Good morning, and welcome to United Community Banks' second quarter 2018 earnings call. Hosting our call today are President and Chief Executive Officer, Lynn Harton, Chief Financial Officer, Jefferson Harralson, 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 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. Both are included on the website at ucbi.com. Copies of this second quarter's earnings release and investor presentation were filed last night on Form 8-K with the SEC, and a replay of this call will be available in the investor relations section of the company's website at ucbi.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 four of the company's 2017 Form 10-K, as well as other information provided by the company in its filings with the SEC and included on its website. Now at this time, I'll turn the call over to Lynn Harton.
Good morning, and thank you all for joining our call. I am once again very pleased with our results for the second quarter. Loan production reached a new record. Our net interest margin improved. We maintained our expense discipline, and our asset quality remains sound. Our teams continue to execute very well in a competitive environment. Our earnings per share reached $0.53 for the quarter, an increase of $0.03 or 6% from last quarter and up 29% over the year-ago quarter. We're also proud to continue to make progress toward reaching our announced 2018 goal of 140 basis points return on assets. This quarter's results reached 139 basis points, demonstrating significant progress toward our goal. Given our strong profitability and positive outlook, during the quarter, our board declared a quarterly cash dividend of $0.15 per share, payable June 15th.
This is a 25% increase over last quarter and a 67% increase over last year. We appreciate the support of our shareholders and are very pleased to be able to share our increasing returns with them. As this is our first full quarter of having Navitas included in our numbers, I'd like to recognize Gary and his team for continuing strong performance. I'm very pleased with the success of our partnership. Loan growth from Navitas in the quarter was above expectations at $42 million, and we continue to invest for additional growth in the business. Jefferson, now I'd like to turn it over to you for more details on our performance.
Thank you, Lynn. We are pleased and encouraged by the growth and momentum we continue to enjoy across the bank, and several of our business units with the strategic partners that have joined us over the past year, Horry County, Four Oaks, and Navitas. We are also proud to be on the verge of reaching our key profitability goals that we laid out at the beginning of the year. If you would like to follow along with me, I am starting on page five of the investor deck. On page five, you will see we had $108.5 million in net interest income in the second quarter, up 5% from the first quarter. The spread growth we generated got a boost from continued increases in our net interest margin. The net interest margin was up about 10 basis points linked quarter and 43 basis points from a year ago.
Further on the margin, rising short-term interest rates were the primary driver of the linked quarter increase. Even more, accretable yield contributed just 2 basis points to our margin in the second quarter versus 6 basis points in the last quarter. The decrease in accretable yield is mainly due to higher prepayments on Navitas loans in the second quarter that are marked at a premium. Moving to slide six, the stability of our core deposit base remains a key strength to our company and a driver of our margin expansion. You can see that our cost of deposits in the second quarter was 33 basis points. This is up from 26 basis points last quarter, representing a 7 basis point linked quarter increase.
Our core transaction deposit base continues to grow, increasing by $36 million during the quarter, primarily driven by DDA increases, and this deposit growth fully funded our loan growth. Finally, our overall cost of funds increased by 9 basis points versus last quarter, partly due to the full impact of Navitas and the full impact of our sub-debt raise in the first quarter, but primarily due to rising deposit cost. Turning to loans on page seven, our annualized core loan growth was 4% in the quarter. This figure is excluding our strategic and direct portfolio runoff. Even more, our loan production in the quarter was very strong at $813 million, and in fact, it was a record up 22% over the same period of last year. Moving forward to page nine, fee revenue in the second quarter was $23.3 million, which is up by $944,000 from last quarter.
Fees were down from last year due to interchange income loss with the Durbin Amendment. Moving further into fee income, our SBA business had a record level, $60 million of commitments for a June quarter, and the second highest commitments result in our history. This quarter's commitment result was 88% higher than a year ago and 125% higher from the first quarter. That said, SBA fee revenue was actually down $225,000 from a year ago and was up $623,000 from the first quarter due to seasonality. The year-over-year decrease is a result of fewer loans being sold.
This is mainly attributable to a recent change in our SBA loan mix toward guaranteed construction loans, which cannot be sold until projects are completed. We now have an $87 million backlog of these SBA construction loans, and we believe that the backlog being created will provide a tailwind to SBA gains for the rest of the year. Our mortgage business also continues to perform well. In the second quarter, we closed loans totaling $259 million, compared with $191 million last quarter and $204 million last year. This is a 27% year-over-year increase in mortgage loans closed. Lynn mentioned that we had record originations, but we also had record number of locks and applications in Q2 as the business continues to grow and take market share.
Despite the strong mortgage volumes versus last quarter, there was a slight linked quarter decrease in mortgage fees, due primarily to a $100,000 write-down of our mortgage servicing asset in Q2 versus a $400,000 write-up in the first quarter. One more comment on fee revenue in the second quarter is that we had $364,000 in securities losses. These losses are part of a larger balance sheet management strategy that included the prepayment of FHLB advances at a gain. The securities losses in Q2 are essentially offset by the prepayment gains that came through in the other non-interest income line item. Moving forward to slide 10, operating expenses, not including merger related and other charges, were up $3.1 million in the quarter versus Q1. About half of this expense increase is due to the full impact of the Navitas acquisition that closed on February the 1st.
One non-operating line item that bears mentioning is a $509,000 write-down of our Georgia State deferred tax asset. At the end of last quarter, there was a decrease in the Georgia State corporate tax rate of 25 basis points from 6% to 5.75% that will take effect in 2019, but required a write-down in Q2. On slide 11, we are pleased to be able to report outstanding credit results again this quarter. Net charge-offs were seven basis points this quarter, compared with eight basis points last quarter. NPAs came in at 20 basis points, which is a four basis point improvement from last quarter. With that, Lynn, I'd like to turn it back over to you.
Thanks, Jefferson. This was a solid quarter in which we were able to report strong performance across the company and in multiple measures, including credit quality, operating efficiency, margin, and a significant increase in our dividend. Our teams also continued to deliver best-in-class customer service, as evidenced by our fifth consecutive year receiving top honors in the J.D. Power Retail Banking Satisfaction Award for the Southeast. Our new markets and our investments are doing very well. I'm optimistic about the remainder of the year and our ability to continue to build our franchise into one of the top performers in the South. Now, we'll be glad to answer any questions.
Ladies and gentlemen, if you have a question at this time, please press *1 on your touch-tone telephone. One moment, please. Our first question comes from Jennifer Demba from SunTrust. Your line is open.
Hi, how are you? Just curious about how Navitas is performing to date, and if you're still expecting the kind of loan production from them you did when you closed the transaction.
Yeah, Jennifer, this is Lynn. Yeah, they're actually doing better than projections, and we've had the opportunities to pick up a couple of teams as well that we think will accelerate that growth some. The expense side was probably a little higher this quarter because of the pickup, but it's investing in the future. Yeah, they're right on top of and slightly exceeding our projections that we put together when we acquired them.
Okay. Could you just clarify your interest in M&A at this point? We've obviously seen some deals in the last two or three months, Most of them, if not all of them, have not been well-received by The Street. I just want to know what you guys are thinking right now and what your stance is on investors' reaction to deals immediately following announcement, How much that sways you one way or the other.
Sure, Jenny. I'll start with, we've got a pretty disciplined strategy that we've had no changes in. Our primary focus is smaller institutions in markets where we want to enter or where we have significant overlap. Primary markets we want are our current four states, but we would be interested also in the right opportunities in Florida or Alabama, given Rob and I's experience in those markets. You've seen the financial metrics we've put up before, earn backs in three years, good EPS accretion. We do have several opportunities, we think, several conversations going on with companies that would fit that description.
The larger deals that we've seen lately, I'm not philosophically opposed to larger deals, and it'd be safe to assume that we've looked at several of ones that have gone on to date, but really haven't purchased them either because, primarily pricing, we think they're pretty fully priced, in some cases, business model or culture. The right one would come along, but I would say we're sticking to kind of the same kind of deals we've been doing. Jefferson, I don't know if you've got anything to add on reactions or
I think that's well said. Our primary strategy is to buy smaller banks, and I think that reduces the risk of a transaction. We have seen some of the other deals and the stock price reactions, but really, our strategy is unchanged.
Thanks so much.
Our next question comes from Catherine Mealor from KBW. Your line is open.
Thanks. Good morning.
Good morning.
All right. You both mentioned that the origination volume was really strong, a record quarter, but as we saw, I'm sure it was offset by pay downs, given your growth outside of Navitas and the indirect auto was relatively flat linked quarter. Can you just kind of dig into the pay down activity, and then talk about your outlook for the rest of the year in that, does the pay down activity that we saw this quarter change your growth outlook for the rest of the year? Or do you think that we'll see better net growth in the third and fourth quarters? Thanks.
Sure, Catherine. I'll start it and then I'll turn to Rob. I do think we'll see better growth in the third and fourth quarters. This quarter did have an elevated amount of paydowns. Fair amount of that coming out of the commercial real estate book. We've been cautious on that book for some time, saw a large kind of number of harvesting of those deals this quarter. To offset that, we feel like we've got great growth coming in our senior living group and our renewable energy group, and we actually started a new area focusing on nonprofits that we think will do well as well. The other piece of kind of repositioning that's gone on has been in our Four Oaks market. I mean, it's a great team. I'm really thrilled. Actually, deposits have grown in that merger, which is unusual.
On the loan side, there's always some differences in kind of targets and culture, et cetera. While our new Raleigh team is up over $100 million, that's been offset to a large degree by kind of some of the repositioning in other credits in that acquisition, and that should taper off as we go into or go away as we go into the third and fourth quarter also. Rob, you have anything to add?
No. We've said historically that we're being selective on multifamily, and we continue to hold that line there. Our commitments on multifamily have essentially been unchanged for the last two and a half years. We continue to reduce those categories strategically that we've talked about in the past, primarily land, and certainly our TDRs continue to come down as well. Some of the paydowns is the kind of stuff that we should be anticipating. Also a little bit of it on the repositioning side.
Okay. Is your growth outlook for the rest of the year unchanged then? Because if so, that would mean we would see some kind of improvement in the back half of the year.
Yeah. We do think there'll be
Do you feel like the repositioning is still going to go through the rest of the year, so maybe the net growth is still a little bit softer?
Yeah. The repositioning, I think, would taper off significantly. The wild card is always the payoff side, but we continue to think that we're on that mid-single digit kind of growth rate, which would mean a pickup in the third and fourth quarter.
Okay. Okay, great. That's helpful. Thank you. On the timing of the SBA loan sales, Jefferson, you mentioned that that's going to create a tailwind for the back half of the year. You're saying that this $87 million in backlog, those will be likely a back half of 2018 event, or do you think some of that could be pushed into next year? Just trying to think about how the timing of that, those construction loans may work.
All right. Thanks for the question. I currently believe that about $50 million of that $87 million would be sold in the second half. If you think about the $50 million, you got to first multiply that times 75%, the piece that we are selling as well. I think $50 million of the $87 million most likely gets sold in the back half, but make sure to adjust that we're selling 75% of those loans, not 100%.
Got it. Okay. That's helpful. All right. Thank you.
Our next question comes from Bill Milsaps from Sandler O'Neill. Your line is open.
Good morning, everyone. This is actually Peter Ruiz on for Brad.
Morning.
Hey, Peter.
I guess just first, following up on fees here, just expanding a little bit, maybe mortgage locks and applications, like you were saying, were at a record quarter this quarter. Can you talk about the dynamics here, just given the industry headwinds? Are you guys adding a lot of new originators here, or is this still an area of expansion for you all and kind of the expectations maybe going forward?
Yes, I'll start, and I'll see if Lynn wants to talk as well. Originators are up significantly over last year. We're probably up 30% originators over last year. It's a major area of business for us. We have expanded our product set to include a balance sheet product. 27% of our originations are construction to perm. We have been adding originators in our major MSA markets. We've been adding originators covering our footprint as we buy banks, adding originators in the new markets. We've been adding products. We've been adding originators. The combination of all that is we expected to have relatively significant market share takeaway over time, and that is coming to fruition as we had planned.
Okay, great. Maybe on expenses here, was there possibly some sort of accruing of the expenses related to the SBA originations here prior to the sales being recognized maybe later this year? Is there sort of a timing impact there?
That's a great question. We can talk expenses here. I don't think SBA had a lot to do with it. A lot of those origination expenses are deferred over time. Yes, there would be some of that increase of expenses with SBA, but a lot of those, again, direct costs are going to be expensed over the life of the loan. That wasn't the major piece of the expense growth quarter-over-quarter. As I mentioned before, about half of the expense growth was just Navitas BNN. The other piece of the growth, a lot of it came from merit increases that come in the second quarter. We had given some salary increases after tax reform. Also we increased our 401(k) match a little bit too. The SBA was not a primary driver of that, but the other items were.
Okay. Maybe this second quarter could be kind of a solid run right here near term, I guess then.
I think you'll see a bit of an increase in Q3. I think you'll see our efficiency ratio improve in Q3 and Q4. We are investing in several businesses and core growth. I think Q3, I'd point you towards a annualized mid-single-digit growth rate and then relatively flat in Q4.
Great. Thanks so much. I'll step back for now.
I didn't quite catch the question there.
Our next question comes from Michael Rose from Raymond James. Your line is open.
Hey, good morning, guys. How are you?
Good morning.
Morning.
Hey, you'd mentioned some additional hiring efforts. What areas are you guys continually looking to hire in? Where are you seeing kind of the greatest opportunities, and where are the areas that you'd like to staff up, whether by geography or by some of your business lines? Thanks.
Sure. As I mentioned, we have added in Navitas, so we're very focused on making sure that that partnership goes well. That's been the primary focus this past quarter. We have added a small new line of business focused on nonprofits, which was an add this quarter. Beyond that, it's just our regular market, so we don't have any particular focus. We'd love to add more in Atlanta. We continue to look in Raleigh, et cetera, but no particular additional areas at this time.
Okay. Maybe one follow-up.
Sure.
You guys have done some securities portfolio restructuring. How does that impact the rate sensitivity from here, and how should we think about the impacts from the June hike as we think about next quarter's margin? Thanks.
Yes, sir. We've kept our duration relatively short. Our duration of our securities portfolio stays right around that three and a half year range. We do believe that we are still asset sensitive in the restructurings. I wouldn't have kept our asset sensitivity basically where it is. I do believe that we do have some benefit from the rate hike coming. From a margin expectation standpoint, we do have some tailwind in our margin from the remix to Navitas loans and away from indirect. We should have a tailwind on the remix more towards a loan-heavy balance sheet with the 82% loan-to-deposit ratio. At the same time, we do want to grow funding. It's getting more competitive to grow funding. You are going to see the deposit beta continue to increase.
If we were thinking there was going to be no rate hike in Q3, with that assumption, I would think the margin would be flat to slightly down. If you believe in a rate hike in Q3, I think there's a chance for the margin to be slightly higher.
That's great color. Thanks for taking my questions, guys.
Our next question comes from Tyler Stafford from Stephens. Your line is open.
Hey, good morning, guys.
Good morning.
Maybe just to start on the last comment you made, Jefferson, can you just talk about the deposit growth that you'd expect to see in the second half of the year? It looks like brokered and the FHLB advances were up pretty substantially at the end of the quarter. Is there an opportunity to reduce those over the near term if deposit growth is stronger?
Yeah. If you look at our deposit growth, I'll point you to one of the slides in the appendix there, we had public funds shrink and our core deposits grow. We look for our public deposits to continue to shrink throughout the year until we get to the fourth quarter, then you'll have a seasonal stronger quarter. Down Q3 and seasonally up Q4. Our public funds were down by about 8.5% in the second quarter. If you look at our seasonality, usually it's down kind of 7%, 7.5%, so our public funds were down a little more than what seasonality would tell you. We were very happy with our core deposit growth, and we had a nice $36 million of core deposit growth. From an FHLB and brokered CD piece of it, we have found the brokered CD pricing more attractive versus FHLB.
Over time, if you were to add together FHLB and brokered, I think the combination of those two will be down. You might see brokered up in a given quarter or FHLB down in a given quarter and a mix change between those two. Right now, we like going out a little further on the curve with the brokered CDs, and we found that to be a little bit more attractive. Later in the year, we do think we will have deposit growth. Like most banks, we have raised rates and CDs and money markets, and even our board rates in some cases. We do want to grow our core funding. We were very happy in the first quarter, we're very happy in the second quarter of core funding growth, and we expect that to continue in the second half.
Okay. Very helpful. Thanks. Do you have what the average Navitas loan yields were this quarter?
Let me get back to you on that. There's a lot of accounting adjustments in there, but let me get back to you on that.
That's fine.
We think their ongoing rate is around 10%, but you also have a premium mark coming out of the acquired loans. I want to get you the official answer, and I'll get back with you.
Yep, that's fine. Maybe just to follow up on the prior SBA question from Catherine Mealor. I think Jefferson Harralson, you mentioned selling the 75% of the $50 million, but would you also expect to sell that plus the portion of the second half of the year production, so sales would actually be higher in the back half of the year rather than the first half of the year? I think you sold $50 million in the first half alone.
That's correct. I would expect higher sales in the second half. It usually happens with seasonality anyway. We have strong origination quarters in Q3 and Q4, and we have the backlog that's going to help that number, and we expect good origination volume as well.
Okay. Just want to clarify that. Just lastly for me, I think you guys may have removed the provision outlook from the earnings release. Just any updated thoughts there?
This is Rob. I would expect the provision to go up in the second half of the year. There's a credit mark on the Navitas loans that have a fairly short lifespan. As that runs out later in the year, you would begin to provision for those losses that we're not really provisioning for a lot in Q2. Maybe flat in Q3 and then begin to climb in Q4.
Would you expect also then the GAAP reserve to build slightly?
Not necessarily. Maybe from a dollar perspective as growth occurs.
Okay. All right. Got it. Thank you.
Our next question comes from Christopher Marinac from FIG Partners. Your line is open.
Thanks. Good morning. I wanted to expand on Atlanta. You continue to have a lot of success in Atlanta. We see it in the production information that you disclosed. I'm just curious, without having to do acquisitions here, you continue to have big success. Is that partly due just to the sheer size of Atlanta, or is it also due to the ongoing build and talent that you've been talking about for many quarters?
Yeah. It's really both. Atlanta's a great market. We've got a significant presence there, as you know, more than 30 offices, $3.5 billion in deposits. We have been adding to that group. We've got our new midtown office is up and doing very well. We think that there will be some opportunities with the disruption that's going on in the market today. We're excited about being able to add some additional talent potentially there. It gives a real focused market for us.
Got it. Jefferson, is there any, I guess, additional color on sort of where you think the loan to deposit ratio may go just a couple of quarters out?
That's a great question. Our plan is to grow loans at a higher pace and grow deposits as well, and to increase that number over time. I haven't been given a target for loan to deposit ratio in the near term. We do think we can take this towards 90% over time. I do think it'll be up from here to year-end, but I don't have a target for you right now. I do think we want to move this towards 90% over time.
Got you. It's fair to say that as you do that will have operating leverage and engage the ROA at a higher level.
Yes.
Great. Thank you, guys. Appreciate your time.
Thanks, Chris.
Our next question comes from Nancy Bush of NAB Research. Your line is open.
Good morning, gentlemen.
Morning.
Jefferson, I'm sorry if I missed it, but did you talk about deposit beta in the quarter versus what you saw in first quarter and what your expectations are?
Our second quarter deposit beta was 24%. That was higher than the first quarter. I do expect this deposit beta to increase in the third quarter. Our historical long-term deposit beta is around 55%. Our deposit beta since the third quarter of 2015 has been very low, or cost of deposit is only up 21 basis points over that timeframe. We do want to grow our funding. It is going to be relatively expensive to grow our funding. We think we're in a better spot versus most banks. The first $40 million of loan growth that we have is funded by the indirect runoff. We don't have quite the needs of other banks to fund each marginal dollar of loan growth. Even with that said, the competition is rising at such a rate that I do expect a higher deposit beta for us.
I had talked about the margin. If we don't get a rate hike in Q3, I think the margin will be flat to slightly down with increasing deposit cost.
Okay. Yeah, just an add-on to that, several of the earnings reports and the calls that I've listened to thus far, they've referenced running specials in some very competitive markets, and those specials, as you know, tend to be CDs. I'm just thinking, have you guys felt the need to do that yet in any of your markets, and are you going to have to given your funding position?
We have been watching our competitors, and we have been pricing with our specials at the midpoint of where our competitors are. We have not gone out the curve and been real aggressive in our pricing, but we have looked at some commercial products, a new commercial checking account. We have introduced pricing in various markets where we have introduced more aggressive pricing in certain markets at some times. We're trying to do everything we can to raise the money we need to raise in as thoughtful way as possible. We're not just going to throw a big rate out there and blanket our markets. We are going to be thoughtful and try to use a little bit of precision to raise the funds we need to raise each quarter. I think the answer is yes to that, but it's work.
All right. Thanks very much.
Thanks.
I'm showing no further questions at this time. I would now like to turn the call over to Lynn Harton for closing remarks.
Well, thank you all for being on the call and for your interest in United. For the United Community Banks team that is also listening in on the call, I'd like to thank you and congratulate you on what you've continued to accomplish every day for this company and for your customers. I hope you all have a great rest of your day. Thank you.
Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may disconnect and have a wonderful day.