United Community Financial Corp. (NASDAQ:UCFC) Q4 2015 Earnings Conference Call January 27, 2016 10:00 AM ET
Tim Esson - CFO
Gary Small - President and CEO
Matt Garrity - EVP, Commercial Lending and Credit Administration
Michael Perito - KBW
Scott Siefers - Sandler O'Neill
Good morning and welcome to the United Community Financial Corp's Fourth Quarter 2015 Earnings Conference Call. At this time, all lines are in a listen-only mode. [Operator Instructions]. Please note, this event is being recorded.
At this time I would like to turn the call over to Tim Esson, Chief Financial Officer of UCFC and Home Savings. Please go ahead.
Good morning and thank you for participating in today's conference call. Before we begin, I'd like to take time to refer you to the Company's forward-looking statements and risk factors, which appear on the screen in front of you or else can be found on our Investor Relations web site at ir.ucfconline.com.
This statement provides the standard cautionary language required by the SEC for forward-looking statements that may be included in today's call. Also a copy of the fourth quarter earnings release can be obtained at ucfconline.com.
I would now like to introduce to you Gary Small, President and CEO of both UCFC and Home Savings.
Thank you, Tim, and good morning to all and thanks for joining us. We are very pleased to report fourth quarter earnings of $4.3 million or $0.09 a share for the quarter. For the full year, this brings our net income to $16.3 million or roughly $0.34 a share. The figures reflect our best normalized quarterly performance in quite some time, and it continues a trend of improvement in quarterly results.
The quarter was in line with our expectations, and we were particularly pleased to be able to absorb $1.3 million prepayment charge related to the early termination of a $30 million repo agreement, while still delivering on our fourth quarter financial targets.
From a year-to-date perspective, revenue is up $11.1 million or 17%, and expenses when you adjust for the impact of debt prepayment penalties in each year, were down 7%; pre-tax income up 130% over the prior year. A recap of performance on issues that were most important to the organization for 2015, we made outstanding progress on our commercial loan growth across all of our geographies and business units. We added 78 new commercial relationships over the year, which was a two-fold improvement over 2014, while which was a strong year in its own right, and we expanded our Commercial Banking team, and we are really seeing the benefits.
Much improved profitability in the residential mortgage business, as a result of higher origination volume. We improved our pricing over the course of the year, and continued to work on lowering our expense base. We had strong deposit growth over the year, north of 6%, and that's providing a nice base for our portfolio growth.
Progress continues on the repositioning of our balance sheet. As I mentioned, the elimination of high cost debt is completed. We are driving toward a better balanced mix between our loan and investment portfolios, and we are also accelerating the pace of diversifying our investment mix within our investment portfolio. As mentioned last quarter, the team success today has encouraged us to revise our three year performance expectations and accelerated trajectories and timelines.
I would remind all that the unfavorable energy industry situation has no material impact on home segments at this time. We have no direct exposure to the energy sector, and our credit exposure spread very favorably across all of northeast Ohio, and Western PA. I also want to acknowledge the addition of a new business line for Home Savings. Earlier this week, we announced the acquisition of James & Sons Insurance, an agency with a rich tradition here in the Mahoning Valley; primarily focused on property and casualty insurance, the firm's product offering matches well with our commercial and consumer needs, and we look forward to the continued growth from within the firm, complemented by some cross-sell opportunities to the existing Home Saving client base.
That said, I will now turn it over to Matt Garrity, who heads up our Lending Group, to provide us an update.
Thanks Gary. I will be updating you on our performance in the Commercial and Residential Lending businesses, as well as providing comments on asset quality. In our commercial business, we had another strong quarter of performance, which was in line with our expectations. Loan production was solid in the fourth quarter, with balances growing 7.9% during the period. For the full year, balances grew 46.2%, which is tremendous growth.
In addition, unfunded commercial commitments continue to grow, and for the year, increased by 77.8%. These commitments will provide a positive impact on balance growth in the coming quarters.
For the full year, loan originations grew by 80% in 2015, compared to the prior year, as we continue to execute on our strategic plan of growth in our key markets, as well as expansion of our commercial team. Since our last earnings call, we have added two experienced bankers in our Columbus market, along with another high quality banker for our Mahoning Valley market. We expect the first quarter to be generally in line with our fourth quarter performance, as we continue to move forward in growing this business line.
In our Residential Lending business, we experienced another solid performance for the quarter, and for the full year, we achieved origination growth of 11.2% compared to 2014. As we have discussed previously, we continue to grow balances in a more measured pace, in comparison to our commercial portfolio. This is consistent with our strategic plan, as we remain committed to achieving greater balance within our overall loan portfolio. We made solid progress in executing this strategy in 2015, but there is more work left to be done. In Consumer Lending, we achieved our third consecutive quarter balance growth, a trend that we expect to continue in the quarters to come.
With respect to asset quality, we did experience a $1.4 million increase in non-performing loans, centered primarily in our residential mortgage and consumer portfolios. We do not see this as part of the larger trend, although we will continue to monitor these portfolios. For the full year, we achieved an 18.1% improvement in this category.
As we have mentioned previously, we have no direct exposure to the energy segment, and have not seen any evidence of significant deterioration in our portfolios, as a result of our customer's involvement in these sectors. As we have stated before, while we have a strong presence in the Mahoning Valley market, this segment makes up about 24% of our total commercial portfolio, and 32% of our total residential and consumer portfolio. While we remain confident in the quality of our loan portfolio, we remain vigilant in terms of monitoring credit performance as well as market conditions.
And now, I will turn it over to Tim Esson, who will provide you some additional details on financial performance.
Thank you, Matt. I would now like to recap for you, select financial highlights from this year's fourth quarter. Loan growth was solid once again within average loans, including loans held for sale, growing approximately $41 million during the fourth quarter. We also continue to diversify the securities portfolio, by adding $12 million of municipal securities during the quarter, while selling approximately $11.5 million of agencies and mortgage-backeds to fund the purchases.
Munis now make up about 5% of our securities portfolio. Going forward, we will continue to seek out opportunities to sell lower yielding securities, and move the proceeds into securities with higher yields.
Currently, the relative size of the securities portfolio continues to shrink, with securities comprising approximately 26% of average earning assets. At the end of last year though, securities were about 30% of earning assets.
Run-off from the investment portfolio continues to help fund the positive double digit loan growth you are seeing, where yields are much higher. Average deposits, while flat, compared to last quarter, are up approximately $74 million from the fourth quarter of 2014. Going forward, we are expecting continued growth in deposits from the public fund sector, along with commercial deposits.
Moving on to net interest income, which was $14.5 million for the fourth quarter, up from $13.4 million recorded in the fourth quarter of 2014, and up from the $14.3 million in the previous quarter. The improvement in the net interest income, when comparing year-over-year, was due to an increase in average net loan balance, totaling approximately $157 million. In addition, funding costs in 2015 were reduced to a modification of a federal home loan bank advance, and the prepayment of two repurchase agreements late in 2014.
Our net interest margin settled in at 3.16% for the current fourth quarter, which did not change from the fourth quarter of 2014. But we did see a slight decrease from the 3.18% recorded in the previous quarter. Lower interest rates in the economy continue to put pressure on yield, on earning assets, but we continue to manage the mix, and volume of earning assets to address this challenge.
Late in December of 2015, the bank again eliminated a high class repurchase agreement. While the elimination of the debt will be beneficial going forward, minimal benefit was recognized during 2015. We would anticipate that the elimination of this add will add six to seven basis points to our net interest margin going forward.
The provision for loan losses was $893,000 in the fourth quarter of 2015, compared to a provision of $194,000 in the same time last year. When looking at the linked quarter, the provision was $673,000.
Provision expense continues to be driven primarily by strong loan growth. Charge-offs to average loans were 21 basis points in the fourth quarter of 2015 and 17 basis points for the entire year.
Non-interest income was $5.5 million in the fourth quarter of 2015 compared to $2.9 million in the fourth quarter of 2014, and up from the $4.9 million recorded in the linked quarter of 2015. The increased quarter-to-quarter was primarily due to fluctuations in the value of mortgage servicing rights between the two quarters, along with higher deposit related fees and security gains.
Improvement when comparing the fourth quarter of 2014 was a result of increased mortgage banking income. As we have talked previously, our 2014 mortgage banking results were impacted or lowered by hedging costs incurred that year, in connection with the origination of construction term loans held for sale. In 2015, we have recaptured those hedging costs, as the construction of those homes were completed, and the loans were sold.
Non-interest expense was $12.8 million in the fourth quarter of 2015 compared to $12.3 million for the third quarter of 2015, and $13.9 million for the fourth quarter of 2014. The increase from the third quarter of 2015 was primarily the result of the third quarter being lower, due to a release of a repurchase reserve associated with mortgage loans sold. The decrease of the fourth quarter of 2014 was due to lower prepayment penalties into fourth quarter 2015, along with lower salaries and employee benefits, which was due to the modification of certain employee benefit plans.
Efforts to increase revenues, while maintaining and/or lowering expenses continue to have the positive impact on the efficiency ratio. The ratio level added 63.7% in the fourth quarter of 2015, which is a significant improvement when comparing to the 72.8% in the fourth quarter of 2014. With continued growth in revenues in 2016, we believe we can see even more improvement in the efficiency ratio during 2016.
With that, I will hand the call back to Gary Small.
Thanks Tim. As we normally do, I will provide some commentary on our expectations going forward for this period, and it will be for all of 2016, and then we will move on to the Q&A session.
We project Home Savings performance improvement to continue to outpace the industry in 2016, with the addition of additional quality commercial bankers, the robust expansion of our unfunded loan commitment position, and our predictable pipeline for business heading into 2016, we expect the commercial loan portfolio to grow in excess of 35% for the year.
Consumer origination will continue to be strong, and this strength will lead to a modest growth in the portfolio. However at this point, we see low to no growth in our one-to-four family residential portfolio. The residential origination activity will be strong, we are just managing our portfolio position. In total, loan growth is expected again to top 12% for the year.
As Tim mentioned, we will see some margin improvement due to reduced borrowing costs, and we expect to have very little impact in 2016 from anticipated Fed rate changes. We will see earning assets grow north of 8%, revenue growth will be in the 12% to 14% range, and expenses will be up a couple percent, inclusive of the addition of the insurance agency acquisition. We anticipate net charge-offs, 20 bps for the year, and expect to maintain a very conservative coverage ratio. Return on equity should improve to the mid-7s level, and our ROI number will probably top out just about 90 bps.
With that, I will turn it back to the operator for the Q&A session.
[Operator Instructions]. And our first question will come from Michael Perito of KBW.
Hey, good morning.
Gary, so a few questions kind of revolving around the expense line item. Looks like the core expense ex the prepay penalty was down in the $11.5 million or so range. But you guys mentioned that you hired a few lenders, but also you have the insurance acquisition coming on with the low single digit expense growth guidance for 2016. How should we think about the near term expense run rate, and where it will shake-out, kind of taking all three of those things into effect? I mean, is it kind of going to bounce back to that $12 million, $12.5 million or it will be higher or lower?
Mike, I think as we are going through the second and third quarter, even though we might have seemingly been outperforming it at any one quarter, we were trying to get some guidance last year. $51 million was kind of what we felt was our normalized expense run rate, for 2016. So we are off that number a bit, even though we did have the prepayment charge. But we are off, because of items that are either one-time only in nature, non-recurring in some [ph] fashion.
So we will still hang in there with last year's normalized being around $51 million, and as we look to 2016, a couple of percent on top of that, inclusive of what we have added for the insurance company. So the math on that would be, maybe just a tick north of $52 million, so plus or minus a million bucks, you know how the range works.
Right. And the insurance acquisition that's expected to close during the first quarter?
Yes it will. We expect a very quick close on that.
Okay. And maybe just switching over to capital and more specifically on that insurance acquisition, have you guys had any internal discussions? Are there any targets that you guys can share with us, in terms of kind of like a timeline and buildout of this business, and what you guys think you could be contributing to the bottom line, and that line item going forward?
Couple of questions there; it will be accretive right out of the gate. This will be our platform company, and we are interested in continuing the good growth that the organization has seen, during the normal cross-sell, although that's not the primary driver of earnings improvement going forward, and then adding to that platform opportunistically with the right sort of firms in the future. The James & Sons today will add just shy of a penny a share to the bottom line. So that in itself is probably all we would want to share at this time, relative to impact, as the numbers grow over time, we will provide some additional figures and so forth.
Okay. And is there still a -- I guess so in terms of pipeline for M&A? I mean, is there additional stuff on the fee income side that you guys are looking at, and just any updates, maybe your thoughts on bank acquisitions, as we kind of start 2016?
Mike, all I can say is that we continue to be active. Obviously, the last few days around here at the top end of the [indiscernible] has been active. We continue to see opportunities evaluate them, and we are selective in what we look. But we are still in the game, and obviously with the insurance announcement, we are spending time on the fee business side as well.
Okay, thanks. And actually just one follow-up on the expense line item and kind of your recent commentary. Do you guys see or expect to see kind of a ramp up in the new hire pipeline, given some of the M&A activity that was announced in your backyard, and does that kind of -- call it 2% to 3% expense growth, does that incorporate any type of additional hires, or would you guys gladly kind of go ahead of that, if you think there is some real opportunity to add some talent from some of those dislocated franchises?
Within that number, there is the expectation that we would have some modest adds even before the latest announcements. But as we have said in the past Mike, if we got the right team identified, we wouldn't hesitate, because the revenue would come with the team. So one goes with the other, we wouldn't have to add it. But we don't have any outside additions, say, on the commercial banking side in the 2016 plan, that's more fit doing some market fill-ins and so forth.
Great. Thanks. Appreciate it.
The next question comes from Scott Siefers of Sandler O'Neill.
Good morning guys.
Good morning Scott.
I see, first question was just on the margin, you guys -- I guessed it [ph] from the fourth quarter repayment, I guess you got a lift of about six or seven basis points going forward. I wonder, Gary or Tim if you can sort of embed that into what you think would happen to the margin just naturally, down a couple of basis points this quarter? Would there be ongoing natural pressure that that should offset? In other words, will you be able to capture full six or seven basis points, or will there be some natural pressure that will offset some of that?
I will take a stab at that Scott. I think we will feel some natural pressure as we did in 2015. I think the prepayment number is solid. We also expect to see a couple of additional basis points, as we continue to move our mix around on the investment portfolio, that's a $400 million plus book, and as we mentioned, we are moving a little bit more quickly into the [indiscernible] space. The spreads are tight, but they are still so much better than what we are earning, or our bullet [ph] and NBS portfolio. So that will add to the mix versus last year.
And we have got some new consumer products, nothing out of the norm, but things that we hadn't developed in the past, which would bring a little bit better yield, which we would believe would be a couple bps too. So there's three or four items that contribute to our expectations. The headwind that we keep looking at, is in our one-to-four residential portfolio, just as the gross yields move around because of prepayments and folks paying off their 4.5% mortgage and jumping back into a variable. That's not too different than what we were experiencing in 2015, and that's what we spent a lot of time on managing.
So whether that will chip away a bp or two, or whether we are successful in offsetting that, that's the trick for us in 2016.
Okay. Perfect. Thank you. And then obviously a lot of activity in your guy's backyard, the last couple of days. Maybe Gary, if you could speak at the top level, just to -- opportunities you would see in terms of any dislocation. Just curious if branches become available are deposit acquisitions of much interest to you guys and if so, any particular areas of interest within that Northeast Ohio area?
Couple of questions there; certainly the announcement will put some good folks in a position of being in the wrong place at the wrong time. So that disruption is something that we study very hard, and we will be looking for opportunities. And maybe I will have Matt speak a little bit from a competitive standpoint. We compete directly with both of these folks on the commercial front. Matt, do you have any comments relative to the impacts for yield?
Well, hard to say how that will all shake out Scott, between speaking now of the Huntington FirstMerit combination, in terms of which people are impacted from which organization, at least in the Northeast Ohio market, that remains to be seen a little bit. There maybe a couple of folks that become available from a market perspective. We haven't seen either institution on a regular basis in the business that we have been competing for. We see them from time to time. So I don't think it provides a ton of disruption necessarily.
On the deposit side Scott, our understanding is that there is a substantial dollar figure that might be in play, in the [indiscernible] market. Certainly a market we are very interested in. Given the size of what I understand the deposit disruption [ph] to be, I am sure there will be a lot of interest in that, and we would have interest in that as well. We do like that market, and deposits are of interest to us, as we continue to fund our loan growth. That takes a little bit longer to play out, and as that story develops and they go through their paces to determine what they have to move off their balance sheet. We will stay very engaged on that.
Okay. That's perfect. Thank you guys very much.
[Operator Instructions]. I am showing no further questions. This will conclude the question-and-answer session. And I would like to turn the call back over to Gary Small for any closing remarks.
Thank you very much. I think 2016 will be a very strong year for the organization, and along the lines of our comments. Movement in the marketplace, [indiscernible] banking, we look at it as an opportunity to go in and make our case with some folks and some clients that might feel in play as well, as a result of those activities, and we are going to make the most of that. And we look forward to a strong year. Any questions, at all never hesitate to call. Thank you.
Conference has now concluded. Thank you for attending today's presentation. You may now disconnect.
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