United Community Banks, Inc. (NASDAQ:UCBI)
Q1 2016 Earnings Conference Call
April 27, 2016 11:00 AM ET
Jimmy Tallent - Chairman and Chief Executive Officer
Rex Schuette - Executive Vice President and Chief Financial Officer
Lynn Harton - Director, President and Chief Operating Officer
Robert Edwards - Executive Vice President and Chief Credit Officer
Brad Milsaps - Sandler O'Neill & Partners
Michael Rose - Raymond James
Christopher Marinac - FIG Partners
Jefferson Harralson - Keefe, Bruyette & Woods, Inc.
Tyler Stafford - Stephens Inc.
Good morning, and welcome to United Community Banks’ First Quarter Earnings Call. Hosting the 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, 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 the first quarter’s earnings release and investor presentation were filed this morning 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 statement should be considered in light of risks and uncertainties described on Page 4 of the company’s 2015 Form 10-K 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 Jimmy Tallent.
Good morning, everyone, and thank you for joining us for our first quarter earnings call. Our first quarter financial results are a great start what we expect to be another outstanding year for United.
During the quarter, we completed all systems conversions for the Palmetto acquisition and its branches are now fully integrated and operating under the United Community Bank brand. Additionally, three weeks ago, we announced another merger, this one with Tidelands Bancshares that I’m very excited about. I’ll talk more about our first quarter results and the Tidelands transaction, but first let me mention some of the quarters highlights.
Reported net income, including merger-related charges was $22.3 million, or $0.31 per diluted share. The rest of this call today will focus on operating performance that excludes the impact of merger-related charges. Our net operating income was $23.9 million, or $0.33 per share. On a per share basis, that is up 14% from a year ago. Our operating return on assets was 1%, up from 99 basis points last quarter and 94 basis points a year ago.
Our operating return on tangible common equity was 10.9%, up slightly from the fourth quarter and up 145 basis points from a year ago. Our margin was 3.41%, up 7 basis points from the fourth quarter and 10 basis points from the first quarter of 2015. Net loan growth was $111 million from the fourth quarter and 7% annualized. First quarter loan production was $562 million. Our provision for credit losses was a negative $200,000, down from $300,000 in the fourth quarter and $1.8 million a year ago. Among other factors, the first quarter provision for credit losses reflects an overall improvement in a number of our largest TDRs.
Net loan charge-offs for the quarter were $2.1 million. That compares to $1.3 million for the fourth quarter and $2.6 million for the first quarter of 2015. Our allowance to loans ratio was 1.09% compared with 1.14% at year-end and 1.46% a year ago. Although improving credit trends continue to reduce our required allowance, the acquired loan portfolios of First National and Palmetto were the key drivers of our allowance ratio decreased from a year ago. This is, because credit losses on their loans are reflected in the purchase discount rather than the allowance for loan losses.
Our nonperforming assets to total assets ratio was 28 basis points. Fee revenue was down $2.7 million from the fourth quarter, mostly due to seasonal factors that affected SBA overdraft and our interchange fees. And all of our capital ratios remained very strong.
Now, I’ll share some details from the quarter. As you can see on Page 12, of the investor presentation, pre-tax, pre-credit earnings were $38.6 million, down 326,000 from the fourth quarter and up $8.4 million from a year ago.
Our net interest margin was up 7 basis points from the fourth quarter and up 10 basis points from a year ago. The increase in the margin along with the lower operating expenses offset the mostly seasonal decline in fee revenue. The 7 basis points increase in the margin was due to higher yields on loans and securities. This mostly reflects the impact of the fourth quarter rate increase on our floating rate loans and securities and some accelerated discount accretion on our purchase loan portfolio.
Turning to loan growth in production, we grew loans by $111 million during the first quarter, representing an annualized growth rate of 7%. As shown on Page 15 of the investor presentation, loan production remained strong at $562 million. Approximately $348 million was produced by our community banks and $145 million by specialized lending.
Looking at the first quarter loan production by categories, more than half was in our C&I and CRE portfolios. Commercial loans accounted for $306 million of the total production and increased outstanding loan balances by approximately $77 million.
Last quarter, I told you about our new loan production office in Charleston, South Carolina and the tremendous progress they were making under Dixon Woodward’s outstanding leadership. That progress continued in the first quarter, bringing their total loans and commitments to an impressive $85 million in less than two quarters of operation.
In the first quarter, we opened another loan production office in Macon, Georgia led by Melanie Marshall, a banking veteran with more than 15 years of commercial lending experience in that market. Melanie came to us from a large regional bank and is already proving to be a great addition for the strong pipeline of new business leads. I’m excited to have her on our team with our first entry into central Georgia.
Moving onto interest sensitivity, with half of our loans and a quarter of our securities at floating rates, our balance sheet at quarter-end remains well-positioned for rising interest rates. Before discussing fee revenue, I want to speak briefly about our provision for credit losses. We’ve had several quarters of declining provisions as a result of low charge-offs and high recoveries of previously charged-off loans.
In the first quarter, the provision was lowered further with the improvement in a number of our TDRs, including the payoffs of two of our largest TDRs, thereby releasing reserves that were held specifically against them. Over the past five quarters, very low charge-off rates combined with our favorable credit quality outlook have driven our required allowance for loan losses lower, which has been reflected in our negative provision.
The consistent improvement in our credit measures as well as the improving mix of our loan portfolio is driving down the levels of our required allowance and provision. Our methodology is prudent and has been applied consistently, but with each quarter our model continues to indicate a lower allowance requirement. You’ll find the trends in fee revenue on Page 12 of the presentation.
First quarter fee revenue was $18.6 million, down $2.7 million from the fourth quarter. The decrease is mostly seasonal, as I mentioned earlier, and therefore, we expect a rebound in the second quarter. Total service charges and fees on deposit accounts were down $1.4 million from the fourth quarter with decreases in each of the three subcategories. The decreases in overdraft fees and interchange fees also follow a seasonal pattern.
Mortgage fees held steady with the fourth quarter, which is encouraging since we typically see some seasonal decline in the first quarter. Compared to the first quarter 2015, mortgage fees were up $534,000 or nearly 20%. We closed $146 million in mortgage loans in the first quarter, up from the $138 million in the fourth quarter and up the $87.9 million a year ago.
Turning to our SBA business in the first quarter, we closed $36 million in SBA loan commitments, funded $22 million in loans and sold $13 million in guaranteed loans. Our closed commitments were up 20% from the $30 million close in the first quarter of 2015. The sales produced $1.2 million in fee revenue.
By comparison, during the fourth quarter, we closed $34 million in SBA loan commitments, funded $24.1 million and sold $25.1 million, producing $2 million in fee revenue. A portion of our first quarter SBA production was construction loans, which cannot be sold until they are fully funded. These loans become part of our pipeline for sales in a later quarter.
Operating expenses are on Page 12 of the investor presentation. They exclude first quarter merger-related charges of $2.65 million, and fourth quarter operating expenses of $9.1 million in merger related and impairment charges that we discussed last quarter.
On Page 39 of the investor presentation, we have included a reconciliation of operating expenses to GAAP expenses. Operating expense was $55.2 million, down $1.2 million from the fourth quarter. The linked quarter decrease is primarily related to Palmetto cost savings. The decrease is only part of the story. What can get lost is the continuing investments that we’re making in talented revenue producers to drive ongoing organic growth.
In our mortgage business, for example we added eight lenders in our metro markets. This is part of strategy to gain mortgage market share by improving our products, improving our margins and extending services within our footprint. In specialized lending, we added 11 people, which include lenders and relationship managers to our growing team.
Almost half of the new lenders are in our targeted SBA verticals and will drive further fee revenue growth. We also added lenders to our Midtown Atlanta and Charleston loan production offices, and as I’ve mentioned earlier, toward the end of the first quarter, we found a new loan production office in Macon, Georgia’s fourth largest city. After quarter end, we added two more middle-market bankers and related support. Our recruiting pipeline remains strong and we’re very excited about the opportunities that we are seeing.
We have been quick to act on strong revenue producing opportunities such as these. Cost savings from the Palmetto acquisition have allowed us to make the investments without increasing our core expense base. Our operating efficiency ratio was 59.1% in the first quarter, down slightly from the fourth quarter.
Last quarter, we reported our entrance into the coastal South Carolina market with a team of experienced commercial lenders, led by a long time Charleston banking leader Dixon Woodward. We have long viewed the fast growing coastal South Carolina market as a tremendous opportunity and knew that in order to fully execute our strategy there we needed to be able to provide a full range of financial service in that market.
So three weeks ago, we announced a merger with Tidelands Bancshares. This accelerates our presence along the coast and provides Dixon and his team combined with the Tidelands team and a media platform to add more lenders and provide a full range of commercial services.
Not only does this acquisition of Tidelands provide the perfect complement to our lift-out strategy in the Charleston market, Tidelands also brings a presence in Myrtle Beach and Hilton Head and a management team with knowledge, experience and relationships in these growth markets.
Under the leadership of Thomas Lyles, they have built a solid franchise with loyal customers and an attractive core deposit base. We expect the Tidelands transaction to close in the third quarter. Excluding one-time charges, it will be immediately accretive to earnings and they add $0.09 to $0.10 per share in 2017.
This acquisition increases the likelihood that we will end the year above $10 billion in assets. If so, the loss of interchange revenue due to the Durbin Amendment and our FDIC insurance cost will result in earnings per reduction, of slightly more than $0.02 for quarter. The earliest this impact would be realized is during the third quarter of 2017.
We believe the earnings accretion from the Tidelands acquisition, supplemented by additional revenue from further expansion in coastal South Carolina and an expansion of our mortgage business will more than offset the impacts of both the Durbin Amendment and the FDIC cost.
Now for brief update on our outlook for the rest of 2016. We remain optimistic about earnings growth. We expect growth in loans and deposits to continue in the mid to high-single digit range.
Assuming no further rate increases by the Fed, we anticipate that competitive loan pricing pressures will lower our margin by a few basis points through the remainder of the year. Our balance sheet remains neutral to slightly asset sensitive, so we’re in good position uncertainty in this interest rate environment.
Our expectation is that the favorable trends and credit quality will continue and will result in more low provisions for credit losses in the near-terms. We expect fee revenue to rebound from the seasonal declines in the first quarter. We will also see a pickup in a mortgage business as we enter the spring and with the new originators added in the first quarter.
Like wise, we expect our investment in SPA lenders, to drive further growth in the fee revenue. With the balance of cost savings from Palmetto now fully realized going into the second quarter, we expect most of the remaining savings will be offset by these and additional investments in revenue generating areas.
With these investments we expect solid free revenue growth in the second quarter and expense to be flat with the first quarter, because of revenue growth, we expect to see our efficiency ratio return to the sub 58% range in the second quarter and we expect the 3% to 5% basis point improvement in our return on assets. We’re off to a great start for the year and we look forward to the opportunities that lie ahead.
Now we’ll be glad to answer your questions.
Our first question comes from the line of Brad Milsaps with Sandler O’Neill. Your line is open.
Hey good morning.
Maybe Rex or Jimmy, just to back up on the fee income, I appreciate all the additional color. Can you maybe talk about a little bit more about the SBA business? I knew you mentioned this quarter had a greater mix of construction loans, which can’t be sold until they are fully funded. Do you expect that mix to change in the coming quarters, so you get more gains there or kind of what’s your outlook?
Brad, this is Lynn. The first quarter for us is always a seasonal low point in SBA. And we do continue and have a fair amount of construction loans in there, which we think is a good thing. Our production was right on target with our internal goals, and be honest our sales were probably $200,000 less than we had anticipated, which is essentially two loans that moved from one quarter to the next.
So our anticipation is the second quarter, we’re back up to or up to the level we were in the fourth quarter and remember the fourth quarter is always a seasonal high point for us. So if you look at the overall trajectory of the business, it continues to increase at a good pace and we feel very good about it.
So if I’m thinking about kind of on an annual basis, you would expect to grow that business in 2016 versus 2015?
Okay. And then just on the provision, again, is there a level in your guys’ mind what, obviously credit has improved a lot and understand the TDR is paying off. But is there a level on reserve as a percentage of loans that that you’re comfortable taking that to? I think you’re just below 1.3%. How much more room do you feel like you have there?
So, Brad, it’s Rob. We’re at 1.09 for quarter-end. And we do – as you know the allowance is mechanically driven and the further you go with strong credit performance, the lower the model drives the provision. So just looking forward through and the model, we expect the provision probably to stay pretty close to where it was this quarter.
Okay, great. And just and if I recall, I guess, I was looking at kind of X acquired loans, but there’s not a big discount right on the Palmetto portfolio. So there’s nothing really there is a huge cushion that that we should be adding back?
So it’s about 32 bps if you add all the credit marks back in. So if you were to take the 1.09 and add the 32, you would be at 141.
That’s FNB and Palmetto combined.
Perfect. Okay great. Thank you.
Our next question comes from Michael Rose of Raymond James. Your line is open.
Hey, good morning, guys. How are you?
I think, Brad, just answered a couple of my questions, maybe if we can just step back and talk about strategically. I understand a lot of moving parts that you laid out Jimmy. And some of the hiring you guys have done, obviously the footprint has expanded a little bit here. Can you talk about your hiring plans for the year and maybe how those are shaping up and maybe some areas you’d maybe want to either expand the geography with another loan production officer or two or maybe look to add selective lenders in certain market that would be helpful. Thanks.
Sure. Really, we’re always have been opportunistic about lenders and adding to the team. The easy part is putting brick-and-mortar around. The challenged part is getting the right people. We will continue to take advantage of that certainly a number of things came together leading into the first quarter, which certainly lay into a number of new adds. But these are very talented very skilled, very experienced folks that we believe will see immediate results from.
And whether we have another expansion of a new LPO next quarter and the following quarter that’s really difficult to answer, because that is like people decision. But we have found that certainly given our balance sheet, our operating model is very attractive to some very, very highly qualified people that certainly we would want to add to the team.
Okay. And then, yes, that’s really helpful. And then I just want to make sure I heard Rex on the margin outlook a couple of basis points down from here. Was that kind of per quarter, or through the remainder of the year? And if we do get another rate increase this year, I mean, what does the assets sensitivity profile look like now versus last quarter? I’m sorry if I missed it in the slide deck?
No, that’s fine, Michael. I think first with respect to the margin, as Jimmy indicated, we do expect further compression and that is driven primarily by loan pricing compression continuing. We see that everyday basically. And for the most part of that offset a part of the 25 basis point increase we had in the first quarter relating to the rate increase in December.
So we’re continuing to see pressure on loan pricing. Even though the loan yield was up 7 basis points on a linked-quarter basis without a further rate increase that’s – a lot of that is driven by the rate increase and our floating rate loans, which were about 50% of the loan portfolio. But we will see further compression through the balance of the year and that 1 or 2 basis points. It might hold steady. If I were to hold steady in the second quarter, but still see pressure through the balance of the year, so to be steady to down a little bit, but continued slight compression through the balance of the year.
However, as we talked about on loan growth, that’s the other side of the picture. And again, that help drive net interest revenue this year – this quarter with interest revenue being up on a linked-quarter basis, and we’ll see that continue with our loan growth through the balance of the year. So we would expect increase in interest revenue on a linked-quarter basis going forward.
Okay. Thanks for taking my questions, guys.
And our next question is from Christopher Marinac with FIG Partners. Your line is open.
Thanks, good morning. I wanted to talk a little bit about the ongoing reserve and provision, particularly as it pertains to kind of making the ROA goals. It doesn’t appear that that’s part of how you get from 1% to 1.10%? But I’m also curious, sort of does that help you get above that 1.10% with low provisions or should we really be thinking about sort of a core pre-ROA in addition to the operating ROA?
Well, I can talk about the reserve. I would say – which is going to say regarding a reserve, like I said, it’s mechanically driven. So as the credit quality numbers improve and stay at a very strong representation of a good asset quality then we would expect continued improvement in the allowance percentage and with the reduced provision like we had this quarter.
I think – this is Rex. On the other side of it, Chris, in our plans and when Jimmy talked about the 1.10% ROA by the fourth quarter of 2016, we would not probably had in our plans that level of provisioning originally. So we are benefiting from that that will help a little bit with respect to ROA as we continue through the balance of the year. But that wasn’t in the original expectations for the year.
Chris, I would just add to that. I know I’m going to get kicked at, but certainly just the larger reserve, the better I mean that’s way that the world has always worked. But again as Rob said it’s very mechanical as nothing in and of itself, and driving the ROA targets for 2016.
Gotcha, and I guess if we went back several quarters we always talk about the inflows of new problems and so my impression is that the inflows are very limited that also is a factor behind kind of the mechanics of the model too, is that right?
Certainly, yes, Chris this is Rob. Certainly the inflow of problem credits is something that we take strong consideration in, and if you look at Slide 10 in our deck, one of the things we track very closely is performing classified loans. In addition to non-accruals and we just continue to see those coming down.
Got it, okay. And then last question sort of separate goes back to the M&A and the ongoing look at potential things you may look at. As you look at this three year payback test, to what extent do you factor in growth of the combined company for anything that you model? Is that something that creates deals that get kicked out because you either can’t grow them enough or you have to make assumptions that you don’t want to do? I just want to get a little more underneath the covers on that point.
Chris, we’ve always used kind of a three year earn back on any tangible book dilution. But that’s kind of our guiding post. We will stay very disciplined to try and make that occur. Certainly Palmetto was a little north of that. We knew that going in, but that was a very strategic opportunity that hit every criteria that we had set forth.
If you look at the Tidelands it’s a two-year earn back. So we look very strategic relative to the markets we would like to be in, partnered with the folks that we know and we believe fit our culture and certainly with – when you had all that together and being the financially compelling with earnings accretion and generally a three year earn back that kind of fits our business model to grow, expand, but also manage the risk that might be associated with that.
Great, Jimmy. Thanks for the color this morning, guys.
Our next question is from Jefferson Harralson with KBW. Your line is open.
Hey, guys, I just want to follow-up on the expenses. I came on just as you were talking about it a little bit. But you had mentioned, I thought that the Palmetto cost savings were all in, but I think the conversion was just kind of recently, so we shouldn’t have seen them yet. But are you saying that the new hires are going to offset the additional Palmetto savings we are going to get, or we actually did get all the Palmetto savings this quarter?
Yes, Jimmy had talked about it a little bit earlier. But let me summarize, again, kind of the expected savings on Palmetto. As we talked last quarter, the total expense savings are about 14.6, or roughly about $3.6 million per quarter. At the end of the first quarter, we would now reduce Palmetto costs by $2.4 million a quarter. And if you recall from last quarter, I noted that we’ve achieved $1.5 million of savings through the end of the year. And most of that was really at the time of the acquisition, a lot of those savings came in immediately, but that left as we talked last quarter $2.1 million for 2016 that we have to hit.
This quarter we got another 900,000 of savings, as Jimmy noted, again, reflective in the decrease in expenses. And that leaves $1.2 million for the second quarter. We’ve converted their systems late in February and the remaining staff and others costs are now gone, which will reduce the expense run rate by $1.2 million going into the second quarter.
Also, as Jimmy noted, we’re growing the business. So we’ve added 26 revenue producers in the first quarter and a new LPO office in Macon. Of those additions, we’ll use approximately 500,000 of the Palmetto savings in the second quarter. Also, it’s that time of year with our annual merit increases, we had a 2.5% merit increase, that’s effective April 1. And additionally the company is increasing its match on the 401(k) by 1% that we gave away in previous years. Both of those increasing our quarterly run rate by about 800,000 going into the second quarter.
So if we did not have a further Palmetto savings of $1.2 million of run rate for the second quarter would have gone up by this $1.3 million I just mentioned. But now we should remain relatively flat or slightly up when you look at a linked-quarter basis. So the key is as Jimmy indicated by maintaining our expense level, growing fee revenue in the second quarter, we’ll see our efficiency rate at or below 58% and ROA improving by the 3 to 5 basis points. I hope that helps to summarize it for you, Jefferson.
Yes, that’s great. Thanks, guys.
Thank you. And our next question is from Tyler Stafford with Stephens. Your line is open.
Hey, good morning, guys.
Hey, just to follow up on the TDRs. Can you tell us the size of those two that paid off and how much of a specific reserve did they have which was released this quarter?
So, Tyler, this is Rob. Really the – there were more than two changes to the TDRs, but we did have two that did payoff. One was in the $10 million range and one was in the $2 million range. But in terms of driving the change in specific reserve, there were really four credits. We had one upgrade, one credit we received in an appraisal, which changed the calculation.
So all in all, when we take those changes and then there’s not too overcomplicate it, but we apply the changes on credits greater than 500 sort of on a ratio basis to the smaller credits. So when all that is factored in on the specific reserve side, the TDR change ends up creating about a $3.9 million release in the allowance.
Okay, got it. Okay, thanks. On the accretion, do you have what the total accretion number was for 1Q and how much of that was accelerated?
Yes, there was – the difference between the two quarters is approximately $450,000 on a linked-quarter basis. So that added about 3 basis points to the loan yield, when you look on the linked-quarter. And for the quarter itself we had about $1.2 million this quarter in accretable income come through in total.
Okay, got it. And then maybe last one for me on the hiring this quarter, so I think 21 or so revenue producers. Is there anything specific that you can point to that’s driving that strong hiring? I mean, are these guys you’ve been talking to for a while, is it a reflection of M&A kind of market displacement? Anything specific that you can point to?
They are people that we’ve been talking to for a while. The first quarter is always a strong – we try to make it, at least, a strong hiring quarter. For several reasons, particularly on businesses like SBA and mortgage, if you don’t bring the producers in Q1, you’are not going to hit your bogie for the year.
So we really try to get the producers in as near as – as close we can. So we recruit heavily in the fall, get to bring them on. And then of course they’re – on the commercial side, they’re receiving their annual bonuses and those of things from their previous employer. So it was right in line with what we wanted to do. And strategically, we’ve been focusing on that Midtown area, the Charleston area, and wanting to get into Macon area for sometime. So they were just all kind of in line with what we’ve been trying to do.
Okay. Got it. Thanks, guys.
I’m not showing any further questions at this time. I’ll now turn the call back over to Mr. Tallent for closing remarks.
We’ll, thank you, operator, and certainly want to thank everyone for being on the call this morning, your interest in United Community Banks. Certainly encourage any of you that would have any follow-up questions to reach out to us. I would like to recognize our team of bankers once again do a – just a superb job and thanking them for their efforts. Thank you, again. And I hope you all have a great day.
Ladies and gentlemen, this does conclude the program, and you may all disconnect. Everyone have a great day.
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