United Community Banks Inc Q2 FY2024 Earnings Call

Good morning, and welcome to United Community Bank's Second Quarter 2024 Earnings Call. Hosting our call today are our 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, pre-tax, 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 this morning on Form 8-K with the SEC. And a 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 may be 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 2023 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.

Good morning, and thank you for joining our call today. We were pleased with our performance this quarter. On an operating basis, our earnings per share of $0.58 was up 5% from last year and 11.5% from last quarter. We moved above a 1% ROA on an operating basis, reaching 1.04% for the quarter. Our net interest margin expanded by 17 basis points, due to our focus on disciplined deposit pricing, as well as ongoing loan repricing. Our margin increase led net interest revenue to increase by $9.6 million for the quarter. While non-interest income was down $3 million from last quarter on a GAAP basis, excluding a non-recurring gain we realized in the first quarter, our non-interest income was essentially flat. We held expenses on an operating basis flat for the quarter and we continue to look for opportunities to reduce our expenses and improve our results. Tangible book value increased by 9% on an annualized basis. Credit trends remained solid and stable. Net charge-offs were 26 basis points, down slightly from 28 basis points last quarter. Equipment finance charge-offs continue to normalize as we expect and were down 24 basis points sequentially. Non-performing assets were up slightly from 58 basis points to 64, while special mention and substandard accruing loans dropped by 10 basis points. We have some additional information in the Appendix this quarter on our office and multifamily portfolios, both of which continue to perform well. While credit continues to be strong, we are selective on new credits and are actively managing existing relationships given the uncertainty in the environment. This, along with caution on the part of our borrowers, contributed to a small decline in our loan outstandings this quarter. We continue to hire new teams and see new opportunities, and we believe growth will improve for the balance of the year. On the deposit side, we consciously allowed some higher-rate unprofitable balances to exit, primarily in our public funds business. We continue to see some movement from non-interest-bearing to higher-rate products. However, the cost of our interest-bearing deposits increased just 3 basis points this quarter compared to 8 basis points last quarter. Our liquidity position continues to be very strong with a loan-to-deposit ratio of 80% and essentially no wholesale borrowings. I'll now turn the call over to Jefferson 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 mentioned, our total deposit balances were down in the second quarter, primarily due to our strategy. With the loan demand being lighter and with significant cash on hand, we were able to lower our public funds pricing and pricing on some of our more promotional deposit accounts which translated into some deposit shrinkage, but also into a higher margin. We did continue to grow total accounts in the quarter and continued our momentum there, but we were able to be more strategic on the more expensive pieces of our funding base. Excluding public funds, our deposits shrunk $132 million or 2.6% annualized with the mix staying relatively stable. Our cost of deposits moved up 3 basis points in the quarter to 2.35%. We turn to our loan portfolio on Page 7, loans shrunk in the quarter by $164 million. Loans being down is a combination of us being cautious on new loans, us moving some downgraded loans out of the bank and lighter loan demand from customers who appear to be holding back on projects due to rates and uncertainty. We saw Navitas loans grow a little bit in the quarter as we pulled back on loan sales given the lighter demand in other areas. 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 strength of our balance sheet, we believe that our balance sheet is in good position with no FHLB borrowings and very limited broker deposits. We believe 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 capital regulatory ratios and our TCE and all of our capital ratios remain above peers. Our leverage ratio was also up 24 basis points in the quarter. Moving on to the margin on Page 10. The margin came in 17 basis points higher in the second quarter on a GAAP basis and was up 15 basis points on a core basis. Our loan yield moved up 19 basis points to 6.43% with our new and renewed loan yields remaining in the 8.5% range for the quarter. We had slightly more loan accretion in the quarter compared to Q1 moving from a benefit of 7 basis points in the first quarter to 9 basis points in the second. From here, I expect our loan yield to continue to increase and that our cost of funds is near a top. That said, we are still having some, albeit slower, negative mix changes, and we have a significant amount of CDs maturing in the third quarter. Currently, our CDs are coming on at about the same rate as maturing CDs, but industry competition could also change. Taken together our net interest margin should be flat in the third quarter plus or minus 1 basis point to 2 basis points. Moving to Page 11. Noninterest income was relatively flat, excluding MSR write-ups in both quarters. Better service charge income offset lower other fees and mortgage was relatively flat. Mortgage volume was higher due to seasonality and our mortgage production continued to be predominantly fixed rate that we sell into the secondary market, generating fewer loans for the balance sheet. Our gain on sale of SBA and Navitas loans was down slightly compared to last quarter. We decided to sell fewer Navitas loans in the quarter to partly offset the soft loan demand at the bank. Our wealth management revenue was $6.4 million in the second quarter, up slightly from Q1, and I will direct you to Page 16. On an ongoing basis, we review all of our business lines and we underwent a study of our wealth businesses and how they fit together. We concluded that our retail, trust, and insurance businesses have a great interconnection with the bank and bank customers, and we are a great long-term fit. While our registered investment adviser, FinTrust was not. We also found growing FinTrust was expensive and generally would require capital to buy advisers and their books at relatively high prices. At that time, we decided to invest in and grow our private bank, trust, and retail businesses and to sell the RIA. And we signed a contract to sell it in June to another large private registered investment adviser. While the deal will not close until the third quarter, most likely we wrote down some of the goodwill associated with FinTrust by $5.1 million. For the second quarter, FinTrust was in our numbers and accounted for 44% of the AUA but only accounted for one-third of the wealth management revenue. FinTrust contributes about $2 million of fees per quarter. Its expenses are roughly equal to its revenue, so the sale will not impact EPS going forward. Back to Page 12. Operating expenses came in at $140.6 million, up just $200,000 from Q1. We had our annual merit process that moved expenses higher and we also had higher health insurance costs, but this was offset by lower other expenses including lower incentives and lower fraud losses. Moving to credit quality. Net charge-offs improved to 26 basis points in the quarter with the bank being very low at just 15 basis points. Our NPAs were up slightly. Our breakout of Navitas losses are on Page 19. Navitas losses were improved at 1.42% and Navitas losses, excluding long-haul trucking were 1.01%, which was also just slightly improved, 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 $12.2 million to cover $11.6 million in net charge-offs, and our ACL increased slightly in the quarter and is up year-over-year. With that, I will pass it back to Lynn.

Thank you, Jefferson. Before we take questions, I'd like to add to Jefferson's comments on our decision to sell our registered investment adviser, FinTrust. Several quarters ago, I asked Melinda Davis Lux, on my team, to review our various wealth-related businesses and develop a more comprehensive strategy. In that process, she interviewed and spent time with multiple external resources, team members of our different wealth businesses, as well as our frontline bankers. As a result of that review and under her leadership, we began to execute on building a more integrated wealth strategy. We want a bank-centric model designed to be understandable to bankers and deepen our relationship with clients. We want to minimize internal competition and conflict, and we want the business to be scalable and profitable. The development of this more focused strategy led to our decision to sell FinTrust. While we recognize a small loss this quarter in doing so in the form of a goodwill write-down, it will be capital accretive upon closing in the third quarter and will have no impact on our ongoing net income. Additionally, I believe the FinTrust team will be more successful individually within a dedicated RIA business. I appreciate Melinda's leadership on this, and I'm excited about the outstanding leadership team she has assembled to drive this business. As we move forward in '24, we will continue to sharpen our focus on execution throughout the company as we build a great bank with the incredible teammates we have here at United. And now we'd like to open the floor for questions.

The first question comes from Stephen Scouten with Piper Sandler. Please go ahead.

Yeah. Thanks good morning. I guess maybe if I could start with loan growth and kind of maybe some color around the view that growth will improve through the balance of the year versus the commentary about taking a more cautious stance on new originations. Just kind of wondering what that looks like. Is there a focus on a different segment of the loan book? Or is it just that, hey, we could actually grow a lot faster if we wanted, but we're going to be cautious, which will still provide some growth, just maybe not what it could have been. If you could just kind of point me in the right direction there.

Good morning Stephen. This is Rich. With regards to Q2 results, as you know, high interest rates, credit tightening, and election uncertainty dampened owners and sponsors' confidence. We do see that improving a little bit. I've spent time talking to each state President as well as all the senior credit officers individually to see what activity looks like going forward. And right now, it does look like it's picking up in Q3 as compared to Q2 and as well as more optimism even in Q4. So we're feeling better about continued loan growth throughout the year. And in terms of products, we see CRE starting to come back a little bit. Because it has been flattened, we've seen a lot of tapering of that product over the last year. It is starting to come back a little bit. In the secondary markets, they are coming back as well. And then where we've got a lot of focus is on owner-occupied CRE and have some specific specials on that, and that's performed very well for us.

Okay, that's helpful Rich, thank you for that. I'd like to discuss the net interest margin for a moment. You mentioned the relative stability of funding costs, but it seems like loan yields increased significantly. I'm curious if there was anything unusual about that, such as non-accrual loans being removed from the balance sheet, and if that had a notable impact. Also, I'd like to understand your outlook on funding costs and loan yields moving forward, especially since you mentioned that it might remain flat quarter-over-quarter.

Thanks, Steve, for your question. There’s nothing particularly unusual about that. The higher loan accretion contributed positively. I anticipate a potential increase of about 6 to 7 basis points in loan yield due to back-book repricing and new loans being issued at 8.5%. The cost of funds is somewhat variable, and our choice to retain or sell Navitas loans will influence this; retaining them could enhance loan yield, which benefited us slightly this quarter. The actual cost of funds as of June 30 was slightly lower than the first quarter average, providing some optimism for the third quarter. However, a significant amount of CDs is set to reprice, and many banks are facing similar situations, making it challenging to predict the rates for new funds. Overall, as I mentioned in my prepared remarks, a flat outcome seems reasonable for your model. However, there's some optimism that things could improve if our current strategy unfolds successfully. Nevertheless, flat remains a prudent estimate given the uncertainties surrounding some of our strategies.

Got it. Okay. Great, I’ll let somebody else. Thanks for the color guys.

Our next question comes from Michael Rose with Raymond James. Please go ahead.

Hi, good morning everyone. Thank you for taking my questions. On a core basis, it appears that expenses were slightly lower than I expected and what the consensus anticipated. Can you provide an update on some of the strategic priorities as you reinvest in the franchise and begin to grow loans, following up on Stephen's questions? Looking ahead to next year, do you anticipate that continued investments in the franchise could result in a mid-single-digit growth rate while balancing investment inflation with ongoing cost reduction initiatives? Thank you.

Michael, this is Lynn. I'll begin, and Jefferson can add on. Earlier this year, our team set a goal to keep our employee expenses steady if possible. That was the challenge I presented as we navigated through the year, while also recognizing the need to invest in growth, as you pointed out. I'm confident we can manage to do both. We recently reviewed positions to identify areas of excess capacity. This was partly due to declines in volume in certain sectors, improvements in technology, and anticipated reductions in employment areas where enhancements were made, along with addressing some organizational redundancy. After rapid growth, we found areas where we could streamline operations. Therefore, we've eliminated a number of positions at the end of this quarter to achieve this. Our aim in this was not solely to reduce expenses but to ensure we can continue investing. Rich is engaging with several teams, and Linda is also in discussions with her teams. It's important to invest in certain control functions that our stakeholders need to support our continued growth. While it was an ambitious target, I'm not guaranteeing we'll achieve it, but that's the framework under which the team is operating.

So I think that's well said. I will only add in that I think that nets out to a low single-digit overall growth rate in expenses, and that is enabled by some of these production-related technology-related cuts that we've made.

Very helpful. And then maybe just as a follow-up and assuming we are going to get some rate cuts, I would assume some of your fee businesses, especially mortgage, would continue to do a little bit better just on a core basis. I’d assume that the expectation for next year would be decent positive operating leverage. Is that the way we should kind of think about it?

Yes, we are aiming for positive operating leverage each year, and we will take the necessary steps to achieve it. It's challenging every year, but I believe we will see loan growth and customer growth. We experienced some mortgage growth last year, and I expect continued growth in our core businesses. Our goal is to keep expense growth lower than revenue growth annually, and I think we can achieve that in 2025 as well. Now, I’ll hand it over to Rich for additional comments.

Yes, Michael you asked about 2025, and we are very optimistic about that. We are still in the best markets. The three lift-outs we've done in Rome, Georgia, East Tennessee, and Middle Tennessee have gone really well and are continuing to go well. And I will tell you, we continue to work on several others and are very excited about that. So we are very optimistic about 2025.

Thanks guys. Maybe just one final one for me. I think you guys had said that M&A wasn't really in the cards until next year. Is that still the base case? I mean I know a lot's going on in the political circles and people are getting excited about just kind of the deregulatory backdrop if one party wins. But just wanted to get any sort of updates in your thought process around deals.

Sure, Michael. This is Lynn again. I would say we are currently in an open yet cautious stance regarding mergers and acquisitions. I don’t feel pressured to pursue M&A at this point. Additionally, the slowdown has allowed us to concentrate on project work, which has had its benefits. The situation is improving for M&A, particularly regarding rate marks, which have gotten better over time with some moderation in rates. However, there are still challenges with credit marks, especially in the commercial real estate sector. The smaller banks we typically consider tend to be heavily involved in commercial real estate, which presents a bit of a headwind. It has been interesting to assess the value of the individual deposit franchises of the banks we are evaluating, as some have recently considered selling, with varying levels of appeal. We are focusing on franchises that we believe will allow us to enhance our offerings and bring in new talent. From what we are observing, we anticipate several such opportunities emerging in the upcoming quarters, and we hope to successfully pursue a select few of the most promising ones. When it comes to deals, we are not overly concerned about regulatory implications due to their smaller scale. However, it will be intriguing to see how the political and regulatory landscape develops after November.

The next question comes from Catherine Mealor with KBW. Please go ahead.

Thanks. I just wanted to follow up on your mention that part of the higher margin this quarter resulted from holding more Navitas loans on the balance sheet, which benefits from a higher yield. As you anticipate improvement in core loan growth, excluding Navitas, in the latter half of the year, do you foresee an increased sale of that product? Or does the current balance between gains from sales and holding them on the balance sheet remain appealing enough that Navitas will continue to grow at this pace?

It is a great question. Last quarter we sold about $27 million. This quarter we sold about $8 million. With the loan growth we are discussing, it's still in the low single-digit range. I think it would depend on the pricing, but it seems likely we will keep more Navitas loans for the second half of the year. While I don't anticipate sales dropping to as low as $8 million, I expect it will be at the lower end of that $8 million to $26 million range. Thus, we are leaning towards retaining more, especially considering that even with improved loan growth, we are still on the lower end of what we had planned for this year.

Okay, great. I want to revisit the loan yield outlook. This quarter's performance was quite high, and I doubt we can sustain this level of loan yield growth in the upcoming quarters. What are your expectations for loan yields moving forward, considering fixed-rate book repricing and potential growth?

Right. So I think if you look at the back book we're adding, put that together it's probably 6 basis points to 7 basis points a quarter of additional loan yield.

All right. Great. Thanks so much. This is all I got.

The next question comes from Gary Tenner with D.A. Davidson. Please go ahead.

Thanks good morning. One quick question on my end. Jefferson you mentioned a couple of times kind of the prospects of CD repricing in the third quarter as a potential headwind. Just wondering if you could detail the amount and rate of CDs that got mature in the third quarter.

Yes, thank you, Gary. That's a great question. We have approximately $1 billion in certificates of deposit maturing this quarter, with a rate around 4.20%. Currently, they are also coming in at about 4.20%, so we are somewhat optimistic that the challenges from the CDs have already been fully accounted for. However, given the large amount, it's difficult to predict. Additionally, other banks also have significant CD maturities. Therefore, we have included some conservatism in our forecast, anticipating that rates may increase slightly. At the moment, they are stable at 4.20% compared to 4.20%, which isn't impacting our margin negatively. However, we believe the situation could change based on the overall market and what we observe from other banks.

Okay. I appreciate that. And actually, while we're on that topic, could you give us the fourth quarter maturity schedule as well with rate?

It is roughly $1 billion. It might vary slightly, and I will need to update you on that, but it's also a very large quarter.

Our next question comes from Russell Gunther with Stephens. Please go ahead.

All right. Good morning, guys. Following up on the margin discussion, you guys also saw a nice lift in the security field. Could you just remind us about what that cash flow looks like coming due over the next couple of quarters and where you'd expect those yields to trend?

Yes. So we have about $40 million of cash flow principal coming in per month there. The average that we are putting that on is 5.90%. This quarter, you saw a bigger jump than you usually would because we had a lot of cash coming into the quarter, a little less loan demand. So we're putting that cash to work in a stronger, bigger fashion than we think we will in the second half of the year. But expect, again, $120 million a quarter, reinvesting at roughly 5.90%.

Got it. Okay. And then just to clarify the expectations for the 6 basis points to 7 basis point pickup in loan yields that assumes a similar level of Navitas loan growth going forward. Is that what's kind of contemplated in that guide?

That's correct. That's correct.

Okay. Excellent. Thanks. And then with the comments made around the conservative approach to credit, the more cautious stance and then moving some problems out. Could you just provide a little more color about kind of where within the loan book you've got that increased incremental conservatism?

So this is Rob. I'll address that. Essentially, what has happened in the commercial real estate sector is twofold. First, we have scaled back our interest in speculative lending. In the past, we may have engaged in speculative warehouse loans, but moving forward, we have decided to exit that market. Additionally, both we and the sponsors in the multifamily sector have reviewed ongoing construction projects. As a result, we have raised our vacancy assumptions during the underwriting process, and the higher interest rates are also affecting our underwriting. All of this necessitates more cash equity. Therefore, we have tightened our approach to underwriting in the commercial real estate investment space, considering factors like interest rates, vacancies, and the speculative nature of certain investments.

Okay. Great. Thank you for that. And then last one for me guys, just an update in terms of your sort of near-term net charge-off expectations, both within Navitas and then the core bank. Thank you.

Yes, this is Rob. I'll begin with Navitas and then discuss the overall bank. For Navitas, we anticipate that charge-offs will continue to decrease. The over-the-road trucking sector was a major concern in the fourth quarter, but it has declined; it decreased in the first quarter and again in the second quarter to $1.7 million of their $5.5 million in net charge-offs. I expect further reductions in the third quarter and a more significant drop in the fourth quarter, stabilizing around the 1% annualized range. Regarding the bank, it has been consistently around $6 million and within the 15 basis point range, and I expect it to remain relatively stable moving forward.

All right. Great. Thank you guys for taking my questions.

The next question comes from Christopher Marinac with Janney Montgomery Scott. Please go ahead.

I want to continue discussing credit with Rob. Can you talk about the inflows and outflows related to both special mention and substandard? Do you see possibilities for upgrades? Are any downgrades expected? I'm interested in the movement over the past quarter.

Yes. So we've seen a fair amount of movement. We see payoffs, we see upgrades. I will give you 2 examples, I guess, one was a senior care credit that we had that we got paid-off on during the quarter. That was a special mention credit. And we are seeing a fair amount of movement in that space, at least an interest coming back in the senior care space. And then one of the credits we had, we upgraded was a C&I credit that I think got caught with some contracts that didn't have the appropriate adjustments in them. And of course, labor costs went up and that was a special mention credit, and we were able to upgrade that credit. They figured it out and some got their contracts reworked and the company back performing very well. And so you just see a variety of those types of either payoffs or upgrades. There is quite a bit of movement and really opportunity in the space.

Thanks, Rob. That was insightful. I appreciate the information in the slides regarding both office and multifamily. The level of criticized loans in those areas already reflects your stress testing for debt service coverage and some adjustments made in the last six months. What I'm trying to understand is that it seems unlikely these risks will change significantly at this point.

Yes, we conduct a stress test for interest rate changes on CRE credits over $1 million that are maturing in the next 12 months. We reevaluate these credits based on how the debt service adjusts to the new interest rates. Last quarter, we experienced several downgrades due to this evaluation, and some of these credits are placed under management watch. They may not be categorized as special mention or substandard yet, and if they have time and the chance to renegotiate their leases, we allow them that opportunity before proceeding with a downgrade. Therefore, while additional downgrades could occur, we continue to see various opportunities to adjust the status of credits between special mention and other categories.

Great. Thanks for all the background today. I appreciate it.

Our next question comes from David Bishop with Hovde Group. Please go ahead.

Good morning. Regarding the credit topic, you mentioned that one of the senior care criticized loans was paid off this quarter, and there's a significant amount coming up over the next six months with many of those being substandard or under special mention. What are your thoughts on this? Do you believe they will continue to be resolved? I'm interested in how you plan to handle the upcoming maturities. Thank you.

We continue to monitor payoffs and upgrades of our credits. There are about 18 credits we are watching, with four of them in non-accrual status. We have reasonable strategies in place for all four that would likely lead to an exit. We are being patient in managing the portfolio. I believe the long-term demand and population demographics that drove construction in this sector are still present, and the demand remains. Although there was a significant pause during COVID, we are still seeing properties and individuals in need of these services, and the demographics support it. We are exercising patience while also encouraging payoffs and exploring additional resolution strategies.

Got it. I have one final question regarding commercial real estate. I appreciate the slide on concentration. I'm curious if there is an interest in growing that closer to the 250 range. Currently, it stands at 205, so there is some room for increase. I would like to know what the comfort level is for adjusting that ratio. Thank you.

Yes, we are comfortable. There is a variety of products in the commercial real estate business. We’ve listed out some. So we would be more comfortable doing some more warehouse that has long-term leases associated with it. We are being selective, particularly around markets and underwriting on the multifamily space. The retail segment appears to be strong. We continue to look at some grocery-anchored tenant properties where the anchor basically handles the debt service. And so we think there are some opportunities, but being strategic about the specific property type that we approach.

Great. Appreciate the color.

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

Well, great. Well first, I appreciate your time and attention and we are excited to take your questions. With anything that comes up later, please feel free to reach out and we will talk to you soon. Thank you.

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