Earnings Call Transcript - UCB Q3 2023

Operator, Operator

Good morning, and welcome to United Community Bank's Third Quarter 2023 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, 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 third quarter's earnings release and investor presentation were filed this morning on Form 8-K with the SEC and a replay of this call will be available in the 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 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'll turn the call over to Lynn Harton.

Lynn Harton, CEO

Good morning and thank you for joining our call today. As you would expect, we continue to see influences of a higher rate environment this quarter. On the positive side, we had strong deposit growth and excellent liquidity. Customer deposits grew $314 million or 5% annualized this quarter, excluding the first Miami acquisition and the two branches we sold in Tennessee. We do continue to see movement into higher-yielding deposit products with DDA as a percentage of total falling slightly to 30%, down from 31% last quarter. Our liquidity position continues to be very strong. During the quarter, we were able to fund organic loan growth of 5.4% annualized, while paying down over $400 million in broker deposits and still reaching over $750 million in cash equivalents at quarter end, all with essentially no short-term borrowings. Our loan-to-deposit ratio remained at 80%, providing ample liquidity to meet our customers' borrowing needs. Our margin continued to be impacted by rate competition and mix change, but the rate of change has slowed. Our net interest margin fell from 337 basis points last quarter to 324 basis points this quarter, a 13 basis point decline. Higher rates are also impacting some of our weaker customers from a credit perspective. As previously disclosed, we took a $19 million charge-off on an 8.7% share of a locally based shared national credit. We also wrote down two memory care centers, which have been on nonaccrual by $3 million, reflecting expected market value for the properties. With the charges, our bank net charge-off ratio, excluding Navitas was 49 basis points, up from 15 basis points last quarter. Our Navitas subsidiary had increased charge-offs this quarter due to higher losses coming from a relatively small exposure to the long-haul trucking segment. Navitas' annualized charge-off rate for the quarter was 1.62%. Excluding the long-haul segment, charge-offs in Navitas were approximately 88 basis points for the quarter. Taken together, our consolidated charge-off ratio for the quarter was 59 basis points, up from 20 basis points last quarter. These losses are somewhat unique. The majority of our portfolio continues to perform well and our local economies continue to be very strong. However, we know from history that the combination of rapid interest rate increases and tightening credit conditions can weaken credit performance, at least in some business segments. We're cautious in our lending and portfolio management strategies for this reason. In summary, our operating earnings this quarter were $0.45 per share, down $0.10 or 18% compared to last quarter. Our operating return on assets was 79 basis points for the quarter, and our pretax pre-provision ROA was 144 basis points, down 21 basis points from last quarter. On the strategic front, we closed on First National Bank of South Miami, July 1, a deal we announced on February 13 of this year. Conversion is scheduled for this weekend, and we look forward to having their outstanding team fully integrated with the Company. Now I'll ask Jefferson to provide more detail on our performance for the quarter.

Jefferson Harralson, CFO

Thank you, Lynn, and good morning to everyone. I am going to start my comments on Page 7 and go into some more details on deposits. As Lynn mentioned, our total deposit balances were up $606 million in the quarter with the addition of First National Bank of South Miami, driving the increase. In the quarter, we had very strong business and consumer deposit growth of $314 million, which more than funded our $241 million of loan growth. In addition to the strong deposit growth, we also had the proceeds of the sale of South Miami's $200 million securities book that allowed us to pay down $427 million of broker deposits and also offset the sale of two branches in Tennessee totaling $110 million in deposits that were outside our targeted footprint. We continue to see increased price competition in the third quarter that drove our cost of deposits up 39 basis points to 2.03% and took our cumulative total deposit beta to 38% since the fourth quarter of 2021. Moving to Page 8. We also saw continued deposit mix change in the third quarter, albeit at a slower pace as our DDA percentage moved to 30% from 31% last quarter. Our deposit base is growing, diversified between industries and geographies and very granular. We turn to our loan portfolio on Page 9. As I mentioned, we grew loans in the third quarter by $241 million, which is 5.4% annualized. On Page 9, 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 10 where we highlight some of the strength of our balance sheet. While our customer deposits grew faster than loans, the effect of paying down the $427 million in broker deposits pushed our loan-to-deposit ratio higher to 80%. But this leaves us with virtually no wholesale funding remaining, which is a positive for 2024. On the bottom of the page, our chart of two of our capital ratios, our TCE ratio and our CET1 ratio, they were just down slightly in the quarter with the impact of South Miami but remain just under 100 basis points higher than our peer medians. On Page 11, we take a deeper look at capital, and we show a tangible book value waterfall chart. Our regulatory ratios also remain above peers and mostly just slightly decreased with the investment into South Miami. Our leverage ratio increased 10 basis points with the delevering effect of paying down South Miami's securities book and paying down the brokered funds. Moving on to the margin on Page 12, the margin decreased 13 basis points compared to last quarter. Our loan yield increased 17 basis points similar to the increase of last quarter with the new loans coming on in the mid-8% range, but our cost of total deposits was up 39 basis points to 2.03%. The main driver of the cost of total deposits increase was a tougher competitive environment in the form of higher deposit rates, but we also saw our balance sheet was more liquid than we had estimated, which cost us 2 basis points on the margin and offset other positive net mix changes. Moving to Page 13. Noninterest income was down $4.4 million relative to last quarter, mostly due to the absence of one-timers I mentioned last quarter. Notable items and fee income included an MSR write-up of $1.1 million and $2.2 million in unrealized losses on equity investments that we do not expect to repeat regularly. Expenses on Page 14 came in at $135.5 million, up $6.5 million. Excluding South Miami, we estimate that our core expenses were up just modestly. We are expecting $1.7 million in quarterly cost savings to begin to materialize in Q4 and to be fully extracted in the first half of 2024. When covered the charge-off and credit trends well in his remarks, but I will talk on the allowance for credit losses on Page 16. We set aside $3.3 million to cover $26.6 million in net charge-offs. In addition to that $3.7 million difference, we added another $3.7 million into the reserve with the South Miami PCD mark. Our allowance for credit losses as a percentage of loans remained essentially flat and our coverage of NPAs improved with the improvement of NPAs. With that, I'll pass it back to Lynn.

Lynn Harton, CEO

Thank you, Jefferson. And many thanks to the United team, I appreciate your focus on living our purpose, building our communities, and I look forward to continuing to succeed together. And now, I'd like to open the floor for questions.

Operator, Operator

We will take our first question from Michael Rose with Raymond James.

Michael Rose, Analyst

Let's start with credit quality. Excluding the Mountain Express Credit, there were some fluctuations in charge-offs and NPAs, and I specifically want to discuss what's happening with home equity. There was a recovery, but NPAs increased. Additionally, I know you mentioned it earlier, but could you provide more details on Navitas as we look ahead, especially considering the challenges this quarter? When you announced this, if I recall correctly, you indicated that the business typically experiences a loss content of about 70 to 80 basis points over the cycle. This quarter, however, it was above that due to some of the issues you mentioned. I would like your updated thoughts on that and what expectations might be for this business moving forward.

Rob Edwards, CRO

It's Rob Edwards. While we anticipate credit tightening and rising interest rates could lead to future challenges with credit losses, we are not seeing any noticeable impacts yet. Overall, our losses have decreased, including a drop from 20 basis points last quarter to 17 basis points this quarter when considering Navitas. We did experience a significant recovery in the home equity sector, which was a unique occurrence related to a specific credit we acquired, but we are not observing any concerning trends in home equity; it continues to perform well. In fact, half of our home equity business consists of first lien loans, indicating a strong portfolio. Regarding Navitas, I initially viewed it as having around a 1% loss expectation, but we are currently exceeding that figure, with our latest guidance placing it in the 95 basis point range. Lynn noted that their number was 88 basis points for the quarter when excluding the transportation segment of the portfolio, but the remainder of the business outside of long-haul trucking appears to be performing within our expectations.

Michael Rose, Analyst

Okay. Great. Maybe just as a follow-up question, switching gears, obviously, rates moved against you and every other bank this quarter. I know last quarter, you kind of talked about expansion in the fourth quarter, at least on a core basis kind of moving forward. Is that kind of still the expectations? And again, sorry if I missed this, I hopped on late, but if you can talk about maybe some of the headwinds that you guys still face and then maybe some of the potential tailwinds, I assume not having any FHLB and hopefully getting to a peak or close to a peak and deposit pricing increases will certainly help, but would love some greater color.

Jefferson Harralson, CFO

In discussing the margin for the fourth quarter and current trends, I believe the margin will decline slightly compared to the third quarter, but not as significantly. On a positive note, we are observing a slowdown in the mix change with DDA decreasing from 31% to 30%. Additionally, we gained 3 basis points from reducing the brokered mid-quarter, which is beneficial. During this quarter, we didn't raise rates, but we noticed our existing customers shifting to our promotional money market rates and opting for CDs, including some more expensive options. This indicates a mix change among our current customers, while new customers are coming in at competitive rates. We are also originating new loans at higher rates, and it’s encouraging to see customers actively seeking and discovering higher rates within our bank. We are proactively reaching out to them to highlight the rates available. Overall, I expect the loan yield to continue increasing steadily, while the cost of funds will rise at a slower rate. Consequently, I anticipate slight compression in the fourth quarter with stabilization and potential growth next year.

Michael Rose, Analyst

Very helpful. And then maybe just one final one for me. The revenue outlook for you and other banks, obviously, remains challenged in a higher for longer type environment. I know you've talked previously about kind of a 4-ish percent kind of expense target as we move forward. But just wanted to see if there are any plans to maybe look to either formally or informally plan to reduce expenses? And is there a possibility under that scenario where you could experience positive operating leverage next year?

Jefferson Harralson, CFO

Yes, I think so. We are currently in our budgeting process. We closed five branches, and Rich can provide more details on that in July. We sold the two branches I mentioned earlier, which have both cost savings and revenue implications. We are actively cutting expenses in certain areas of our business, particularly in mortgage, similar to many banks. We are considering various strategies for expense management and implementing them. It's challenging to provide a specific number at this stage since we are still working through the budget, but targeting around 3% seems reasonable. However, given the current inflationary environment and our ongoing budget discussions, my projections are higher than 3%, though we will aim for that target.

Catherine Mealor, Analyst

I want just to ask about your loan growth outlook. You maintained a pretty steady growth pace, I feel like over the past few quarters. Just curious how you're thinking about that into next year? And then also within that conversation, I noticed that Navitas growth slowed a little bit this quarter. Is that something that you plan to continue through next year as well?

Rich Bradshaw, President and Chief Banking Officer

Catherine, this is Rich Bradshaw. We're still looking at mid-single-digit loan growth, but probably a little bit less than the pace in Q3, recognizing the higher interest rates and some of the stress out there. And we expect that to kind of continue into Q1. However, we are optimistic about the opportunity that some of the downsizing of banks are doing, and that's going to create real opportunities on the customer side. So we remain very optimistic about that.

Jefferson Harralson, CFO

And this is Jefferson. I'll take the Navitas question. Navitas trends were pretty similar on the growth front, but you'll notice that we sold more loans this quarter. We kind of leaned into selling a little bit more. We have our Navitas loans are 8% of total loans. We like that ratio. We've talked about keeping it below 10%, but our target is the 8% range. So, I think you'll see us selling a higher number of loans each quarter as long as that market is accommodating and amenable.

Catherine Mealor, Analyst

What is your outlook for Navitas charge-off? Do you believe we will maintain this elevated level in the trucking sector for the next few quarters, or do you anticipate a return to more normalized levels?

Rob Edwards, CRO

No, we're thinking the same way you're thinking in the next couple of quarters. We think definitely next quarter will be similar to this quarter, but then thinking it will begin to subside early next year.

Stephen Scouten, Analyst

Could you clarify the margin situation? Jefferson mentioned it was largely due to existing customers accepting higher rates and transactional accounts. Last quarter you indicated a potential downside of 5 basis points, but we observed around 15. Now it seems we might be looking at stabilization in the fourth quarter or possibly in 2024. Are there any other factors influencing this delay? The loan yields appear strong, and I'm trying to understand if there's anything else contributing beyond the changes with existing customers regarding deposit rates.

Jefferson Harralson, CFO

Yes, that's pretty much it. We are growing deposits at a good pace, and when deposits grow, they're generally at market rates. This faster growth in deposits tends to have a slight negative impact on the current margin in the near term. However, the main factor is that existing customers are transitioning to our more promotional rates, often prompted by our team to ensure they're receiving the best rates available. We haven't significantly increased rates; it's mainly about existing customers moving into our promotional offerings.

Stephen Scouten, Analyst

Okay. And I think you said last quarter, securities restructuring wasn't really on the table. Has that view changed at all? Or I mean, do you think about the math on any of the longer-dated mortgage backs at this point if we really are in kind of a higher for longer environment at this point?

Jefferson Harralson, CFO

We have run the calculations and reviewed the numbers, but we have not given this serious consideration at this time. We do have the capability to do this with our higher capital ratios, which would involve taking a capital hit and reinvesting that into higher-yielding securities, but it is not something we are actively considering yet.

Stephen Scouten, Analyst

Okay. Lastly for me, at a high level, are there any other branch footprint changes we should anticipate? Conversely, is mergers and acquisitions still more of a potential endeavor for mid to late 2024, or is there any activity changing that might lead to a near-term opportunity?

Rich Bradshaw, President and Chief Banking Officer

Rich here. I'll start with the question about branches. We're currently going through the budget process and will always assess profitability and what makes sense for the market. This is something we evaluate every year, and we will continue that process.

Lynn Harton, CEO

This is Lynn. Regarding M&A, I still anticipate it to be slow, mainly due to the marks involved. In a typical environment, two things occur. First, large marks are not common. Second, we generally plan for minimal loan growth in an M&A transaction at the start because of the new policies and changes the teams have to adapt to. Even if we have a strong franchise, we aim for flat growth initially, which can be challenging for the incoming teams. In this current environment, we usually bring in our other products to drive growth, but in a slower loan growth environment, it's tougher to achieve that, alongside the larger upfront marks. So, at this point, it’s more of a mathematical issue, and I expect traditional M&A to remain slow until about mid-next year.

Christopher Marinac, Analyst

I wanted to ask if there is an internal limit on sort of the shared national credits and club deals and things of that nature. Just curious if that is going to change at all as a result of last quarter's experience.

Rob Edwards, CRO

Hey, Chris, it's Rob. We do have an internal limit. All the segments of the portfolio have triggers and limits established. We are right now very low and quite a bit below the limit that we have established, and we really consider this one credit to be an outlier and not really representative of what we would expect from that portfolio.

Christopher Marinac, Analyst

Great. And Rob, I guess just a general question about the reserve level. I mean given the reserve or the charge-off comments that were made earlier, does this reserve level kind of cover that? Or would you see kind of gradually increasing reserves next year?

Rob Edwards, CRO

So, we have increased the reserve by $40 million this year, and we did increase the reserve by about $50 million last year, really the reserve is driven by asset quality in general, portfolio mix, loan growth and now the sort of the economic forecast. And more recently, it's been about the economic forecast. And so given the last two years, I could see the allowance growing. In my personal opinion, it would be more likely driven by the economic forecasting and economic experience that ends up driving growth if there is any.

Christopher Marinac, Analyst

Got it. And then just last question on credit is just related to kind of the combined substandard and special mention. I know it's hard to compare with past cycles because the Company is so radically different in terms of your portfolio and scale. But is the criticized numbers combined, could those elevate next year? Or would you kind of think about managing those more stable?

Rob Edwards, CRO

So if I look back at the chart, it was 4.1 at the beginning of 2020. If you combine the two numbers, you're at 4.1% of the loan portfolio. And right now, we're at 2.9. So, I would expect the numbers to increase. It seems like we're at a low point at the moment. I would consider it more of a normalization than anything else.

Russell Gunther, Analyst

Just a follow-up. I appreciate the commentary on Navitas losses and how you'd expect that to trend. So as we think about that normalizing in the beginning of next year, and potential credit migration in the core bank. How are you guys thinking about aggregate charge-offs on appropriate range in '24?

Rob Edwards, CRO

We have previously indicated that we expect our loss rate to align with a 30 basis point experience throughout the cycle. This is our assessment for a normalized environment. Excluding the outlier, we recorded a loss rate of 20 basis points last quarter and 17 basis points this quarter, which takes into account the higher losses from the transportation sector related to Navitas. Historically, we have considered ourselves to be operating as a 30 basis point business.

Russell Gunther, Analyst

Okay. So no change to the outlook there. Got it. And then just a follow-up on the margin conversation. Jefferson, I appreciate the high-level commentary. Could you just share a bit about what you're anticipating in there from a continued remix perspective out of noninterest-bearing and then how you guys would expect the loan-to-deposit ratio to trend for peer. Do you want to actively manage around 80%, could that drift higher? Just some updated thoughts.

Jefferson Harralson, CFO

Yes. The change in mix should generally be favorable for us, particularly in the first half of the year, as the securities portfolio continues to shrink while loans grow modestly. This should lead to a positive shift in our asset mix. The DDA aspect is more challenging; we have noticed a slowdown there, which gives me some optimism that it may continue, especially if rates do not increase significantly. We are currently modeling projections based on several forecasts, but our recent results have exceeded those expectations, suggesting there might be potential for better outcomes. However, we're also observing a trend of our customers opting for higher rate products. Regarding the loan-to-deposit ratio, I believe it could increase slightly. We have a solid funding base and plan to leverage the strength of our balance sheet along with the positive deposit growth we've experienced, particularly in October. We anticipate being somewhat conservative with the rates we offer in the coming months and into next year. If we manage this effectively, we could see a slight slowdown in deposit growth, improvement in the loan-to-deposit ratio, and a more favorable cost of funds experience.

Russell Gunther, Analyst

Okay. Really helpful. And then just lastly, on the loan growth outlook, which I believe you guys are saying mid-single digits. How do you think about the contribution via asset class and any particular geographies of strength there?

Rich Bradshaw, President and Chief Banking Officer

Ross, this is Rich. We'll see it, I think, to change a little bit of the mix a little bit away from CRE into C&I. We've got several different initiatives that we're working through. Our biggest geography contributor this past quarter was North Carolina, and they led the bank in C&I. So we're leveraging their experience across the footprint, and so that's how I kind of think about that.

Jefferson Harralson, CFO

Want to talk about Tennessee and some of the...

Rich Bradshaw, President and Chief Banking Officer

Yes. And in Tennessee, it's a good story for us. We put our new State President there, Kelley Kee, over the last three months. We've hired 20 commercial professionals and already not pipelines, but closings. Those have paid really good dividends. It's going to take a little bit more time to turn that ship. But I think we're going to start seeing the very positive results of that, if not first quarter, certainly second quarter next year.

Michael Rose, Analyst

That's great, thank you guys. That's it for me.

Operator, Operator

Our next question will come from Brandon King with Truist. Please go ahead.

Brandon King, Analyst

So Jefferson, could you quantify what the spot cost of deposits was at the end of the quarter? And then what is the new rate for new relationships and new deposit customers?

Jefferson Harralson, CFO

Yes. The average spot cost of deposits for the quarter was $2.02, with the spot being approximately 5 basis points higher for September. I have two numbers in mind regarding new deposit relationships, but I’d prefer to discuss that offline to provide you with the correct figure.

Rich Bradshaw, President and Chief Banking Officer

It's probably worth noting...

Jefferson Harralson, CFO

Hang on one second, Brandon.

Rich Bradshaw, President and Chief Banking Officer

It's probably worth noting that we had a deposit pricing committee this past Monday, and we surveyed all the state presidents individually about their exception pricing requests, which are certainly down. So we do see a slight relief in that area.

Brandon King, Analyst

Good. And then when you think about a cumulative deposit beta, I know before, I think you talked about 38%. But what are your thoughts now just given that rates would essentially be higher for longer?

Jefferson Harralson, CFO

Yes, that's an excellent question. We are currently working on our budget, and I want to emphasize that we do not have a forecast for our 2024 margin or our cost of funds at this moment. Let's keep in contact regarding this. In the short term, I expect our loan yields will increase by a similar amount as last quarter, approximately 18 basis points. Additionally, with the margin guidance I provided, indicating a decrease that may be about half of last quarter's decline, you can estimate an increase in our cost of deposits for this quarter. I believe deposits are continuing to grow at a faster rate than loans, and we will discuss our 2024 forecast in the next quarter during budget season.

Brandon King, Analyst

Okay. Makes sense. And just not to be beating a dead horse, but following up on Navitas and expectations for losses to kind of ease next year. Just wanted to get more of a sense of what gives you confidence that losses will ease and maybe is it just more of a function of that trucking segment just kind of running off?

Rob Edwards, CRO

Yes, I think that's exactly the way I would describe it, Brandon, is that the trucking segment is, I think if you add all the different trucking aspects of it together, I think it's 10% of the total portfolio. And then this specific piece where we're experiencing the highest stress level is much smaller than that, so probably 3%. So it's just such a small portion of the overall book, and we're continuing to see consistent performance of the remainder of the book, evidenced by the 88 basis points of performance in the third quarter.

Operator, Operator

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

David Bishop, Analyst

Jefferson, I believe you mentioned that your liquidity is slightly higher than it was last quarter. Can you share where you plan to allocate some of that cash in the near term? I know you have paid off a significant amount of short-term borrowings, and I'm interested in where you see the opportunity to use that.

Jefferson Harralson, CFO

Yes, with the inverted yield curve, I'm not seeing a ton of opportunity there. We are most likely to hold in cash or roll short treasuries with that cash.

David Bishop, Analyst

Got it. And then final question. There's a lot to discuss regarding the merger and its impact on operating expenses and fee income. I'm interested in understanding, from a financial standpoint, where you anticipate those figures to stabilize in the fourth quarter.

Jefferson Harralson, CFO

Yes. I expect expenses to decrease in the fourth quarter. We are realizing the majority of the cost savings from South Miami this quarter. Regarding fees, we have identified two non-operating items, which means the base is about $1 million higher than what is currently presented. We are observing strong underlying growth in our wealth management and treasury management segments. Mortgage performance is somewhat uncertain, but I anticipate seeing net growth from that slightly higher base, considering the two adjustments we mentioned.

Operator, Operator

And this concludes our question-and-answer session. I'd like to turn the conference back over to Lynn Harton for any closing remarks.

Lynn Harton, CEO

Great. Well, thank you all once again for joining the call, and we'll be glad to follow up with any additional questions, just reach out and we will talk to you soon. Thank you.

Operator, Operator

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