII. So is that kind of the driver behind that? And just kind of curious how big you plan to take that brokered piece? Yes, thanks. Great questions, Brad. I'll start with the brokered piece of it. You did see an increase in broker deposits this quarter that was mostly offset by shrinkage in the FHLB book. We think of those as being, I guess, interchangeable. And what we saw is the just more attractive rate and broker CDs versus FHLB, especially for anything that has some term with it. So you'll see that if you think about those together, we didn't really add a lot of levers this quarter. It kind of looked like it if you look just at the broker CDs, but the FHLB mainly offsets that. On the margin, we did have nice margin expansion this quarter. Some of that a lot of that was accretable yield. We do think that the I guess for a forecasted margin, I think flat is probably a decent forecast for the margin going forward. We have had a nice 15 basis points of margin expansion over the last couple of quarters. We do have some tailwind from a remix towards Navitas and we do think we did become a more liquid bank this quarter with the strong deposit growth that we had. And we do think over time we should have a lower deposit beta versus peers. And I think that we have some flexibility there are a lot of banks versus other banks there. So I do for Q4, I think it's relatively flat. I do think there is a positive story in the margin over time. I think there was another part of your question that I might not have gotten to. Yes, just the mix. And I don't know if you address the mix change is more Navitas loans coming on and how that impacted the loan yield during the quarter? So the loan yield was up 17 basis points in the quarter. Of that 17, 8 was the accretable yield increase and 9 was core. So I don't have the breakout of exactly how much of that 9% core was Navitas, but a good bit of that 9 basis points of core would be Navitas. Okay. So otherwise, loan yields kind of staying fairly stable outside of the growth in Navitas? Yes, maybe up 2 or 3 basis points there. Okay. All right. Great. Thank you very much. I'll hop back in the queue. And our next question comes from the line of Catherine Mealor of KBW. Your line is now open. Thanks. Good morning. Good morning. Good morning. So the total loan growth has been a little bit soft the past couple of quarters. What do you think would be the driver to this improving moving forward? Or is a low single digit growth rate kind of more appropriate at this stage of the game? Thanks. Hey, Catherine. This is Lynn. Yes, I think honestly I think for the next 2 or 3 quarters, probably the same kind of rate is probably appropriate. And a couple of reasons. One is our credit appetite. We've talked about commercial real estate and our appetite in some of the products that we think are a little overheated. And honestly, I think commercial real estate is going to slow down overall anyway when you look at rate increases, materials inflation, labor inflation, I think that will slow for the industry by naturally. The other place that we could get a lot of growth that we decided that we've chosen not to is in leverage lending and again in a rising rate environment. I don't know that it makes sense to lean in there. So some of it is our credit appetite. Part of it is though we are addressing. So we have been laser focused on our new acquisitions. So we've invested heavily in South Carolina with the acquisitions there and new relationship managers. We've invested heavily in North Carolina and the Raleigh market with our acquisitions there. And we are we've invested heavily in Navitas. We're actually up a lot of several producers in Navitas. And that's been positive and good. And if you look at our numbers, those are the areas that are growing. Now what we have not done and this has been my mistake is we haven't shown the same attention to recruiting in our legacy growth markets. We're actually down 1RM year over year in Atlanta. That doesn't make sense. I shouldn't have let that happen. We're down 1RM in Savanna year over year. So one of Rich's new mandates is to kind of restart the recruiting engine in those markets, Charlotte as well. We are actively just began a pretty big recruiting effort in Atlanta as we speak. But that will take a few quarters to kick off. I'm confident we'll be successful. We've always had great success recruiting. But all that pulled together, I would say, for the next 2 or 3 quarters is probably the kind of growth that we're going to we're expecting. Okay, really helpful. Thank you, Lynn. And on the buyback, can you remind us what your current authorization is and how and if the buyback is something that you're considering now with the pullback in your stock? Yes. Thanks, Catherine. So we have authorization of a little less than $30,000,000 remaining to buy. We haven't bought shares in 2018 or 2017. We are growing capital at a good pace. As you can see in our deck, we do think that it's possible that an acquisition could come up maybe that we can put some cash into. I think if we are unsuccessful in acquisitions through 2019, perhaps we'll take a stronger look at the buyback. So the buyback is out there. It is a lever that we can pull to increase earnings, but we think that we can most likely use it in a more efficient way in 2019. Okay. So I'm hearing you right, it doesn't sound like you'll be active this upcoming quarter just given where your stock is? I don't think we'll be active this quarter. Okay, great. Thank you. And our next question comes from the line of Jennifer Demba of SunTrust. Your line is now open. Thank you. Good morning. Good morning. Good morning. On the recruiting side, Lynn, you said you wanted to reignite some efforts in Atlanta and Savannah. What would be your goals in terms of number of RMs you'd want to pick up over the next year or so? Yes. So I don't want to put a number out there yet. I have shocked Rich with a number, so he's absorbing that. But the first step is we are recruiting a new overall leader for Atlanta. We're very excited about that and kicking that off. And so we're scoping that as we're going through the budget now in terms of investment versus payoff. And so I'm not ready to put a specific number on there, but it is a focus of the company for as we go into 2019. Okay. And follow-up on the last question, buyback M and A, that topic. What are you seeing? I mean, it's not been too long since the stocks have been behaving so poorly in the sector, but what are you hearing from the M and A targets right now and their willingness to talk in this environment? Yes, it's a great question. So to me, I would break it into kind of the long view and the short view. Over the long term, if you think over the next 3, 5 years, all the elements that have pushed a lot of consolidation are still in place and are still going on. And so we're having conversations with either companies that would add capabilities, whether they're private banking, wealth management or geographies that move us into faster growth areas or consolidation opportunities. We've got active conversations going on with companies that fit all three of those pieces, looking building those relationships to be ready over that timeframe. So I think we will participate over the long term. Look, the reality is in the short view though, at these prices, it's very difficult to make anything work unless it's a very small deal that potentially you could do for all cash and it might just be a fill in cost savings exercise. So I think I think the conversations are going on, but I don't think a lot of things of significance are going to happen at these prices or they shouldn't. Right. Thank you. And our next question comes from the line of Michael Rose of Raymond James. Your line is now open. Hey, good morning guys. How are you? Good morning. Hey, just wanted to touch on profitability. You guys have hit your target. And obviously, the environment is getting a little more challenging here as you laid out from a growth perspective. Good to hear the NIM is going to be flat. But should we think about you guys being able to at least sustain kind of the ROA around the target that you just hit? And I guess what are the levers do you have both on the revenue expense side to maybe help improve that as we move through the next couple of quarters? Thanks. Yes, great question. And we do feel confident in being able to sustain that. We're committed to that and believe we can. I might let Jefferson give a little more put a little more color to that. Yes. So we're not backing off our ability to maintain returns. We're not backing off our ability to have operating leverage in 20 19. If we don't see the revenue we like, we'll pull the expense lever to get there. We are in the budget process of 2019. It's not the easiest budget year for us or I think a lot of banks, but we do think we can maintain this profitability going into next year. We're not putting out our guidance for ROA or ROE for 2019, I don't believe we'll revisit in the next quarter. We do want to be in the top quartile versus peers. And that's what we are focused on every day is to be a top quartile profitability bank. Okay. So maybe just a follow-up. So I assume you guys and you laid out your you have some hiring goals. I assume that you would want those hires to go forward regardless. So I guess what I'm trying to figure out is what other areas could you either reduce investment or cut costs? And I assume some of those branches, etcetera, but if you could just give a little more color, that would be great. Thanks. Yes. We're looking at all those areas. So branches, other back office areas where we've been on a pretty good tear on the M and A side and our focus has been on converting those correctly, getting them in the house correctly, if you will. And so we've got a fair number of efficiency opportunities we think to take advantage of as we go into 2019. We're looking at every non comp expense very hard with this budget and going into 2019 as well. Good color. Thanks for taking my questions. And our next question comes from the line of Tyler Stafford of Stephens Incorporated. Your line is now open. Hey, good morning guys. Good morning. Just want to start on the margin, just a follow-up. What's the normal amount of scheduled accretion that you would expect to see on a quarterly basis? So it's right in this range here. If you think about accretable yield will have to come through, in total it's about $28,000,000 We had $2,200,000 this quarter. So we've had and if you look at the marks that we've taken in the past, we're comfortably below the loss rates of those marks would anticipate. So I think this level seems like a good level and possibly could go up over time in the near term. And there's again, there's $28,000,000 left to go through in total. Okay. So to clarify the comment about the flattish margin in the 4th quarter that I guess that if the accretion is remaining constant, that would apply to both GAAP and core margin? Correct. Okay. On the marks, what's the remaining mark on the Navitas portfolio at this point? And how should we be thinking about the associated charge offs and provisioning impacts going forward as a result? So Tyler, it's Rob. There's a it's just shy of $2,000,000 marks remaining there. We did charge off just shy of $500,000 independent of the mark. So as we go forward, we're transitioning away from the credit marks. The marks that we have, of course, are on specific loans. So that's the way the accounting works there. So I would anticipate, we've kind of what they've run historically is just shy of a 1% loss rate and that's kind of the way we're thinking about it going forward. And I might add in this quarter and fill in Rob is that we were flat quarter to quarter on net charge offs, but there was a mix change a little bit where we saw some Navitas charge offs coming in a little bit and you saw our core legacy net charge offs improve and netted out to flat quarter to quarter. So last quarter, we were completely covered in the Navitas charge off by the credit mark. So we had no Navitas charge offs in the $1,400,000 charge off last quarter. This quarter's $1,500,000 included the $480,000 Navitas charge offs. So what Jefferson is saying is right. Our core bank charge offs asset quality is just very strong. So if the mark is largely gone and the, I guess, core credit or the credit profile of the core bank remains very strong here, What's the net, I guess, impact to the provisioning that we should be thinking about? Yes. So the provision is going to go up, of course, as the mark goes away, right? So if you say you've got a $500,000,000 portfolio and just for round numbers, we're using 1%, That's $5,000,000 provision next year to cover charge offs. And so you do probably $5,000,000 to cover charge offs and some loan growth. And then on the core bank, just from maybe it's just because I'm a credit guy, it feels awkward to budget less than 10% in charge offs. Tom, sorry, ten basis points. Thank you. So but we've had 7 basis points losses the last 2 years running. So kind of be the combination of those two things. You got to I will just remind you to keep in mind and I know I keep saying it, but the allowance is a function of 3 things. It's asset quality, which is of course very strong. We just talked about what we expect there, but also loan growth, which we're saying is low single digits. And then also it's the portfolio mix, right? So we were land loans were down $20,000,000 in the quarter. That's a high reserve rate in the model and replacing it with other even Navitas is lower than land loans. And so there's a little bit of a pickup you get in the shifting mix of the portfolio that is small, but it's sort of it continues on. Tom, I might just layer in too on the Navitas in total. And we originally said when we bought it, we thought we'd have $30,000,000 to $35,000,000 of quarterly growth. We've been investing in that business as you've seen some in the expense line. We had $44,000,000 of growth this quarter and we think that number can increase as we go through 2019 as well. Great. That's very clear. Thanks. And then just last one, just around the SBA business and with the pricing pressure that the industry is seeing, I'm just curious how you guys are thinking about that volume going forward? Yes. So we're we have seen decreases in the gain on sale as everyone has on gain on sale of SBA. We've been very happy with our investment in the business and the increase in originations over time. And we do have this really nice construction backlog of $91,000,000 that should help our ability to sell loans over time. The gain on sale of the 10 year piece, which is about half of what we do, has fallen from the 110 range to the kind of 108, 108.5 range. And so we absorbed that this quarter. If you think about our loans sold this quarter were up about 25% and our gain on loans sold was up only about $200,000 versus last quarter. So we do have there is some changes with the expectation and the actuality of higher prepayments in that business. The prepayments reached 20% for the industry there and that has translated into lower gain on sale. So as we go into next year, we do think we'll have higher originations next year, but the gain on sale could be lower if current market conditions exist. We have talked and I think we have talked with you too, is with the yield on these loans now around what we know call it 7%, 7.5% and a gain on sale around 8%, 8.5%, you could choose to keep some of these loans on balance sheet and not really lose a lot of income on that half of your production because you earn it back very quickly. So if the market conditions remain the same as we go into 2019, we could take a piece of our originations, hold it on balance sheet, help loan growth add a great quality asset with a 7.5% yield and come to breakeven in a very short period of time given the yield versus the gain on sale. Okay. That makes sense. Thanks, Jefferson. Thank you. And our next question comes from the line of Christopher Marinac of FIG Partners. Your line is now open. Thanks. Good morning. I had a question on the allowance and credit trends and Rob partially talked about it a few minutes ago, but just kind of want to get deeper, which is if the economy were to slow or you would see some negativity on credit trends, what has to happen to really kick in the reserve from the credit piece? I understand the loan, I mean the growth and the mix components as Rob described. I just want to get drill down on the first piece, which is what has to happen to really make a material shift in reserve policy? So we track lots of metrics that drive our view of expectations around credit quality. So risk grading migration or upticks in non accruals or changes in substandard assets. I mean, I quite honestly, I think our credit metrics are unusually low at the moment. As an institution, I think probably somewhere in 2016 was more of a, what I would call, a normalized expectation just from our institution's performance. So I could see some of our metrics kind of climbing up a little bit and that would still be a very normal view. So I think maybe the answer to your question is it would have to be a pretty sizable sort of recognizable shift in performance versus just kind of a minor fluctuation. Chris, I'll layer this. We have our reserve percentage that you see, but we also have a pretty healthy mark on loans that we have bought over time. And I think that if you add together the mark plus reserve on total loans, it's 1. 1.08. 1.08. Yes, so you got 74.34. So there's some additional cushion that you don't see there in the press release. And we do think that we have built this bank to withstand the next credit cycle in a very strong way. Also just add in there that you have a complete new model for credit losses coming in at the end of next year as well in the form of CECL. So we'll be running that parallel internally for 2019 and of course have the new accounting standard hit us at the end of the year. Right. Got you. No, that's very helpful. But and again, the trends that would have to deteriorate have even begun to deteriorate. And that was one of the points I wanted to just kind of reaffirm. I think when we see the Q, it will reaffirm that here in a couple of weeks. Yes, they have not. Great. Thanks guys. Appreciate the additional color. And our next question comes from the line of Kevin Swanson of Zekhavsky Group. Your line is now open. Good morning. So I just had maybe a follow-up question on credit costs excuse me, just credit in general. I guess just given some of the announcements in the past few quarters and maybe especially 1 or 2 this quarter around the industry, what appears to be, I guess, one off credit scores right now? Just curious on more of a on a higher level what you're thinking in terms of where we are in the credit cycle and anything specific that's starting to cause concern? Thanks. So the short answer is I'm truly not seeing anything from our perspective that's causing any concern, certainly not in our portfolio and really not economically. I do think we sort of are watching something. In fact, I met with our credit team yesterday and we talked about being sure that we're paying close attention to increasing interest rates in our underwriting and approval processes. And so we're not seeing anything from that today. So there's no signs of it. But if you're to say, if you look out into the future, I think everybody is saying and it's appropriate to be contemplating increasing interest rates in your underwriting processes. But we continue to we've not revised our like Lynn said it earlier and it's true and probably worth restating because of the credit questions, but our risk appetite has remained consistent. We continue to get strong equity in our deals. We started 4 years ago transitioning a land portfolio into a true vertical residential construction portfolio. We've accomplished that. We have very, very granular exposure across the portfolio. We've got project limits of no more than $18,000,000 on any single project. Our largest A and D project is $4,000,000 So we just have very granular and we've used the last 4 years to really position the portfolio and we stuck to our underwriting and I think it's been very effective. So I'm not concerned about our portfolio. We're not seeing any trends. I feel like we're very well positioned for whatever may come, but we're not seeing more sort of globally, we're not seeing any signs of weakening in any specific portfolio. Yes. I would echo that and just pick up on what Rob said about rates. If there's anything that could happen just because of the strength of the economy, I think we're on the cusp of a historically tight labor market, maybe beyond that. So wage pressures, our customers are telling us about material price increases. So you could see rates increase maybe faster or go further than the market might expect. And look when rates go up asset prices go down. So I mean you could have a slowdown caused by rates moving a little faster than people think. But we're very cognizant of that looking at that in all of our underwriting and feel really good about how we're positioned. Great. Thanks everyone. And our next question comes from the line of Tyler Stafford of Stephens. Your line is now open. Hey, sorry. Just one more for me on expenses. Jefferson, I think you said in your prepared remarks there was maybe some incentive expenses in the Q3. I'm just trying to figure out if there's anything that should fall out of this expense run rate or if this is a good kind of starting point going into Q4? Thanks, Tyler. So I think it is a good starting point from this quarter. I do expect the expense line to be relatively flat versus the last quarter. If you kind of look through the expenses of this quarter, I do see some lot of incentives in there. A lot of that some of that good share of it is Navitas being ahead of expectations and their incentive plan kicking in. You have I see other incentives here. I see bonus. I see also we had lower deferred costs this quarter with slower volume. So I think if you add it all together, think about the expense line being relatively flat in Q4. Okay, perfect. Thanks, Jefferson. And I'm showing no further questions at this time. I would now like to turn the call back to Lynn Harton for closing remarks. Great. Thank you all for your interest. Great questions and look forward to next quarter. Thank you. Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Everyone have a great day.