United Community Banks Inc (UCBIO) 2015 Q3 法說會逐字稿

Good morning and welcome to United Community Banks' third-quarter earnings call. Hosting our 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; core pretax, 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 the end of the investor presentation. Both are included on the website at UCBI.com.

Copies of the third 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 Company's investor relations section of United'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 2014 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 will turn the call over to Jimmy Tallent.

Good morning and thank you for joining us for our third-quarter earnings call.

First, I want to thank all of you who attended our investor day conference in Atlanta on October 8. We hope you gained insight into our Company, our markets, our strategy, and the depth of our management team. For those unable to attend, a replay of the webcast is available in the investor relations section of our website at UCBI.com.

Now I will discuss the third quarter. Overall, I am pleased with our performance and especially all that we accomplished strategically. Our team completed the systems conversion for First National Bank in mid-July, significantly expanding our footprint in fast-growing markets in eastern Tennessee. For efficiency, we consolidated six branches that were overlapping as a result of the merger. Although we had been out of the merger business for several years, our highly skilled bankers' execution of the First National merger was seamless.

On September 1, we completed our second merger of 2015, this one with Palmetto Bank. As with First National, this acquisition accelerated our expansion in an attractive market, in this case upstate South Carolina. Palmetto brings to us an excellent banking team ready to lead our growth there and statewide as strategic opportunities present themselves.

In mid-August, we had a successful offering of $85 million in senior notes, proceeds of which were used to finance the cash portion of the Palmetto purchase. Also, on September 15, we redeemed $32 million in high-cost trust preferred securities. So we've made good progress during the quarter enhancing our footprint in growth markets.

Now I will cover highlights of our financial results. Reported net income, including merger-related charges, was $17.9 million or $0.27 per share. The remaining discussions of this call will focus on operating performance that excludes the impact of merger-related charges.

Net operating income was $21.7 million or $0.33 per share. That's up 14% from the third quarter of 2014. During the past two quarters, we maintained our operating return on assets at our 1% goal, compared with 95 basis points a year ago. Our operating return on tangible common equity was 10.3%, compared to 10.2% last quarter and 9.6% a year ago.

Total revenue, excluding the provision for credit losses, was $84 million, up $12.6 million or 18% from a year ago. Our margin was 3.26%, down 4 basis points from the second quarter and 6 basis points from the third quarter of 2014.

Solid loan production of $452 million for the third quarter brought year-to-date production to $1.4 billion. Our provision for credit losses were $700,000, down from $900,000 in the second quarter and from $2 million a year ago. Among other factors, the declining trend in the provision for credit losses continues to be impacted by higher loan recovery levels of previously charged-off loans.

Net loan charge-offs for the third quarter were $1.4 million, compared with $1 million and $3.2 million for the second quarter of 2015 and third quarter of 2014, respectively.

Our allowance to loans ratio, excluding acquired loans, was 1.37%, down from 1.42% last quarter. The addition of the First National and Palmetto loans, which have a purchase discount rather than an allowance for loan losses, lowered this ratio by 22 basis points to a reported allowance ratio of 1.15%.

Our nonperforming assets to total assets ratio was 29 basis points, up 3 basis points from the second quarter primarily as a result of the addition of Palmetto's foreclosed properties. Fee revenue was up $1 million from the second quarter, or 24% annualized. And all of our capital ratios remain very strong.

Now I will share some details from the quarter. As you can see on page 5 of the investor presentation, core pretax, pre-credit earnings were $35.4 million, up $2 million from the second quarter and up $5.1 million from a year ago.

Our net interest margin was down 4 basis points from the second quarter, reflecting an 8 basis-point decrease in our loan yield and the cost of the senior notes we issued in mid-August. The decrease in loan yield was influenced by the composition of floating- and fixed-rate loans within the loan portfolio, as well as continued pricing pressures.

During the third quarter and consistent with the first two quarters of 2015, 70% of our loan production was at floating rates. This increase in floating-rate loans has shifted our balance sheet to a more asset-sensitive position. It has also created opportunities to improve our margin and net interest revenue through interest rate swaps on our floating-rate loans or securities portfolio without significantly increasing our overall risk to rising rates.

Also, negatively impacting our margin this quarter was the issuance of $85 million in senior notes, which I mentioned earlier. They had an average rate of 5.2% and were used to finance the cash portion of the Palmetto acquisition. Partially offsetting this negative impact on our margin was a $32 million redemption of our trust preferred securities, which paid an average rate of 8.4%. Combined, these two transactions accounted for 2 basis points of a margin compression in the third quarter on a net basis.

On the positive side, we expect the full-quarter benefit of Palmetto's higher-yielding loan mix and lower cost of funds to partially offset further margin compression during the fourth quarter of 2015 and into 2016.

Turning to loan growth and production, we grew loans by $53 million during the third quarter. This excludes the $796 million in loans acquired in the Palmetto merger. While net loan growth was down from the previous quarters due to payoffs, our 9% growth year to date is on target for 2015.

Loan production remains strong at $452 million, as shown on page 7 of the investor presentation. Approximately $256 million was driven by our community banks and $150 million by specialized lending. Our leadership and talent investments in these areas continue to be both a financial and strategic win.

Looking at third-quarter loan production by categories, more than half of the production was in our C&I and CRE portfolios, similar to prior quarters. Commercial loans accounted for $250 million of the total production, down about $50 million from the record level achieved in the second quarter. Excluding Palmetto's loans, commercial production increased outstanding loan balances by approximately $31 million during the third quarter.

Before I move on from the third-quarter loan production, I want to take a moment to talk about our recently announced plans to exit the corporate healthcare business in Nashville. Early this month, we announced the sale of this business, representing about $190 million in loans, to a large regional bank. Although our talented Nashville team has been successful in developing larger positions in syndicated shared national credits, they had been less successful building the full relationship-based business we had envisioned.

As a result, we felt that the business's strengths were better suited for a larger financial institution. We expect the closing to be completed in the next several weeks. Proceeds from the sale will be invested initially in our securities portfolio, offsetting the majority of the net earnings impact. Over time, we will reinvest in growth opportunities consistent with our strategy.

We remain committed to serving the healthcare industry in our footprint with a focus on the full relationship-based business in which we specialize and excel.

Moving on to interest sensitivity, our balance sheet remained asset sensitive at quarter-end. Our interest sensitivity modeling indicates that a 200 basis-point ramp-up in interest rates over the next year would improve net interest revenue by 1.6%.

We still hold a large balance of floating-rate securities to help manage our exposure to rising interest rates. Floating-rate securities accounted for 27% of our investment portfolio at the end of the third quarter.

Before discussing fee revenue, I want to speak briefly about our provision for credit losses. We have had two consecutive quarters of low provisions for credit losses as a result of abnormally low charge-offs and higher recoveries of previously charged-off loans. As a result of the sale of the corporate healthcare loan portfolio, as well as our projection for continued lower levels of net charge-offs, the current level of provisions could continue into 2016.

Next, you will find the trends on core fee revenue on page 5 of the investor presentation. Third-quarter core fee revenue was $18.4 million, up $1.2 million from the second quarter, with increases in nearly every category. Total service charges and fees on deposit accounts were up $960,000 from the second quarter, with increases in each of the three subcategories.

Mortgage fees were up $133,000 from the second quarter and $1.7 million from a year ago. The growth from a year ago reflects a solid increase in home purchase production, as well as our strategic focus on this business, illustrated in part by the addition of four sales managers and 19 mortgage originators in our metro markets over the past year, including six from the Palmetto merger.

We closed $141 million in mortgage loans in the third quarter, up from $128 million in the second quarter and up $84 million from a year ago. 62% of the third-quarter production represented home purchases and 38% was for refinancing activities.

During the third quarter, we funded $26.5 million in SBA and USDA guaranteed loans and we sold $17.8 million. Sales of SBA loans produced $1.6 million in fee revenue. That is up 10% from the second quarter.

Selling portions of our SBA loan production and resulting gains in fee revenue are a core part of our SBA business strategy. Five quarters into this business, we are seeing impressive results and we believe the outlook for future growth is strong as well. Growing fee revenue generating businesses continues to be a strategic focus as we broaden our business mix. I'm very pleased with the progress we're making in this area.

Core operating expenses are on page 5 of the investor presentation. As a reminder, our presentation of core operating expenses excludes market-value adjustments to our deferred compensation plan liability, severance charges, and foreclosed property costs. It also excludes merger-related charges of $5.740 million during the third quarter and $3.170 million in the second quarter. The merger-related charges are primarily advisory fees, systems and conversion costs, and professional fees.

We have included a reconciliation of core operating expense in the investor presentation. Core operating expenses were $48.8 million, up $3.6 million from the second quarter. Palmetto's September operating expenses account for approximately $2.7 million of this increase. At quarter-end, we had 1,927 employees, up 283 from the second quarter. The acquisition of Palmetto added 290 employees. Our operating efficiency ratio for the third quarter was 57.8%.

Now I want to take a moment to talk about our acquisitions. As I previously mentioned, we completed all systems conversions for First National Bank in mid-July. Since First National Bank was an in-market merger with significant branch overlap, our plans called for closing and consolidating six branches. All six branches were closed in August and all expected staff reductions have occurred.

We closed our merger with Palmetto on September 1 and they are now part of United. Palmetto's results for September are included in our quarter-end results.

Last quarter, I discussed the strategic importance of this merger, and today, I want to comment on the close cultural similarities between our companies. I am reminded of just how important that is as I see these two banking teams work together to become one, to become United, if I may. If you didn't know better, you would think they had been part of the same team for many years. Watching this unfold and having the opportunity to participate with them has been nothing short of an inspiration.

We have scheduled the Palmetto systems conversion for late February. We selected this date due to the upcoming holiday schedules and other activities, but also recognizing the need for extra time to complete this important job carefully and successfully. Timely completion of systems conversion is important to us, but not as important as making sure we do it right. Our conversion teams meet regularly to make sure we stay on task and to avoid any disruption for customers.

I am very proud to welcome First National and Palmetto to United and I'm excited about the tremendous opportunity we have together to further grow and enhance our footprint.

Before we open the call for your questions, I want to provide a brief update on our outlook. We expect loan and deposit growth to continue in the mid to high single-digit range. We expect continued growth in fee revenue from our mortgage and SBA lending businesses. We anticipate a slight decline in our margin due to a shift to floating-rate loans and ongoing competitive pressures on loan prices.

Loan growth should offset most of the impact of margin compression, leading to modest growth in net interest revenue.

The work required to achieve our expected expense savings from the First National Bank transaction was completed in the third quarter and the full benefit of our expense run rate will be reflected in the fourth quarter. Expense savings from the Palmetto acquisition will be fully realized starting in the second quarter of 2016. Excluding the effect of the mergers, we expect modest expense increases, but at a slower pace than revenue growth. Overall, we continue to be optimistic about our earnings growth.

As we mentioned last quarter, the acquisition of Palmetto pushes us closer to the $10 billion mark. We project that the earliest period of financial impact from the Durbin amendment on our interchange fees will be the third quarter of 2017. We are focused on identifying opportunities to offset a portion of this impact through various projects related to fee revenue generation and expense and efficiency improvements, as well as selected acquisitions.

In summary, our third-quarter financial results are a reflection of the hard work and dedication of United bankers. They face every challenge with determination and every opportunity with a can-do spirit and execute our strategy flawlessly. They make me proud every day to be part of this organization.

Now we will be glad to answer your questions.

(Operator Instructions). Jennifer Demba, SunTrust.

After you exited the healthcare portfolio in Nashville, do you have any remaining shared national credits on your books after you have done that?

Rob, you want to handle that question?

Sure. The answer is yes. We have a number of them. I don't have -- let me see. We track exposure at the SNC level, so it would be -- it is about half of our shared national credits, the ones -- so we have 380 total, of what the 190 would be half.

Okay. And are those -- I assume they are in market. Can you characterize the content of (multiple speakers)

We have -- Jennifer, we have a corporate business calling on middle-market customers in the C&I space. It is in footprint and integrated into our markets.

Jennifer, this is Lynn. These would also be much smaller, typical size in terms of the total credit, so they are much more likely to be club deals or just barely in the syndication arena versus healthcare, which were much larger total credit sizes.

Thank you.

Michael Rose, Raymond James.

I just wanted to clarify the comments on expenses. It seems like with the conversion happening in February, I think you said all the expense savings would be in the run rate by the end of the second quarter. If that's correct, do you have a baseline for what you expect that run rate to be, approximately?

Sure. Rex?

Yes, Michael, when you look at our run rate in the current quarter, backing out merger charges, we are about $48.6 million, as Jimmy indicated.

Looking at that, as he also noted, there was about $2.7 million or so of Palmetto expenses for the month in the quarter, and if you normalize that, it means that we're going to add about another $5.5 million, $5.4 million in Q4 to our run rate.

In looking at the $2.7 million, that pretty much reflects about -- a little over $1 million in savings already. If you recall, Palmetto had a run rate of about $10 million a quarter, and again we see a few more expenses coming in Q4, but again we are down about $1 million, $1.1 million already on run rate going into Q4 and the balance of it, which would take about $2.6 million more of savings, we expect that to come right at the end of the quarter after conversion late February.

And by the second-quarter run rate, we will be down another $2.6 million on run rate from what I just mentioned on a linked-quarter basis from Q1 to Q2 of next year.

Okay, that's very helpful.

And then, I think you had said that you would expect the provision to run over the next few quarters where it has over the past maybe two. How should we think about -- I obviously understand the purchase accounting, but how should we think about the absolute level of reserves to loans? And I'm obviously cognizant that you are still having recoveries and you should probably still expect some reserve release. But is there a level where you -- I don't know if it is below 1% or wherever it may be that you think is a bottom?

This is Rob Edwards again. We look back eight quarters for allowance levels, eight quarters of our quarterly losses. And when we go back probably 13 years, our median is right at 134, and so we are at 137 right now. We expect the range to be 25% up or down from that 13-year rolling eight-quarter average.

Okay, and I guess have you added any or have you made any changes to any of the qualitative factors?

We continue to look at the qualitative factors, and so that would be part of the process, in addition to the eight quarter losses. As you can imagine and Jimmy mentioned it earlier, our credit losses continue to improve, so year to date we are at 13 bps in credit losses, which is a far cry from 137.

Okay, and then just one more for me. You guys have done a good job growing the indirect auto portfolio. It is about 7% of loans at this point. But we have seen some banks pull back in that sector as of late. Are you seeing any kind of warning signs? And then, is there a level at which you wouldn't want it to exceed as a percentage of the total portfolio? Thanks.

So we do have some portfolio strategies established, and we have said previously and continue to believe we are at a good level as it represents, as you said, 7% of the portfolio, so we would expect it to continue to remain in that range.

We have not seen any degradation of quality. It continues to perform very well. We have -- our average FICO score in the indirect book is 740, so it's a very strong performance and we expect it to continue.

Great, thanks for taking my questions.

Kevin Fitzsimmons, Hovde Group.

Just wanted to follow up on the margin outlook. From what I recall at the investor day just earlier this month, you guys had talked about the margin as being more stable looking out and you're talking about slight compression. Just want to -- I know I just may be splitting hairs here, but just want to get a sense. Has something changed or is it just more when you talk about roughly stable, this kind of is in line with that? Thanks.

Yes, Kevin, Rex here. It is kind of in line with what we said earlier in October at our investor day conference. It probably is in this next quarter in the 1 to 2 basis-point compression, fairly stable.

We still have continued, as we talked about in the investor day conference, pricing pressure. And again, our mix continues at about the two-thirds the 70% and floating rate, which on average is coming in at about prime plus 25.

So, one, that mix continues to put pressure on the margin overall, and as we noted also, the debt issuance is reflected now in the margin, so that 2 basis points is in the run rate. The TruPS redemption will offset the full-quarter benefit of the senior debt that was issued in the quarter, so it will stay about that same level with respect to the debt impact on the margin.

Got it, got it. All right, Rex, thanks. That's helpful.

One just quick question. What is -- if you can remind us, what is the outlook or the game plan for the small amount of preferred stock that you guys have, which I believe is from the FNB acquisition? How should we be thinking about that and the preferred dividends going out in future quarters? Thanks.

Yes, that is related to the FNB acquisition. It is just under $10 million. In March, that rate would go up from 1% to 9%, so our plan would be to fund that internally with cash we have on hand to repay that in the late first quarter of 2016.

So that's former SBLF or --

Yes.

Or SBLF, that's what it is? Okay.

Yes, small business.

Great. Thank you, guys.

Brad Milsaps, Sandler O'Neill.

Jimmy, I appreciate all the color on loan growth. Just curious on the production numbers, if you could maybe give us a little more color. Pretty equal to last year, but maybe a step down from the second quarter. Is some of that just you guys being busy with getting the Palmetto deal closed? With them in the fold now, do you expect that number to maybe return closer to the second-quarter number, above $0.5 billion a quarter? Or any additional color there would be helpful.

Sure, Lynn, do you want to handle?

So one piece of it, if you look at slide 7 on the deck, is healthcare. So healthcare you can see, already in the third quarter, was beginning to run down as we changed the strategy there, and that also impacted net loan growth as well, which you wouldn't have in front of you. But we actually shrank in the third quarter in the healthcare book even prior to the sale, as opposed to about a $25 million -- by $5 million as opposed to about a $25 million growth in the second quarter.

So that healthcare loan was a big piece of the delta. The other pieces to think about, Tennessee, we always have one quarter or so where you are adjusting from being internally focused to outwardly focused. We expected that and you'll see that those numbers for the third quarter, being with Tennessee down a little bit, we would expect that to bounce back up.

At the same time, we expect and had planned for the same kind of situation for Palmetto, so to me, you would see a similar quarter to the third quarter in the fourth quarter and then first quarter getting back on our traditional run rate, as you mentioned.

Great, and Rex, just curious. Do you have a sense for how some of the discount accretion will flow through on a quarterly basis? Will it be pretty consistent with the third quarter, even though they are only there a month, multiplying it by 3? But will it be fairly consistent or how are you guys thinking about that?

Yes, it would be fairly consistent for the month. Running through for the quarter, it is about $200,000, so that run rate carried out for the fourth quarter.

Okay, and then just one housekeeping question. Do you have the CDI number for the quarter? I know you mentioned that was a lot of the increase in other, but just was curious if you had that exact -- I missed that in the release.

Right, that's a little over $700,000 for the quarter, and it is primarily -- $100,000 is FNB and roughly $174,000 of that is Palmetto increase from second quarter.

Okay, and that just reflects one month, okay. Great. Thank you.

Nick Grant, KBW.

Congrats on a nice quarter. I had a quick question on the SBA business. It looks like -- obviously, margins were down slightly in the quarter. Can you guys discuss what trends you are seeing there and how we should look at that moving forward? Thanks.

Sure. Some of that is impacted by the fundings. We have -- about half our production is in construction. If you look at gross production, we were up in the third quarter. We produced gross production of $41 million versus $36 million in the second quarter.

We expect a pretty good increase in the fourth quarter. Fourth quarter is always a strong quarter in SBA. So we feel very good about it. The gains this quarter, of course, were up from last quarter and that's in the face of a little bit smaller margins.

If margins had held equal to second quarter, our gains would have been probably $150,000 greater. So we feel -- continue to feel very, very good about SBA.

Okay, thanks. How do you see that margin holding moving forward? Like in 4Q, should we still be around this 9% range or do you see a chance to elevate that?

It's hard to predict. It has firmed up a little bit in the last few days, so we're hopeful. We don't think it will be below the third quarter and it could firm some up from there.

Okay, great. Thank you.

Nancy Bush, NAB Research.

Jimmy, a question for you. I guess I would go back to the healthcare business that is being sold. I would just ask what you saw in that business originally that made you enthusiastic about it and what developed that made you less enthusiastic about it? And has this been a learning experience?

Well, to begin with, Nancy, the move into the healthcare space with the people that we had, we still believe that was the right thing at the right time.

What we were hoping to achieve is a higher percentage of more relationship banking versus the syndicated credits. We just felt that given the size of those loans, given the lack of the relationship build opportunity, given the narrow margin on that piece of business and capital allocation, all of those kind of things, there is probably a better utilization of that capital. Great team, credits were very, very solid, but when you look at the size of those, the return. Unlike the remainder of our SNC book that Jennifer asked earlier about, that book, that remaining book basically has relationships that come from that business.

And so, therefore, it was just a strategic decision that we felt was in the best interest of what we wanted to achieve and we can invest that in other areas we think will be much better long term.

Are there any other sectors out there that this experience would keep you away from or is it not a sector issue, it's a portfolio issue? That's what I'm trying to get to.

Yes, it's not so much a sector. This was an area that we felt very comfortable as we went in and the fact that our strategy was the -- almost the opposite, somewhere in the 50% to 70% in a relationship arrangement and a much smaller piece of that in the syndicated credit.

So I wouldn't say a lesson learned as much as it just did not fit the strategy that we felt was in the best interests of the Company long term. And certainly through that process, sure, we learned things, but at the end of the day, what we did and how we exited, we are pleased with that.

And I would also ask, just cutting away the acquisitions and everything in the quarter, how do you feel about the underlying tenor of the business right now? We're getting all sorts of indications all over the place that things are softening and we had mixed results at some of your peers. How do you feel about your underlying business?

Well, the pricing on the lending side continues to get very competitive, and really not a surprise of that. I think maybe volume wise, I would say my instincts would tell me in the banking side, the community banking side, I would say it's a little softer than in the specialized arena. That continues to be very solid and very pleased with that aspect.

But we are in an environment where typically most of us banks have our cost of funds as low as we can get that. You have got your loan book turning over. It is a, we believe, smart move to put that new loan production in as much floating-rate lending as we can, preparing for the event of rates to increase. And as a result of that, certainly it is still a very challenged environment.

All right, thank you.

Christopher Marinac, FIG Partners.

Jimmy, Rex, and team, I wanted to just get back to the SBA question. I know you covered this a little bit at the analyst day a few weeks ago, but was the gain this quarter, does that give you any more visibility into how the next couple of quarters may look, where we see this slightly reduced level of gain percentage?

Yes, again, it has really firmed back up in the last few days. It really weakened right around the time of the Fed meeting and the decisions on rates or what rates were going to do. So we don't think, again, it is going to go below the third-quarter level and we think it could firm up as well.

Okay. Very good. And then, Jimmy, at the tail end of the analyst meeting a few weeks ago, there was a discussion about M&A as it pertains to metro versus nonmetro markets, and I guess I was curious in terms of what you are seeing in terms of the difference in pricing between the two. Does that at all weigh in terms of your interest level in looking at one versus the other?

Pricing expectations, of course, continue to move up, Chris. I think the pricing in rural markets I suspect would be less than certainly the metro markets.

Our focus continues to be or our bias would be in metro markets as we have been focused on that for a long time. We have totally transitioned the Company whereby 70% of the footprint now resides in an MSA supported by very strong, deep market share of our legacy markets.

But there is still a lot of opportunity out there. We are very strategic in our thinking as far as continuing to enhance and build our franchise. I think when you look at FNB and the end market overlap cost saves that could come out, increased visibility add to bench strength in that market, and then when you look at the Palmetto, the strategic initiatives there that really accelerated us into the upstate South Carolina in a very meaningful way with a fabulous team, that's the type of -- I guess that would be the flavor of our strategy in the M&A arena.

Okay, very well. Thanks for the background there.

Thank you and I'm not showing any further questions. I will now turn the call back over to Mr. Jimmy Tallent.

Thank you, Operator, and thank all of you for being on the call today. We sincerely appreciate your interest, your questions with UCBI, and certainly look forward to speaking with you again soon. I want to thank all of our employees of this Company for your continued hard work, day in and day out. So, I thank all of you and hope you have a great day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may all disconnect. Everyone, have a great day.