United Community Banks, Inc. (UCB) Earnings Call Transcript & Summary

Good morning, and welcome to United Community Banks Second Quarter 2023 Earnings Call. Hosting the call today are Chairman and Chief Executive Officer, Lynn Harton; Chief Financial Officer, Jefferson Harralson; President and Chief Banking Officer, Rich Bradshaw; and Chief Risk Officer, Rob Edwards. United's presentation today includes references to operating earnings, 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 at the end of the investor presentation. Both are included on the website at ucbi.com. Copies of the second quarter's earnings release and investor presentation were filed last night on Form 8-K with the SEC, and 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 maybe made by representatives of United. Any forward-looking statements should be considered in light of risks and uncertainties described on Pages 5 and 6 of the company's 2022 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 Lynn Harton.

Well, good morning, and thank you all for joining our call today. Our operating earnings this quarter were $0.55 per share, down slightly from $0.58 per share last quarter. Our operating return on assets was 1% for the quarter, and our operating pretax pre-provision ROA was 165 basis points, down modestly from 171 basis points last quarter. As expected, the current level of interest rates and particularly the pace of rate increases is influencing our results. While we were pleased with our deposit growth for the quarter, we did see continued deposit mix changes as customers move from noninterest-bearing accounts into higher-yielding products. Our cost of deposits increased 164 basis points, up from 110 basis points last quarter. This was partially offset by a 21 basis point increase in our earning asset yields, leaving our net interest margin at 3.37% for the quarter. Our overall liquidity position continues to be strong with no short-term borrowings or Federal Home Loan Bank advances. Our loan-to-deposit ratio remained steady at 78%, providing ample liquidity to continue to serve our clients' borrowing needs. Loans grew at an annualized rate of 6.3% for the quarter, and we continue to be excited about the opportunities we are seeing to expand our lending team with new hiring opportunities. Our markets continue to perform well economically, with all of our states having both unemployment rates below the national average and ranking in the top 10 states nationally for in-migration. Even with the strength of our markets, we are cautious about credit given the inverted yield curve and the Fed's focus on slowing the economy. Changes in our economic forecasting model caused us to build our allowance during the quarter, which now stands at 1.22% of loans. Over the past year, we've increased our allowance relative to loans by 16%. While we believe it's prudent to increase our reserve coverage, we are currently not seeing signs of widespread credit weakening. Past dues have been low, and our special mention in substandard loans have been essentially flat for several quarters. However, we are seeing those credits identified as substandard, become weaker as interest rates and inflationary costs are hurting their ability to recover and be upgraded. Our nonaccrual loans increased this quarter as one of our senior care relationships already identified as substandard, was placed in the nonaccrual. On the strategic front, the Progress Bank conversion went very well, and we're excited to be operating with that team under the United brand. They have great momentum and have been an outstanding addition to our franchise. On July 1, we closed on First National Bank of South Miami, a deal we announced on February 13 of this year. Conversion is scheduled for October, and we look forward to having their fantastic team fully integrated with the company. Progress was the first partner to be converted using our new branding and new logo. We think it looks great and represents both our history and our future in a positive way. This month, we will also begin rebranding Seaside as United Community. When complete, we will be excited to have all of our banking franchise operating under one brand. And with that, I'll turn it to Jefferson for more detail on our performance.

Thank you, Lynn, and good morning to everyone. I'm going to start my comments on Page 8 and go into some more details on deposits. As Lynn mentioned, we had deposit growth in the quarter, up $249 million. And excluding broker deposits and public funds, we grew deposits by $109 million or 2.3% annualized. Year-to-date, our customer deposits are up $533 million or 5.1% annualized. We did see increased price competition in the second quarter that drove our cost of deposits up 54 basis points to 1.64% and took our cumulative total deposit beta to 32% since the fourth quarter of 2021. We also saw continued deposit mix change in the second quarter as our customers are reasonably moving some liquid dollars into CDs and higher-yielding money market accounts, This quarter, our DDA as a percentage of deposits moved to 31% from 34%. And conversely, the percentage of CDs moved to 17% of deposits from 14%. On another note, we have a very granular deposit base as represented by the graph on the lower right. We turn to our loan portfolio on Page 10. We grew loans in the second quarter by $270 million, which is 6.3% annualized and similar to the dollars at which we grew deposits this quarter. On Page 10, we also layout that our loan portfolio is very diversified and generally less commercial real estate heavy as compared to peers. Finally, on Page 10, you can also see our manufactured housing slice of the pie at 2%. You will recall that this business came with the Reliance transaction in early 2022. After the deal, we had said we would take some time to evaluate the business. And after some time of looking at it, we have decided that it doesn't fit into our model, and we have stopped originating new loans, and we will wind down the business. We will continue servicing the existing book, while it runs off over time. Turning to Page 11, where we will highlight some of the strength of our balance sheet. First, with similar dollars in loans and deposit growth, our loan-to-deposit ratio was flat at 78% in the quarter. On the bottom of our charts of two of our capital ratios, our TCE and our CET1 ratios, they were flat this quarter and remain about 100 basis points higher than peers. On Page 12, we take a deeper look at capital, and we show a tangible book value waterfall chart. Our regulatory ratios remain above peers and generally increased slightly as compared to last quarter. Moving on to the margin on Page 13. The margin increased 18 basis points year-over-year, but fell 24 basis points from last quarter. Our loan yield increased 17 basis points in the higher rate environment as new loans are being put on in the high 7s, but our cost of total deposits was up 54 basis points to 1.64%. The main driver of the cost of total deposits increased was a tougher competitive environment in the form of higher deposit rates. 18 basis points of the margin decrease came from the impact of us moving rates higher. In addition to the higher rates, we had a continuation of mix change away from DDA to higher cost money market and CDs this quarter that contributed another 5 basis points of higher deposit costs, which is similar to the run rate of last quarter. So we have the benefits of loan yields moving higher and a positive mix change on the asset side that was more than offset by higher deposit costs and a negative mix change in deposits. On Page 15, our fee income was up $6.2 million compared to last quarter. The increase was driven by higher service charges, an increase in mortgage income and greater gains from SBA and Navitas loan sales. We did have two notable nonrecurring items, including a $1.6 million gain from the sale of a small commercial insurance and corporate benefits business, and we also had a $1.4 million MSR gain this quarter. Expenses on Page 15 came in at $128.8 million, down $2.4 million from last quarter. The main drivers of the improvement are listed on the page. Moving to Page 16 and on the topic of credit, we set aside $22.8 million to cover $8.4 million in net charge offs and built the allowance for credit losses to 1.22% of loans. The main driver of the increase was a decrease in the forecast for the CRE price index, which drove a $7 million increase in the provision. NPAs increased to 60 basis points in the quarter mainly due to the movement of a single senior care loan into nonaccrual. For the quarter, Navitas had just $2.5 million in net charge-offs or 69 basis points. That said, we expect Navitas losses to be higher than typical in the third quarter and then to moderate in the fourth and end up in the 90 to 95 basis point range for the full year. With that, I'll pass it back to Lynn.

Thank you, Jefferson. And many thanks to the United team for your tremendous focus and drive to perform and your heart for our customers. And now I'd like to open the floor for questions.

[Operator Instructions] Our first question comes from Catherine Mealor of KBW.

I thought I'd just start with the margin. Jefferson, could you just walk us through your thoughts on your outlook for the margin over the back half of the year? Do you see some stabilization? Or do you think we'll still see some further compression after this quarter's decline?

Catherine, I think we're at or near a bottom with the margin modeling down 5 for my model for the third quarter, and I think you see increases from there. Some of the main drivers there are the mix change. We're seeing a little less mix change through June and into July. So hard to predict, but it feels like it's stabilizing. The exception pricing has been out there for us. It's, again, something that's hard to model. But again, we're getting less request there. So that feels a little better as well. We've got some tailwind with First Miami -- First National Bank of South Miami closing to get the rate hike that helps a little bit, too. Although we're pretty neutral now that I mentioned earlier that the new own yields are coming in the high 7s and we get mix change on the asset side as well. So I think we're at or near bottom and increasing from there.

Okay. Great. And then on credit, can you just talk a little bit about the senior care book? It's only 2% of loans. It's not a big book, but I know it's been a book that we've talked a lot about over the past couple of years. Any other credits in the net book that are showing signs of deterioration like the one we saw this quarter and maybe just your outlook maybe in terms of just overall kind of credit trends that you're seeing within that book and then the broader CRE book as well?

Thanks, Catherine. So on the senior care book, it's interesting. The credit that did move into nonaccrual that was mentioned or the relationship had been in substandard accruing for some period of time. And so if you look at, that $106 million that's showing as substandard on the slide, that's basically $32 million now nonaccrual. We moved one into nonaccrual in Q1. And then the second relationship in Q2. And so there's three facilities in nonaccrual now, totaling that $32 million. We're not seeing a lot of inflow into the substandard category. So we've been at -- if you look at the whole criticized and classified bucket. If you go back 2 years on that chart, you're at $240 million 2 years ago. We're down to $200 million or $214 million now. So feel like there's not been a ton of change. There's half a dozen relationships that we're wrestling with in the substandard and nonaccrual space. And I think that's likely to happen. If you have $100 million of substandard accruing, some of those are going to fall over into nonaccrual and we'll work through those. So we feel like we have the portfolio properly identified and we see some improvement. We've had an upgrade and a payoff and you see some that haven't turned the corner. And that's kind of just where we are in that process. And if you're asking just about the industry, I think a lot of it just depends on what else is coming online in the market. We have one property that we're kind of -- is a substandard property, but somebody has decided to build a hospital across the street. So we think that's fairly, sometimes you get lucky. And so -- but generally, we're seeing some properties show improvement and gain traction and some are slower to gain traction. So that's senior care, and that's really the driver in our CRE portfolio. So your second question around CRE, in general, is that we're seeing really favorable and consistent performance across the portfolio right now other than the senior care space.

Great. So that increase in the reserve, would you say that's directly tied to this portfolio or just kind of general CECL qualitative kind of factors?

Well, it's -- yes, so the -- as it relates to CECL, the drivers are charge-offs, loan growth and economic forecast. And really the drivers in the economic forecast for the quarter were the CRE price index and then not to the same degree, but to a lesser degree, a decline forecasted decline in business investment. And so the dramatic change was what Jefferson mentioned, the CRE price index. But to a lesser degree, the business investment expected forecast also drove some of the allowance up in some of the C&I and equipment finance categories.

Our next question comes from Stephen Scouten of Piper Sandler Companies.

I guess, if I could maybe dig back into the margin guidance a little bit more, Jefferson, I know you said maybe 5 basis points down next quarter. But could you give kind of updated thoughts on where you think that cumulative deposit beta might go for the full cycle and kind of how you're thinking about the floor on noninterest-bearing deposits as a percentage?

Great questions. On the total deposit beta mentioned. I think that can move into the kind of 36% to 38% range is what we're thinking about. The -- that's what we're currently modeling. Now what's going on is that the you get the continuation of the asset beta too, that I think will offset that. So you have both continuing to increase the rest of this year and into next year. The DDA percentage is -- I think we are modeling for that to continue to move down. I think it could be down another 100 basis points, maybe 200 basis points. I know that kind of 10 years ago, we were much lower in the DDA percentage. But I think our bank has much changed since then, with a lot more C&I mix in there since then. So I don't think we're going back to where we were like way back historically. So I think you're getting close. I really think that once you see rates stop moving higher, that's when you're going to see that DDA percentage start to stabilize. I feel like we've already seen it start to stabilize. So I think it's moving down. We're modeling it to move down, but I don't think it's going back to 2015 levels or 2012 levels.

Yes, that makes a lot of sense, Jefferson. Appreciate that. And then just kind of conversely on the asset side, is the repricing of fixed rate loans? Is that kind of the dynamic that makes you think the NIM could bottom here in the third quarter? And do you have any sort of numbers for how much of that book will reprice maybe fourth quarter or in '24 or what have you?

I might have to get offline with that, but I do have that, but it's coming off at like 4.5% and coming on around 7%. But I have to look at how much is actually coming off. And so -- but that is a driver of it. And in addition, we're trying to push a little more towards putting on variable now. So the mix of variable and fix is coming on the high 7s now. Navitas is coming on just in the low 10s now. So I was thinking about it more in combination, but we can certainly look at the fix by itself. I know it's coming off at 4.50% and going on close to 7%.

Okay. That's great. And maybe just last thing for me. You guys hold a little bit more capital than peers on the average. It sounds like continued hiring is probably in the plans, but can you give me some thoughts on just capital priorities as you look out maybe over the next year or 2 kind of longer term?

Yes. So organic growth will be #1. It always has been. Dividends will be #2 and a distant third is buybacks. M&A would be kind of akin with the organic growth there. So we like having more capital. We think that serves us in times like now. We are buying back put a modest amount of preferred. We like the opportunity with our preferred being less than $25. And we bought back less than $300,000 this quarter, but we're continuing to buy back a little preferred just because it's trading below that $25 level and you get a small gain on the TCE. The other part on the growth on the -- you mentioned hiring. Should we go there with Rich and talk about hiring and how we're thinking about that?

Sure. This is Rich. And it's important to note that we did our -- another lift out here in East Tennessee that was a leader in 6 commercial people. And since the last earnings call, we have brought on Kelley Kee as our State President in Tennessee. We're very excited about that. He had 25 years at a super regional in Nashville. And between the lift-out in East Tennessee and other hiring, we have gotten 14 yeses on the commercial side and 11 have started. So we're very excited in addition to our two lift-outs in the first quarter. So we're very selective on this. I don't have anything actively going at the moment going forward. I think we want to get this real right, but we're very excited and extremely excited about the opportunity in Tennessee.

Our next question comes from Brandon King of Truist.

So I wanted to talk about Navitas and appreciate the guidance. It seems like losses were lower this quarter in respect to that -- expecting that to trend higher next quarter remain moderate in the fourth quarter, but could you give some context as to the cadence of the losses for this year? And kind of what gives you confidence that losses will moderate towards the end of the year?

So Brandon, this is Rob. Just as it relates to Navitas, if you go back, we purchased Navitas in 2018. And we sort of anticipated at that time a 1% loss rate. Following that, two things happened, one is, I think they improved sort of moved upscale and their customer selection. And of course, we had some economic favorability. We continue to believe that the customer selection that they experienced over the last really 4.5 years has improved, but they've experienced in just one small segment of their transportation portfolio over the last 18 months. When they look back in time, they've identified about a $35 million book of long-haul tractor trailer loans that -- where the values have come down and the revenues have also come down on those businesses. Shipping costs have come down. And so they've identified a pool that they're going to have higher-than-normal stress in -- during the year -- during the second half of the year. And so that's really what's driving that. It's a small portfolio that they've contained, but it will drive losses up and really the size of it being small is really why we anticipated waning back in the latter half of the year.

So I'll just add in that. We like that 90 to 95 basis point range for the year, but it's just going to be higher in the third quarter and lower in the fourth.

Okay, okay. So it's just coming from the smaller subsidiary loans, just kind of a normalized rate going into next year?

Yes, yes.

Okay. And then on expenses, Jefferson, what are your kind of expectations for the run rate with First Miami coming online in third quarter in the back half of the year?

Right. Great question. And on the run rate of expenses, so the expenses you saw this quarter are a pretty good run rate for us. I know they were down. We were pleased to be able to offset the natural merit increases that we had this quarter. So I think this number plus First Miami with a small growth rate on it. We've been thinking a lot about expenses and where you have expenses or in the branch network and 60% of our expenses are on people. I mean, over the last 3 years, we've closed 16 branches -- we're about to close. We have 5 that are set to close at the end of July. We're going to be reviewing that. We have a management today get together coming up here where I think we'll talk about these types of things and look at branches again. 60% of the expenses, as I mentioned, are in people when we think about productivity quite a bit. What we have happening now, and it's a little bit despite of what Rich has mentioned, is a hiring what we call a chill. It's not a hiring freeze because we're always going to hire great people or great producers, but we're being a lot more selective there than elsewhere in the bank, but really trying to successfully complete -- or successfully enact this hiring chills. You'll see less new hires coming through. On the mortgage side, we've had multiple cuts there as their volumes have come down with higher rates. So those are the types of things we're thinking about expenses, but I think kind of flattish with a small growth rate is how we're thinking about it. and then others can jump in there if they like. I'll mention one more thing there is that our efficiency as our margin has come down, our efficiency ratio has gone higher. So our plans to move this down is going to be some of the growth, some of the hires that Rich talked about, being able to grow loans in this mid-single-digit range, keep expenses as flat as we can and improve the efficiency ratio like that.

Got it, got it. And then last one for me. Jefferson, do you happen to have the NIM in the month of June?

So I don't have that. We get -- I have it, but there's so many of these nonrecurring things that you annualize times 12, and it just doesn't make a lot of sense. But I mean, I do think we're -- if you put a run rate -- if I try to put a run rate on the June margin, it'd be very close to where we are now. I think our margin is bottomed out, pretty close. It's really hard to take some of these things that are going in and out multiply times 12 and get a real feel for what that is.

Our next question comes from Michael Rose of Raymond James.

Jefferson maybe just to go back to the margin briefly. I know First Miami just closed. Can you give us a sense for what the total amount of accretable yield is now with First Miami? And then what you would expect the accretion to kind of run out over the next couple of quarters just on a scheduled basis?

That's a great question because we're going to do final marks now. So the numbers I'm giving you could change as we do the final mark. So without First Miami, we have $40 million of accretion to go through. Our initial expectation of the marks were that First Miami was going to add another $40 million on top of that. So we had $4 million of accretion come through before First Miami, currently modeling for the third quarter that, that $6 million, although, again, that's -- we don't have the final mark. So it's really -- it's tough, but the rates haven't changed that much since we announced First Miami. So maybe that $40 million mark stays in there. But what I'm using for my forecast right now is that $40 million, but it is subject to change as we get to the final mark. So for now, I'm using that we're at $80 million currently, most likely, but then we'll get the final mark here probably in a month or two before [indiscernible].

That's very helpful. And I think you said that the margin was kind of nearing a trough. I think you stood down about 5 basis points or so was your expectation for the third quarter. I assume that's on a core basis, correct, without the impact of accretable yield? Or is it all in just want to clarify?

They're very close because the addition I'm using for the third quarter is $2 million. So those numbers are very close. But I was thinking about it with, but the difference isn't super huge at $2 million of increase I'm expecting for the third quarter.

Okay. Perfect. I appreciate it. Maybe just switching gears a little bit. So you guys have been very kind of active with M&A over the years. I know your target size is kind of $1 billion to $3 billion is kind of what you kind of targeted. You guys have pretty good currency. There's a lot of chatter about M&A out there. Obviously, many people can't do it loan marks, Credit/interest rate marks are prohibitive. But just wanted to get a sense for are you guys still open for business as it relates to M&A? And are you actively engaged with anybody at this point?

Michael, this is Lynn. So I would say we continue to be actively engaged in terms of talking to people, building relationships. I feel like we are in the selection set of those people considering selling. So from that perspective, we're active in terms of actual transactions. My expectation is not much happens over the next several quarters really for the reason you mentioned. The math is difficult, marks prices are not what some sellers are expecting. So I don't know. I do hear chatter about deals getting announced, but I would personally think that we don't see that pick up until maybe the middle part of next year or something like that.

Okay. So maybe an M&A chill just like a hiring chill as opposed to [indiscernible].

Yes, that's right knowing our technology team, this is the opportunity to drive some of those projects a little quicker than we've been doing, which we're kind of excited about. We've got a lot of great things on the path for that.

Perfect. Maybe just finally for me. I know it's hard to predict, but the Navitas SBA gains were up a little bit. Just can you kind of describe the environment and what we might be able to expect in terms of loan sales here in the next couple of quarters?

So I'll pass to Rich on the SBA gains, and we'll talk about that. I'll follow up on the Navitas one.