United Community Banks Inc Q1 FY2024 Earnings Call

Good morning, and thank you all for joining our call today. We're pleased to report solid performance this quarter. Operating earnings per share came in at $0.52, down $0.01 from last quarter, in part due to seasonally higher employment costs. Our operating return on assets was 93 basis points, up slightly from 92 basis points last quarter. As we've continued to work through changes in the interest rate environment, one of our focus areas naturally has been our net interest margin. We were pleased to see those efforts begin to pay off this quarter with the margin holding steady, up 1 basis point on a GAAP basis and up 2 basis points on a core basis, excluding loan accretion income. We continue to improve our loan and deposit pricing strategies to perform in a higher-for-longer rate environment. We're also seeing the effects of higher rates on loan growth as growth came in lower than we anticipated at 1.2%. The two portfolios with the highest correlation to interest rates, commercial real estate, including construction, and mortgage were essentially flat with our C&I portfolio growing during the quarter. Deposits appear relatively flat on an overall level, but as Jefferson will discuss, we had solid core deposit growth outside of our higher-rate public funds portfolio. Credit continues to perform well. Total losses came in at 28 basis points; we have two portfolios that are designed to have higher loss levels, Navitas and manufactured housing. Both portfolios also have higher coupon rates that compensate us for those higher loss levels. So excluding those portfolios, core bank losses were 12 basis points. Nonperforming loans increased slightly to 58 basis points, and substandard loans decreased 3 basis points to 1.3%. Overall, credit metrics remain in a range consistent with strong underlying economic conditions. We continue to be mindful of how Fed efforts to slow the economy could negatively impact credit performance, but we're pleased with our results and have a positive outlook. Our liquidity position continues to be very strong with a loan-to-deposit ratio of 79% and essentially no wholesale borrowings. I want to turn the call over to Jefferson now for more detail on the quarter.

Thank you, Lynn, and good morning to everyone. I'm going to start my comments on Page 6 and go into some more details on deposits. As Lynn spoke to, our deposit balances in total were essentially flat in the first quarter, and we saw some continued, albeit slower shrinkage in our demand deposits. Underlying this flat result, we had $228 million of deposit shrinkage in our public funds. This decrease was partly due to seasonality and partly due to our strategy to not match pricing in certain cases. We were pleased to be able to more than replace the public funds runoff with solid retail and commercial deposit growth this quarter. Our cost of deposits moved up 8 basis points in the quarter to 2.32%. Our deposit betas for the cycle were below the industry median a year ago, but are above the industry median now at 44%, and we are hopeful to move closer to peers to get some of that back in 2024. We turned to our loan portfolio on Page 7. We grew loans in the first quarter by $56 million, which is 1.2% annualized. This is a little lighter than we originally expected. We are seeing less demand from our customers who appear to be holding back on projects due to rates and uncertainty. We saw growth in C&I, but this was offset by shrinkage in investor CRE and in residential construction. We saw Navitas loans be relatively flat as we kept loan sales high in that area at $28 million, similar to last quarter. On Page 7, we also lay out that our loan portfolio is diversified and generally more granular and less commercial real estate heavy as compared to peers. Turning to Page 8, where we highlight some of the strengths of our balance sheet, we believe that our balance sheet is in good position with no FHLB borrowings and very limited broker deposits. This gives us some flexibility in managing through a tough interest rate and competitive environment. On Page 9, we look at capital; we had increases in our regulatory capital ratios and our TCE and all of our capital ratios remain above peers. Our leverage ratio was also up 21 basis points. We did not repurchase any preferreds in Q1, but we remain opportunistic as we bought back $7 million last year at a discount to par. Moving on to the margin on Page 10, the margin came in just slightly higher, up a basis point on a GAAP basis and up 2 basis points on a core basis. Our loan yield moved up 9 basis points to 6.24% with our new and renewed loan yield in the 8.5% range for the quarter. We had slightly less loan accretion in the quarter as compared to Q4. Loan accretion went from 8 basis points in the fourth quarter to a 7 basis point benefit in the first. Our net interest margin should be moving higher in Q2, up 5 basis points by our estimation, plus or minus 1 to 2 basis points. On the positive side, our loan yields should continue increasing and our cost of CDs should be near a top as new CD costs are very near maturing CD costs. That said, we are still seeing mix changes with DDA and savings shrinking and mix change towards more promotional pricing within now and money market accounts. Last quarter, I mentioned that our terminal deposit beta would be 45%, but now we are thinking it's closer to 46%. Moving to Page 11, noninterest income was up $8.6 million to $37.2 million on an operating basis. Better mortgage fee income of $5.6 million drove most of the $8.6 million increase. For the quarter, we had $1.4 million of an MSR write-up, which compared to a $2.4 million write-down last quarter. This was a $3.8 million positive swing and the gain added just under $0.01 to earnings in Q1. Aside from the MSR swing, core mortgage income was $1.8 million higher as we had greater volumes and a mix change towards fixed-rate products, over 90% was fixed-rate that we sell and get more of the economics upfront. Our gain on the sale of other loans was down $700,000 in Q1 and was driven by fewer SBA loans sold even though the gain-on-sale percentages were a bit better. Operating expenses on Page 12 came in at $140.4 million, up $1.6 million. The primary reason for the increase is a $1.5 million increase in FICA taxes. We also saw fewer expenses we were able to defer as more of our mortgages ended up being sold. So the mix change towards fixed-rate loans in the mortgage business ended up creating more loan sale gains, but we also had fewer deferred costs of about $700,000 because fewer loans came onto the balance sheet. Moving to credit quality, net charge-offs were 28 basis points in the quarter, with the bank being very low at just 16 basis points. Our NPAs were up slightly. Our breakout on Navitas loan losses are on Page 18. We first broke out long-haul trucking two quarters ago. The book has shrunk from $57 million to $38 million over that time. We had $2.4 million of long-haul losses in Q1 as compared to $4.4 million last quarter. Navitas losses, excluding long-haul, were 1.06%, and we are putting on new loans in the 10.5% range. I will finish back on Page 14 with the allowance for credit losses. We set aside $12.9 million to cover $12.9 million in net charge-offs and our ACL stayed relatively flat quarter-to-quarter and is up year-over-year. With that, I'll pass it back to Lynn.

Thank you, Jefferson. Before we take questions, I'd like to recognize our teams for a great accomplishment this quarter. At the end of March, J.D. Power recognized United Community as the winner of the Retail Banking Satisfaction survey for the Southeast in 2023. While not announced publicly, we also know that we were rated as #1 in trust in the Southeast. This is the tenth time that United has received this recognition; a testament to the dedication of our teams and taking care of our customers. We also received 15 Greenwich Excellence Awards for Small Business Banking, a new high for us. I am fortunate to work with some incredible teammates throughout our company, and I look forward to a great 2024 with them. And now we'd like to open the floor for questions.

The first question comes from Catherine Mealor with KBW.

I want to start on growth. You mentioned that growth was a little bit slower this quarter and clients are being more conservative in pulling back. How are you thinking about growth for the rest of the year, especially if we don't get rate cuts and how that may impact origination levels?

Good morning, Catherine, this is Rich. I'll take that one. Well, certainly, interest rates are impacting, and we have customers that have kind of hit the pause button. So we do expect low single-digit loan growth greater than Q1; but absent a change from the Fed, we don't see significant loan growth moving forward in 2024.

And how about deposit growth, should that match loan growth? Or are there more initiatives to still maybe even grow deposits at a faster pace than that?

Yes, it's Jefferson. Our overall strategy is to be more aggressive in pricing for our highest-value depositors, such as public funds. We are not matching some of the pricing on public funds, which may lead to some of our most price-sensitive customers leaving the bank. However, we are experiencing strong growth in our retail and core commercial areas. We're making some adjustments to our mix, so it's possible we might see a quarter with negative deposit growth due to this strategy shift. Nonetheless, for the entire year, I expect we will have positive growth.

Great. Is the change in the mix partially what leads you to believe that the margin will expand by 5 basis points next quarter?

That's a little bit. Coming on the funding side.

It's encouraging to see a solid recovery in mortgages this quarter. I would like to understand the trends there, the pipelines, and I noticed that some of the loan sale gains were somewhat lower. I’m interested in your perspective on the market for SBA and Navitas paper, as we try to envision what fee income might look like in the upcoming quarters.

Michael, this is Rich again. We expect our mortgage production in Q2 to exceed that of Q1, and we also anticipate an increase in fee revenue. However, with current interest rates at 7.5%, we do not expect the seasonal uptick to be as significant as typically observed. Regarding the SBA sector, much of our work involves construction, and a certificate of occupancy is necessary for sales. This year, the timing has been slightly off, resulting in fewer loans available for sale this quarter. Nonetheless, our pipeline is strong, and we believe we will catch up, particularly in the second half of the year. Additionally, we are optimistic since the secondary market has improved by about 20% to 25% compared to last year.

Yes. So from SBA, the first quarter is our slowest seasonal quarter, and we do expect increases, just like Rich said. On the Navitas loan sale piece of it, we only grew very flat on the Navitas side for the first quarter. We sold on the higher end of what we have historically sold at $28 million. So as I go into the second quarter, we're going to reevaluate, do we sell a little bit less and have that loan growth be a little higher? Or do we keep the loan sales where they are and keep that book flat? So I don't know if we've made that decision a little bit, but it's possible we could pull back on our loan sales a little bit. But the main driver of that line item is really that SBA line because it has a higher gain. So I would expect that line item to increase throughout the year.

That's very helpful, Jefferson. Just as a follow-up, I know you guys have talked about M&A likely being a 2025 dynamic totally get that. But you guys have obviously very strong capital levels. You do have a buyback in place. I know the earnback maybe isn't as good as it would be if you were trading lower, but nonetheless, still very attractive as we think about it. Any reason that you wouldn't more aggressively look at the buyback and usage of it? Or you just it's uncertain out there. You don't know the direction of the economy, so you'd rather just maintain relatively high capital levels nearer-term?

I think it's a little more of the latter. We do have the preferred buybacks still in place, but we saw that price move closer to par since the beginning of the year. So I think we're still of, I guess, actively looking at that lever. We like buying at less than par because of the increase to tangible equity if we do. The buyback, we really like having higher capital relative to peers in this environment. So we're always looking at it. We always have our authorization there, but we're not actively looking at that strategy currently.

I guess on the Navitas loans, it sounds like a 10.5% yield, even though the net charge-offs have been obviously higher that the spreads there remain extremely attractive. So is that kind of the math that would drive potentially sell a little less and holding a little more?

Yes. And we are looking at that. We want to stay below our kind of self-imposed limit. We do have a little room there. We continue to really like the business, like the team there, and so that is a consideration as we go forward.

Okay. Regarding the credit aspect of that portfolio and the mention of manufactured housing, which may face higher losses over time, it appears that for Navitas, we might have reached a plateau considering what you've indicated about the long-haul trucking balances. What is your perspective on the outlook for that portfolio in the upcoming quarters, particularly in manufactured housing?

Yes. Hey Stephen, it's Rob Edwards. On the Navitas book, it is also our view that losses did crest and have now come down. In fact, during the quarter in the long-haul sector, we saw past dues come down dramatically. So we're expecting continued improvement in that portfolio to come down in the second quarter and then maybe more normalized results in the third and fourth quarter. As it relates to manufactured housing, charge-offs are up, but I would say we've done a lot of studies. Freddie Mac has 20 years of results on manufactured housing and our results are consistent with what you should expect of this portfolio. And so we're not surprised by the performance. But I would just say, keep in mind, we did stop originating last year, and so the loss rates may seem a little higher than normal. And any time you have a runoff book as you're not originating new credit, the loss rates will be a little bit higher, but it's consistent with what we have expected and modeled.

Very helpful. Lastly, I have a broader question. I'm interested in understanding how challenging it has been for you to operate as a bank in the current environment. I hope conditions improve in 2025. From a strategic standpoint, what are your main priorities today as you plan to position yourselves to outperform your competitors when the situation eventually stabilizes and gets better?

Thanks. This is Lynn, Stephen. Our main focus is on driving organic growth through our teams. Rich is actively hiring and working on this, particularly in stabilizing and turning around our Tennessee franchise, which is very encouraging. We have seen past challenges there, but we believe Florida is starting to progress as well. Our internal initiatives related to growth are our priority. On the pricing side, Jefferson discussed margins, and we're working on various strategies to improve our pricing and enhance our balance sheet. Therefore, our attention is primarily on internal matters. I am also exploring M&A opportunities, and it’s surprising to see the number of available opportunities given the current market conditions. Nevertheless, our main focus remains on preparing for what we anticipate to be significant opportunities in 2025.

I wanted to follow up on the margin discussion. So Jefferson, I appreciate the commentary you gave for the coming quarter. Would you expect that type of pattern to continue absent rate cuts? Or how are you kind of contemplating the remainder of the year? And then as we do get cuts, if we do get cuts, how would you expect the margin to behave?

Thank you for the question, Russell. We are essentially neutral to rate cuts right now. To maintain a flat margin, we need to achieve a 39% decrease in total deposit beta. We believe we can accomplish that, but it largely depends on our competitors' actions and how much rate trimming we implement before any cuts occur. Essentially, we think we are neutral regarding rates. You can expect some of the trends we’re discussing to persist in the latter half of the year. Therefore, I anticipate our margin will increase if there are no rate cuts. If rate cuts do happen, we believe it's neutral for the margin but beneficial for the overall bank. I think Rich's loan growth forecast would adjust accordingly in response to rate cuts, and our credit risk and other factors would also change. We believe that with rate cuts, we are positioned as a stronger industry and bank, but regarding the margin specifically, I don’t think it will change significantly. Rich, would you like to add anything?

Yes. I was trying to think of the best way to illustrate that currently; our underwriting interest rate is 8.5%. So that makes it difficult for some of these deals and projects to pencil out where if rates go down, then all of a sudden, you're talking this makes a lot more sense. So that's why we're very optimistic if we see some rate decreases.

Thank you. Good question, Russell. And so to lay out the expense, what it looks like this year. Number one, we had some eliminations at the end of the year that we started getting benefit from probably in February. We have 4 branch closures that should be kind of late April, early May. So we have many projects across the bank with targeted outcomes, either via new technology, making us more efficient or just trying to be more efficient with people or processes. So that is kind of the bigger picture. The more direct picture is in the second quarter; we have about a $2 million increase due to merit. We have a little bit of offset of that from seasonal FICA expenses declining, then I expect kind of that normal, kind of low single-digit growth rate kind of besides that. So you have a little bit of a bump in Q2 and then flattens out for the rest of the year.

Had a little bit of a follow-up to the NIM question. As we're looking at it from the loan yield side, 9 basis points expansion this quarter, a little bit less than you had in the fourth quarter. Barring any changes to the rate environment, do you suspect we have a similar amount of yield pickup in 2Q, 3Q? Or is the kind of lower loan growth outlook may be an impediment to that level of expansion?

Yes. So I think in Q2, that 9 basis point range is a good target. I can see it waning off a little bit in the third and fourth quarter if the growth doesn't pick up a little bit because that replacement with the new 8.5% loans coming on slowing down, I can see that slowing it down a little bit. But I like the plus 9% for Q2 and then maybe slowing down a little bit from there.

Thanks, Jefferson. In relation to your guidance of 5 basis points plus or minus 2 basis points, would you say that deposit pricing or loan growth is currently a bigger factor for you?

That's a good question. I would say that deposit pricing is our bigger lever. We have a bit more control over that, and it seems to have a greater impact, although both factors do influence the situation.

I wanted to ask either Rob or Rich, just about the inflows and outflows on sort of criticized assets this quarter, whether you look at it from the special mention or the classified side. Just wanted to get more detail on the puts and takes on what's coming and going on and off.

Yes. So Chris, it's Rob. So on the classified side, basically, we upgraded one very large substandard credit, C&I credit. And so that played a role there. In terms of other items, we do go through a process, and we just finished one in Q1 where we look at maturing loans in the next 12 months and reamortize them, look at the impact of interest rates on payments and trying to identify upcoming problems and address the risk rate at that time. So we did have a senior care project that got downgraded, and we had a large C&I credit that got upgraded. So just some movement in those types of spaces.

And Rob, I presume that some of that also is just debt service coverage and normal things, but they're still performing as agreed.

That's correct. Yes. That's right.

That's a great question. I'll start with that. I would say on Navitas, where it's a very profitable company, but we're used to it being a lot more profitable than it is today. So we are really looking forward to those losses normalizing between now and Q4 to get that back up to the profitability that we like.

If you look at our marginal deposit yield or cost and our marginal loan yield, but maybe speak to that because it's really a matter of we've got to burn off some of these old fixed-rate loans.

That's correct. Our new loans are now yielding 8.5% while our new deposits are coming in at the low 4s, creating a strong incremental margin. There are pricing pressures on both sides of the balance sheet, making the environment challenging. However, I am optimistic going into the latter half of the year and into 2025, as the older fixed-rate loans that are impacting our profitability will eventually roll off. Time will help improve our return on assets and return on equity. We are not satisfied with having a return on assets below 1%, and our plans indicate that we will surpass that over time. We feel confident about the progress in our individual businesses and can discuss specifics if needed. Our goal is to become a more profitable bank with increasing returns on assets and equity over time.

Yes. I would add that it's been about two months since we focused on our pricing strategy and implemented a new pricing model. We're starting to see the benefits of that now, along with a greater emphasis on commercial and industrial sectors compared to commercial real estate, which has been a significant factor in our approach. We're tracking this on a monthly basis by geography to assess the results.

Great. That's super helpful. Thank you all for your contributions there. I mean it's an interesting illustration that the new borrower paying $850 million certainly comes on as a strong credit, strong coverage so that their ability to repay is still very good.

Jeff, I think a follow-up question on the balance sheet. How should we think about securities cash flows per quarter and I assume some of that's going to flow into funding loan growth this year? Just curious how those balance sheet dynamics should work?

That's right. So we were getting a couple of hundred million dollars a quarter, call it, $150 million to $200 million a quarter of cash flow coming from the securities portfolio. Our loan growth has been lighter than that. So you've seen a lot of more reinvestment to the securities portfolio. And that is a reason that you're seeing, and we're expecting to see that securities yield to grow throughout the year because we are investing into new securities. So a lot of that question, the answer we will see comes from our expected deposit growth. Deposit growth with our strategy that we've been talking about going to stay flat, then you're going to see a lot more reinvestment in the securities portfolio, and that can fund the loan growth as well. So my base plan is for relatively flat deposits, take the cash flow from the securities, see how much of that funds in loans and maybe it funds all the loans; we don't know. But I think maybe the bigger question that you're asking is, I think you will see the balance sheet be relatively flat this year, but grow a little bit, all depending upon what deposits do.

I appreciate that guidance. And then one final question. You mentioned the hope or desire potentially to start dialing back rates there. Are you seeing any of your competitors to tap down the ratio on money market or CD specials or how they stabilized your market allowing you to move down? Just curious what you're seeing from a competitive backdrop?

Maybe I'll start real quick and pass to Rich. I would say, very limited and scattered, but we're a little bit. Would you?

I would agree, and there are still occasional rational instances, but it has definitely calmed down a lot and has come down significantly.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Lynn Harton for any closing remarks.

Great. Well, thank you all for joining the call. We look forward to additional questions. If you have them, please reach out directly. And we look forward to talking soon. Thank you so much.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.