Unity Bancorp, Inc. (UNTY) Earnings Call Transcript & Summary

Hello, and welcome to the Unity Bancorp, Inc. Annual Meeting of Shareholders. Please note that today's meeting is being recorded. During the meeting, we'll have a question-and-answer session. You can submit questions or comments at any time by clicking on the message icon. It is now my pleasure to turn today's meeting over to David Dallas, Chairman of the Board. Mr. Dallas, the floor is yours.

Thank you. Good morning, ladies and gentlemen. My name is David Dallas, and I am honored to be the Chairman of the Board of Directors of Unity Bancorp. On behalf of the Board of Directors, management and staff, I'd like to welcome all those listening to the 2020 Annual Meeting of the Shareholders of Unity Bancorp. As you are all aware, due to the current health impact of the corona outbreak and to support the health and well-being of our partners and shareholders, we are conducting the shareholders meeting in virtual meeting format. For those listening, we would like to thank you for your efforts in attending today's meeting and your continued support as shareholders of the company. I am pleased to report that 2019 was another year of record earnings Unity reported earnings of $23.7 million, which is a 7.9% increase over the prior year. Another significant accomplishment was that Unity has been recognized by the American Banker Magazine as the 13th highest performing publicly traded community bank in the nation for banks less than $2 billion in assets. Unity has now climbed the list 3 consecutive years from 27th in 2017 to 19th in 2018 and now 13th in 2019. In addition, Unity Bank was named one of the best places to work in New Jersey for the fourth year in a row by New Jersey Biz magazine. Mr. Hughes will further elaborate on more of Unity's accomplishments, the year's highlights, Unity's strategic goals and the future growth of the organization later in this morning's meeting. I would now like to call the meeting to order and proceed according to today's agenda. The next item on the agenda is the recap of the proposals voted for. As you know, this year, our shareholders of record have been asked to cast their vote on 2 proposals: number one, for the election of Unity's 4 nominees for Director; and two, to ratify the selection of RSM US LLP as the company's independent external auditors for the year ending December 31, 2020. The next item on the agenda is the appointment of judges and the inspector of election and the announcement of a quorum. Today's judges of election are Ms. Laureen Cook, Unity Bank's Senior Vice President and Controller; and Ms. Linda McDermott, Unity Bank's Corporate Secretary. Would you both please acknowledge your presence by stating your names?

Laureen Cook.

Linda McDermott.

Thank you. Today's inspector of election is Ms. Ruby Singh, a representative from the company's stock transfer agent, Computershare. Ms. Singh, would you please identify yourself?

This is Ruby Singh.

Thank you. Ms. Singh, may I please have the current tally of the total votes received and the percentage of the total outstanding share that this tally represents.

Mr. Chairman, based on the total votes received of 9,838,832, representing 90.39% of the total outstanding shares, a quorum is determined to exist for the continuation of today's meeting.

Great. Thank you, Ruby. The next item on the agenda will be opening of the polls for vote on the 2 proposals. I hereby open the polls for further voting. If you have not voted or wish to change your vote, you may do so now by clicking on the link provided online. Any shareholder who has already voted and does not want to change their vote need not take any further action. And now as we wait for the final votes to be submitted, I would like to encourage any shareholders present to submit questions online by clicking on the dialogue icon in the upper right-hand corner of the meeting screen. Please try to limit your questions to 1 or 2 each. We will try to address as many questions as possible towards the end of the meeting. If your question is not answered, please feel free to reach out through our Investors Relation link on the Unity Bank website. Also, within the virtual meeting portal, you will see available for viewing our 2019 annual report and our 2020 proxy report. Within our proxy report, you will find a full list of our directors and executive management team. At this time, I would entertain a motion to close the polls for voting at the 2020 Annual Shareholder Meeting of Unity Bancorp. With us today, representing the shareholders of the company are: Dr. Mark Brody and Robert Dallas, Directors of the corporation. May I have a motion, please?

Motion.

Second.

Thank you. Next on the agenda is the company's report to our shareholders. I would like now to turn the meeting over to our President and Chief Executive Officer, James Hughes. Jim?

Thank you, David. Good morning, everyone. I hope everyone's well. We have a lot to go through this morning. I'm not going to spend as much time as I normally would on our results for 2019 because I think we're probably more concerned about what's going on with the COVID-19. So I'm going to spend a little time on the '19, talk a little bit about the first quarter. At the end of the presentation, I'll go over the pending BSA consent order, and then I'll close it up with COVID-19, the actions that the bank has taken to protect its shareholders, its customers and its employees. So on Slide 1, you can see, again, as Mr. Dallas said, it was a better year for Unity. We made $23.7 million, 8% increase from the prior year. On a per share basis, it was $2.14 versus $2.01, and the growth was primarily attributed to 3 items. One, it was the growth in our net earning assets. You can see, total loans increased by $0.093. We were also able to keep our margin in the high 3s. We were also very successful at controlling our expenses at around 4% expense control, and those 2 items were somewhat offset by an increase in the state tax rate as a result of New Jersey requiring consolidated filings. So our effective tax rate really went from 20% to 22.5% in '19. As the slide shows, loans increased by 9.3%. Most of the growth was allocated 15% growth in consumer, commercial had a very strong year, about $160 million of production for 10% growth, and our mortgage division continues to be a shining star in our lending program. We had another record year, about 7.3% growth. You can see on the slide shows our total deposits only increased 3.5% from the prior year, but that was planned as we drove out some of our higher cost CDs. But our core deposit growth was 8.7%, which really funded the 9.3% increase in total loans. Next slide. Okay. The next slide shows our first quarter performance. We released our earnings last Friday, and we decided to increase our provision for loan losses by $1 million from $500,000 to $1.5 million as a result of the pandemic. There was no specific loans that we are aware of that are impacted as of yet. This was just a general increase in the provision, with the assumption that there will be some deterioration in credit quality as a result of businesses being forced to shut down. But our return on average assets, 1.32%, return on average equity, 13.23%, still extremely strong. Have we not taken the provision, our performance ratios would have been very, very close to what they were at the end of 2019. We were able to hold our margin at 3.92%. There were some significant rate reductions in March. I still believe we'll be able to keep our margin in the top quartile of our peer group. In 2020, our efficiency ratio 51.92% kind of flat from last year. The next slide shows our accomplishments for last year, many of them which Mr. Dallas went over. We were very proud to be named one of the best places to work 4 years in a row, which speaks to the culture of the organization where we had over 80% of our employees participate in responding to the survey. We do a lot of things to say thank you to the employees that make this organization what it is. Thanks again to Sandler O'Neill for naming us an all-star 2 years in a row based upon our performance. And as Mr. Dallas reported, we were ranked 13th in the country out of publicly traded banks. So I think there's 620 in that asset class. So we're in the top 2% of all banks performing nationwide based upon ROA for 3 years average. The next slide talks about some of our initiatives. Again, our mortgage department continues to do extremely well. Last year, we had a record volume of $255 million. Vince Geraci, who heads that division, is telling me that he has a record pipeline. That business is robust despite the fact that home sales in New Jersey are down 8.5%. We had a record first quarter in mortgage production. Our consumer production was also extremely strong of $104 million. The majority of that is really allocated to residential single lot construction loans, which is extremely accretive. It's worked very, very well as a lot of the finished product converts either to salable products or goes into our own portfolio. 2019, the commercial production was close to $160 million. It was on target. Clearly, this year, commercial production is going to go down. I think everybody is in the wait and see mode to see when businesses reopen. There'll be, I think, more repairing than there will be increases in loans. But we will have an increase certainly in production. I'll talk about it later as a result of the PPP program where all loan officers, both SBA and commercial, are working feverishly to satisfy and get the money in the hands of our customers. We spend about $0.5 million upgrading our loan origination system to help us become paperless, become more efficient and to provide better reporting. We invested in onboard adviser to help onboard our new depository accounts. We've upgraded all of the computers in the company. In 2020, we're going to have online account opening. I think it's first, it's going to be focused on personal accounts, and then later with business accounts, and we're going to switch from Popmoney to Zelle as a person-to-person payment system on our online suite of products. The next slide shows our branch locations. We have 19 branches. For the foreseeable future, we're not going to be opening any branches. We have a couple of newly opened branches, Bethlehem and Ramsey. They're not up at full mass in terms of outstandings. So we have a lot of capacity left in our 19 branches. We are continuing to upgrade our branches. We're putting new signage. We have new signage out in Edison and North Plainfield, next would be Clinton. This year, we sold the Union branch, most of the branches we own, we sold Union. We're leasing it back, and we're going to be relocating to a newer facility right across the street from our existing branch later this year. One of the thing that comes out of this whole pandemic, and I think it's really kind of a paradigm shift is branch banking going to return to normal branch banking. After the restrictions are lifted, I think we're all amazed at how efficiently we're able to do it through the drive-through and through lobby appointments. So it's going to be interesting to see how the industry addresses retail branch banking going forward. The next slide just shows our core growth and our balance sheet over the last 5 years, and this is really what's driving our profitability, is our ability to be a successful loan generator. All of our asset growth is through loans, as you can see, growing our deposits through a core basis, through a combination of just sales efforts. It's all hands on deck to grow deposits. Actually, we get a lot of our deposit growth comes from our residential division as well. But the real story here, you can see our compounded annual growth rate of equity far exceeds the growth in our assets, which is adding tremendously to book value. And that's really what we're driving at, to increase shareholder value, increase our core capital to provide more capital for us to expand the organization. The next slide shows -- talks about asset quality. Relatively speaking, our asset quality is exceptionally strong with only 43 basis points of nonperforming assets, the total assets. We went up slightly in the first quarter. Nothing to do with COVID-19, just 1 or 2 small loans that we put into nonaccrual. The positive side -- there is a positive side of nonperforming assets is that 75% of our nonperforming assets are residential. And it's just really the duration of liquidation of those assets in New Jersey is a challenge. It's probably on average, about 18 months. You can see net charge-offs are very reasonable 9 basis points last year. Again, I do not see a significant increase in net charge-offs in 2020. And I'll talk about that later at the end of the presentation about asset quality relative to the COVID virus. The next slide shows our income statement. Comparative to 2018, you can see kind of the categories of where the components -- most of our increase in net income is where you would expect it to be. Net interest income is up 7% from the prior year. Noninterest expense was 4% growth. So we were able to control our expenses. As I talked before, the provision for income taxes in absolute percentages went up 24% from the prior year due to the increase in the state tax effective rate. You can see our performance ratios below for last year, extremely strong. By all measures, we are the second most profitable publicly traded bank in the state of New Jersey as measured by return on assets and return on average equity. The next slide shows our net interest income, our net interest margin. You can see the significant growth in absolute dollars in net interest income over the last 5 years. And you can see how successful we have been in growing our margin. Now that the prime rate has dropped to 3.25%. I do expect a little bit of a decline in our margin percentage, but I think we'll fare much better than most as we're still able to get very favorable pricing on our mortgage product and our commercial product. Next slide shows the components of noninterest income. The only really stories here are gains on sale of SBA loans were down year-over-year. We have a new management team in SBA. We were very, very hopeful in 2020 to double our volume. We were building a good pipeline. And then COVID-19 stopped that. All hands are on deck and now processing those loans. Certainly, the revenue from the PPP loans will more than offset the loss of potential income from 7(a) loans. Gains on sales of mortgages are still expected to be strong. BOLI income has been going down, simply a function of lower yields on that product. Other income was up from the prior year due to a gain on the sale of the Union branch, $700,000 or $800,000 in that lineup. The next slide shows just noninterest expense. Every year, we're driving the percentage of noninterest expense to average assets down. Our goal is to continue to drive that down in 2020 and beyond. The next slide shows some of the components, nothing really major to speak of other than the increases in expenses outside of comp and benefits are really where you would expect them as we reinvest a lot of our money in technology and in software, processing, communication is up, furniture and equipment is up. Deposit insurance was down due to the overfunding of the FDIC program. That's expected to return to normalized levels in 2020. The next slide shows the profitability on a per share basis over the last 5 years. So you can see in 5 years we've doubled our earnings from $1.02 a share to $2.14 a share. The next slide shows the same level of growth in book value of $7 a share to more than $14 a share over the same 5-year period. Based upon our trajectory, we should be north of $16 by the end of 2020. On the bottom of the slide, you really can't see it here, there it is, okay. We suspended -- we had a 5% stock buyback program, which we were just starting early in 2020 to take advantage of. We stopped when COVID-19 came out. But we are going to reinstate the stock purchase program when we believe that things are starting to be clearer as to what the future is going to be. We see the flattening of the yield curve -- not the yield curve, but the virus curve. We see states are starting to reopen the second wave of funding for the PPP program. So we certainly are more optimistic today than we were a month ago. The next slide talks of the dividends. I'll just wait for the slide to come up. We're currently paying $0.08 a share right now. So on an annualized basis, $0.32. Currently, we're going to keep the dividend where it is. With a yield north of 2.5%, we think that's a fair return based upon the current rate environment and the capital will be better served for other uses. The next slide shows kind of a pie chart of the stock ownership. The story here is that 28% of the stock is owned by insiders. So we're certainly invested here around the table, 51% owned by institutional investors and 20% by other. And other is probably predominantly other institutional investors as well and retail investors. The next slide is the BSA pending consent order. And we would have had it already. However, due to the virus, I think everything is being pushed back. But first and foremost, just to give a little background as what happened. During our normal safety and soundness exam last year, the FDIC note -- reported to the Board that we had significant deficiencies in our CSA (sic) [ BSA ] program, which really caught us all off guard because every year, we were getting satisfactory examinations, even as recent as 2 months prior to the examination, our external/internal auditors gave us a satisfactory review. But after we analyze and kind of got into the details, we agree with the FDIC that there are some significant deficiencies. And the deficiencies, for the most part, were centered around the onboarding of new accounts to the bank. When a new commercial business comes on board, what is the expected deposit activity? What is the nature of deposit activity? And the documentation and the description of those type of items were deficient, and the validation of those items were also deficient. So that was a flaw in knowing our customer, and there was also a flaw in our training. So that was one of the major items. The second one was the risk rating of our accounts. They thought was too -- it wasn't analytical enough. It was either you were a high risk or no risk. They want us to really broaden that, better define the risk profiles of all of our customers. So we take this extremely seriously. Our goal, our culture is to comply 200% with what is expected of us as a financial institution. And it's been all hands on deck to remediate the process, and we are significantly through it already due to the delay in the consent order. So when it comes to us, we should be almost complete with the remediation of our BSA program. One of the things that -- one of the most efficient things was with the reinstallation and recalibration of our software system, it was not -- it was like -- I can only compare it to having an 8-cylinder Cadillac and only 3 of the cylinders were working. And so we reinstalled it. We had advisers to come back in, to help us recalibrate it. Mercadien has been working with us. And we hope to have the whole BSA program completed by early June. And so we have a Board Compliance Committee meeting twice a month, managing the oversight of it. We have enhanced our training for BSA with more focus on account openings. We are currently searching for a new BSA officer. We have a consultant who is working with us, who may become our new BSA officer, we haven't decided that yet. Unfortunately, the cost of remediation is not that significant. It's really the cost of the look back. But in total, the anticipated cost of both the remediation and the look back will probably be somewhere around $1.5 million in 2020. Most of, I think, it is going to occur in the third quarter when the look back is expected to commence. Okay. The next slide, talk about COVID-19. So first and foremost, we're doing everything humanly possible from a safety point of view to protect our customers and our employees. Obviously, our branches are only open through drive-throughs. Occasionally, we will allow a walk-in by appointment only, but we're doing all the obvious necessary things, like wiping down the canisters, keeping the ATM machines clean. In terms of being able to work remotely, 100% of our nonbranch personnel have the capacity to work remotely. So from a technology point of view, we were fortunate enough to be able to quickly allow people to work from home with very little disruption. We are allowing those that choose to come to work to come to work. I'd say about 60% to 65% of our employees are choosing to work remotely, the rest of them are still working here in Clinton. The first order of business was doing deferments. We were calling up all of our customers, deferring loans. We actually deferred the entire SBA portfolio for 90 days on day 1, and then we were deferring commercial accounts, residential accounts and then the PPP program came out, and then it's been all hands on deck there processing them. We only have 2 portals available, unfortunately, to us. So it's really -- it's a queuing issue. We did -- 450 applications were approved and submitted, and we will have funded $90 million by the end of this week with the first wave of fundings. The second wave of funding is anticipated. I think we're all hopeful that by either Thursday night or Friday, the SBA will be refunded. The number here on the slide is changing as we speak. It's probably closer to 250 applications now, and it's probably closer to $50 million in the queue. How much of it we can fund? It all depends upon when the money runs out. So it's really just going to be a process of inputting. The government also decided to make all 7(a) loan payments for the next 6 months. So actually, our highest risk portfolio is now our safest portfolio because the government is making all loan payments from April to September. So when you think about that, coupled with the fact that many of those businesses are also PPP customers, asset quality could be very strong in our 7(a) portfolio. In terms of our normal -- our business portfolio, to the extent somebody got a PPP loan, we rescinded their deferral. So the deferrals on the commercial side are not that significant. On the residential side, we did about 17% of our portfolio is deferred. We're also looking at this as an opportunity. When you have lemons, make lemonade. And we've been getting a lot of requests from noncustomers, I would say, 90% of the loans that we're doing, maybe 95% are our customers, primary focus with our loan customers first, then deposit customers. But the phone's been ringing because of all the trouble other businesses are having with their banks to get loans. So we have been very selective in allowing noncustomers to come, but on a case-by-case basis, so we are beginning, to the extent that we can attract a new customer and new business and help them with the PPP process. That's what we're here for. So in terms of other risks, we do have probably a higher level of concentration to industries that you would think would be a slightly higher risk. We have about $50 million of restaurant portfolio and about $44 million of hotels. I can just tell you from the hotel portfolio, again, half of that is in the SBA. It's a pretty aged portfolio. The average life is about 10 years. Really have not gotten any calls from customers saying that they're not going to make it, that their business is failing. The same on the restaurant portfolio. Most of our restaurants are independently owned. We kind of shy away from franchise restaurants. Most of our real estate's secured. So I'm not overly concerned. Overall, from where we're sitting today, I do not see a significant decline in asset quality as -- with the caveat, assuming we get back to business and doors are opened in a reasonable period of time, and I think reasonable, sometime in the second quarter, early June, late June. I mean if this thing drags on beyond that, we have to kind of reassess it. But I think between the deferments and the PPP money and the SBA making loan payments and just knowing our customers, I don't see a significant deterioration in asset quality. Are there going to be increased levels of nonperforming? Yes. I'm suspecting there's probably going to be more on the residential side where people may have lost their job or have been downsized or put on furlough. But on a commercial and SBA side, I don't -- I'm not overly concerned at this point. So with that, I'd like to conclude. [ Jason ], is there any -- so there's no questions? So I'd like to thank you once again for attending today's meeting. Dave, back to you.

Thank you, Jim. And I would now like to proceed with the remainder of today's meeting by requesting the report of the inspector of election. Ms. Singh, may I please have the final tally on the voting for proposal 1, the election of Unity's 4 nominees for director?

Mr. Chairman, each of the 4 directors has been elected by at least 66% votes in favor.

Thank you. And number two, to ratify the selection of RSM US LLP as the company's independent external auditors for the year ending 12/31/2020?

Mr. Chairman, to ratify this election of the auditors, RSM US LLP has been approved by 99% votes in favor.

Thank you. Finally, on behalf of the directors, management and staff, I thank you again for listening to today's meeting, and I look forward to seeing you all next year. There being no further business to come before today's annual meeting, I would like to entertain a motion to adjourn.

I'll make the motion.

Is there a second?

Second.

Thank you. The 2020 Annual Meeting of the Shareholders of Unity Bancorp is adjourned. Thank you all.

This concludes the meeting. You may now disconnect.