Earnings Call Transcript - UCB Q1 2020

Operator, Operator

Good morning. And welcome to United Community Banks First Quarter 2020 Earnings Call. Hosting our call today are Chairman and Chief Executive Officer, Lynn Harton; Chief Financial Officer, Jefferson Harralson; 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 of these are included on the website at ucbi.com. Copies of the fourth quarter’s earnings release and investor presentation were filed last night 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 page three of the company’s 2019 Form 10-K, as well as other information provided by the company in its filings with the SEC and included on its website. And at this time, I will turn the call over to Lynn Harton.

Lynn Harton, CEO

Good morning. You know normally I prefer to have a short earnings call and just let the numbers speak for themselves. But this quarter obviously the numbers don’t tell the whole story, so I am going to spend a bit more time on some other topics. So please just bear with me a few minutes. I will start on page three of the deck with how I am viewing our response to the COVID crisis. Fundamentally, I am focusing on all our employees, our customers and our risk management processes. Employees and customers because they are the drivers of our long-term value post-crisis. Risk management because that’s what’s going to drive our ability to come out of the crisis and shape to take advantage of the opportunities we expect. And my support for those areas comes from our comprehensive pandemic plan and our Board governance. As I note on slide four, we have got an extraordinarily strong Board, including three members, who are actually active senior executives at major U.S. banks during the last crisis. Their knowledge and challenge to the management team, along with the rest of our Board and an additional three of whom lived through the crisis as United Board members, continues to provide the right balance of oversight and support as we make our plans. On slide five, I have also been pleased with the thoroughness and responsiveness of our business continuity plan owners to put our plan in place quickly and to make adjustments as need dictates. Turning to our focus areas on slide seven through nine, I outline several steps we have taken to support our teams. Currently, we have 54% of our branch teams working remotely and we have the ability to scale that up to 88%, if needed. I also describe some of the other actions we have taken to make our teams understand that they are valued, supported and safe during this time. One of these initiatives is our share of the good program you will see highlighted on slide eight, where we encourage our teams to share encouragement with one another and with our customers. Speaking of customers starting on slide 11, we are being flexible and proactive in payment deferral options. We know we are good underwriters. We know how to select customers. So our goal is to support and bridge as many of them as possible to the recovery phase. That’s one reason we committed early to be a leader with the PPP program. Our team was able to get approval for almost 7,000 loans totaling more than $960 million before the program ran out of funding. In context, this equals more than 14% of our existing commercial loan portfolio. This was a tremendous effort involving hundreds of people across the Bank and I want to recognize the entire United team for going all in to support each other and our customers. We have also stepped up customer communication. We are adjusting fees, changing limits all with the goal of supporting our class and living our brand promise to be the Bank that serves well. This is actually one of the most energizing and rewarding times of my career to be a banker. Our teams can see more clearly than ever how they are making a difference. This will pay off in the long term. And as you see on slides 12 and 13, we are actually seeing it pay dividends today as we look at digital engagement across the Board, site traffic is up substantially, active online and mobile banking users are up, more customers continue to open up deposit accounts online and our social media connections are growing rapidly as well. As we look at risk on slide 15, we are relying on our three risk principles. When you arrive at a crisis it is generally unexpected, and the risk you enter a crisis with is the risk you are going to live with. There’s really no time to make major adjustments. So we have tried to manage with a through-the-cycle approach in mind, avoiding concentrations, so as to not bet the Bank, taking only the risk we believe we understand and having a culture that rewards speaking up and addressing problems realistically. Speaking of risk, Jefferson why don’t you cover some of our portfolio statistics and then our performance numbers for the quarter. And after that I’d like to come back for just a quick look forward before we open it up for questions.

Jefferson Harralson, CFO

Thank you, Lynn. This quarter I am making a change and starting with loans and credit on page 17. Our ending balance of loans was up $122 million from 12/31 or 6% annualized. Of the $122 million about $60 million came from draw activity. These draws came in the middle and at the end of March at the beginning of the stress but had been stable throughout April and into this week. Our commercial loans to commitments ratio moved to about 67% from 63% at year-end with withdrawals. As Lynn mentioned, we have $961 million of PPP loans coming onto the Q2 balance sheet, which represents about 14% of our existing commercial book. As far as funding goes we expect a significant portion of the PPP loans will be funded this week and early next week. We expect to use a mix of available cash, the PPP liquidity facility, and perhaps some FHLB funding as well depending on timing. In our initial planning, we are estimating that 70% of the PPP loans will be forgiven to the borrower within six months. On the credit side, we have booked approximately $900 million in loan deferrals as of Friday or about 10% of our loan book. Of the $900 million in loan deferrals about $169 million comes from Navitas. To give you some transparency later in the deck, we have some additional information on Navitas, Seaside, as well as our restaurant, hotel and senior care portfolios that we are carefully monitoring. Specifically, our restaurant book and our hotel book each separately make up about 3% of loans or about 6% in total, and again, in the back there are some more details on these exposures. Navitas makes up about 8.5% of our loan book and we did execute a $22 million sale of Navitas loans in February at a 6% gain. Our credit philosophy is that we are very selective in the customers we choose and believe they will fare better than most. We are also very disappointed on the size of our individual exposures and very selective on the size of each book relative to capital. On page 18, we look at our credit for the quarter, our net loan losses in the quarter were higher than we have been running at $8.1 million and annualized at 37 basis points in losses. The main driver of the increase in net charge-offs was a $6.4 million loss on a single loan. This $6.4 million loan was in our leveraged loan book of which we have about $73 million left. The company was in the pulmonary medical testing business. It had significant private equity money behind it but struggled; the PE walked away and the company subsequently failed. All right, let’s turn the page to allowance for credit losses on page 19. We adopted CECL on January 1st and we declined on the opportunity to go back to the incurred loss method. In the first quarter, we posted our loan loss provision of $22.2 million. Our allowance for credit losses is up 19% from January 1st and up 35% from year-end. In terms of dollars, our allowance for credit losses was up $14 million from January 1st and up about $23 million from year-end. I want to share with you a little bit of how we are thinking about CECL. We believe the future is unknowable and that the models are based on historical economic correlations, but neither we nor anyone else has seen an environment like this one. Throughout the quarter we considered and ran many scenarios and stressed our input and assumptions, and of course, we will continue to do so as the public health crisis continues to play out. Moving to page 20, capital, before I talk about the numbers I will talk about strategy for a bit. As the pandemic became increasingly apparent, we stopped our buybacks and began reviewing our contingency plans and rerunning our capital and liquidity stress models, and we feel comfortable with where we are. Our capital ratios are flat in the quarter and up about 40 basis points to 50 basis points from last year. Moving to page 21, again, I will mention that we just don’t know how long this environment is going to last or how bad this is going to get. But we do believe that we are coming into the cycle from a position of strength. We are coming to the cycle with more capital than our peers. We also come into the cycle with about 20% more profitability than peers as measured by pre-tax, pre-provision ROA in Q4. I would also argue that we are more liquid than our peers with our 81% loan to deposit ratio and with almost no wholesale funding in place, we have a lot of flexibility on the balance sheet. We also have very strong core funding with 33% of our deposits in DDA in the first quarter and we have one of the lowest cost deposit bases in the Southeast. Moving on to our net interest income results. We had 150 basis points of rate cuts in March that affected the end of the quarter. So we had about two months of what I would call a normal quarter and the crisis started impacting our March numbers. Our net interest income grew 7% annualized and our NIM increased by 14 basis points. This increase had the help of an unusual amount of accretion in the quarter; accretion income moved to $7.6 million in Q1 from $3.4 million last quarter and added 15 basis points to the NIM versus the last quarter and contributed 26 basis points in total. The switch to CECL had the initial impact of shortening the timeframe of which we accrete our loan alone, specifically now we agreed to the contractual maturity versus the expected resolution date which was often longer. We have $15 million left to accrete to the margin and we are expecting $3 million to $3.5 million next quarter, depending on prepayments or about 10 basis points. Excluding accretion, our core NIM was down only 1 basis point versus last quarter to 3.81% and the NII itself was down 2% versus last quarter. Our core NIM benefited from the run-off and sale of our low yielding indirect portfolio last quarter that helped the NIM by about 3 basis points. We also had some positive remix on the funding side with strong core deposit growth and shrinkage in average CDs. We had more than $165 million of DDA growth that more than funded our $112 million of loan growth. All in, our cost of funds moved to 95 basis points from 103 basis points last quarter, or down about 8 basis points. Let’s talk a little on our philosophy and culture of risk here. We have been derisking our securities portfolio and balance sheet for two years at least. We sold and let our CLOs run-off from a peak as high as about $330 million in 2017. We also ran off our indirect auto portfolio to zero, a portfolio that peaked at around $440 million also in 2017. We maintained our liquidity with our low 80% loan to deposit ratio. We also deleveraged our balance sheets since 2018, freeing up capital and liquidity, as we ran off about $700 million in FHLB borrowings from its peak in 2018. The combination of these things also took our TCE from the low 9% range two years ago to 10.2% this quarter. Moving on to page 23 and fee income, the first quarter is typically our weakest quarter for fee income being seasonally slower for both SBA and mortgage. Our fee income was down $4 million from last quarter, but it was also up $5 million from the year-ago quarter at $25.8 million. As the crisis set in, we saw a sharp drop in rates and turmoil in the markets including significant illiquidity in certain asset classes throughout the quarter; our lock volume was over $800 million in the quarter well above our previous record. With the refinance environment, we had to write down the value of our mortgage servicing asset by $4.3 million as expected life of our loan service shortened dramatically. All said, it was a great quarter for mortgages. As I mentioned and as I know you are aware, there was volatility and illiquidity at times in the credit markets this quarter that, of course, affected the gain on loans sold right on the UC at $1.7 million. In February, we sold $22.2 million of Navitas loans at a 6% gain; usually in Q1, you would see us with about a $1 million or so in SBA loan sale gains, but we elected not to sell this quarter because the pricing narrowed and we preferred to hold them. For Q2 and the rest of the year, we are not expecting Navitas loan sales but we will be monitoring market conditions. Moving expenses briefly total expenses were down $800,000 versus Q4 excluding merger charges. And with that, I will pass it back to Lynn to conclude our prepared remarks.

Lynn Harton, CEO

Thank you, Jefferson. Clearly, the shutdown has caused the most serious economic stoppage of our lifetimes combined with the most massive government intervention in history and we simply don’t know at this point what the ultimate ramifications for our customer base will be. But I do believe and I want to close my prepared remarks with this, that we will be able to accelerate many of our long-term goals as we execute over the next several quarters. The investments we have made in technology will show results and we are already seeing how we can digitize our business even more quickly than we imagined. Our branch delivery system will be able to be improved more rapidly as well. Our brand will be strengthened, as service and connection will stand out in this environment. And by the way, we just found out late yesterday that we were recognized by J.D. Power for having the highest retail banking satisfaction in the Southeast for 2020. That’s the sixth time in the past seven years we have received that honor, which is a truly amazing testament to our team and how they live our brand out every day. And finally, we believe that M&A opportunities post-crisis will likely increase for the type of service-oriented banks we like to partner with. And speaking of M&A on slide 26, I have a few comments about our Seaside acquisition, which we announced right before the COVID crisis began. As we have progressed, our decision to partner with Seaside has only been reinforced. We are in constant contact with their team and that time together continues to prove the similarities of our cultures. We both remain focused on serving our clients and I believe that both during and after the crisis we will be better together. And with that, I’d like to open it up for questions.

Operator, Operator

And our first question will come from Brad Milsaps from Piper Sandler. You may begin.

Brad Milsaps, Analyst

Hey. Good morning, guys.

Lynn Harton, CEO

Good morning.

Jefferson Harralson, CFO

Good morning.

Brad Milsaps, Analyst

Jefferson, you guys did a nice job hanging onto the net interest margin this quarter in light of everything that happened, a lot of it happened in late March. Just curious if you maybe had spot rates for maybe loan yields and deposit costs at the end of the quarter, just trying to get a sense of directionally kind of what kind of pressure might be on the horizon?

Jefferson Harralson, CFO

I may need to follow up with you about the spot rate, but let's discuss the margin briefly. I anticipate that our margin will trend downward since we experienced an unusual amount of accretion. This quarter, we saw an increase of 26 basis points, but the ongoing rate is likely closer to 10 basis points. Therefore, I expect a potential decline of around 15 basis points due to the accretion factor. The LIBOR rate has been irrationally high, aligning with the fed funds rate, and we have $3 billion in LIBOR loans. I expect that number to decrease, especially with future rate cuts. Additionally, we have a significant amount of certificates of deposit maturing at high rates, including $300 million at 190 basis points. Consequently, you should see a continued reduction in funding costs. There are numerous moving parts to consider regarding the timing, particularly with the Paycheck Protection Program. While I haven’t provided specific margin guidance, I can touch base later with my thoughts on the spot rates for yields and costs.

Brad Milsaps, Analyst

Okay. Great. That would be helpful. And you brought up PPP for a moment, I think, you noted in the slide deck that you thought kind of most of your loan growth would just be kind of limited to that program. You guys had tremendous production again this quarter, didn’t necessarily translate to a lot of net growth. But would you back away from kind of where we are now, kind of your mid-single-digit kind of loan growth excluding the PPP program or do you think there’s opportunities, if you guys can take advantage out there, given how strong your capital is, all the liquidity as kind of being in a better seat than most banks?

Rich Bradshaw, CBO

So, Brad. This is Rich. You bring up a great question. So, number one, we are being cautious and very selective. However to your point, we do see an opportunity. There are a lot of long-term strong companies out there and we really feel like the big banks are going to take their eye off them that’s a great opportunity for us. We will look for those companies to demonstrate the impact of COVID-19 on them now and on the future, and what their action plan is, so providing they could do that we would be supportive of those requests.

Brad Milsaps, Analyst

You might want to talk about the hires you made in the first quarter as well…

Rich Bradshaw, CBO

Sure.

Brad Milsaps, Analyst

…before?

Rich Bradshaw, CBO

We usually start with that, but the circumstances have changed. We had a very successful first quarter and made a significant move in Atlanta. We added a team leader, Craig Daudi, along with four Commercial Relationship Managers from SunTrust. I mention SunTrust because we also have one from BB&T. They joined us late in March and immediately brought in deals and deposits, and they have also participated in our PPP program. We are enthusiastic about what they can contribute.

Brad Milsaps, Analyst

Okay. Great. Maybe one final one, Jefferson, would you expect kind of weighted average fee on the PPP loans to be around 3% for you guys?

Jefferson Harralson, CFO

That’s in the ballpark.

Brad Milsaps, Analyst

Okay. Great. I will hop back in queue. Thank you.

Lynn Harton, CEO

Okay.

Operator, Operator

And our next question will come from the line of Jennifer Demba from SunTrust. You may begin.

Brandon King, Analyst

Hey. This is Brandon King on for Jennifer. I see that you disclose your deferral rate for the Navitas portfolio, but I was wondering what the deferral rates per industry were for the broader portfolio?

Rob Edwards, CRO

So, this is Rob. So if you go to the back of the deck there’s we have broken out deferral rates, talk some about restaurants and hotels. So we have listed some of those and then also senior care at the back of the package. So that’s probably a good place to start and then maybe just I would break out for you kind of the overall Bank is at right around 9% deferral rate and Navitas is around 22%. So that’s probably kind of within those maybe five different categories. That’s a good way to think about it.

Brandon King, Analyst

Okay. Were there any other sectors that stood out? How much you are seeing?

Rob Edwards, CRO

No. There are various numbers, but those are the key figures we focused on when putting the presentation together, as they appeared to be among the highest. Additionally, the Navitas figures are listed separately, and if you refer to page 28, you will find the top five sector deferral rates for Navitas specifically.

Brandon King, Analyst

Okay.

Rob Edwards, CRO

Yeah.

Brandon King, Analyst

And then one more question, how does your loan loss reserve currently compare to the losses indicated in your internal stress test results?

Rob Edwards, CRO

That's a great question. Thanks for bringing it up. We run numerous stress tests, including those from the last cycle and specific tests related to our losses during that time. We conduct various CCAR stress tests, totaling around 20 capital stress tests. We believe we have significant capital and, as we continue to conduct stress tests, I'm reviewing the latest Moody's results. We feel confident in our capital position and believe it can withstand almost any reasonable loss scenario.

Brandon King, Analyst

All right. Thank you very much for the color.

Operator, Operator

And our next question comes from the line of Tyler Stafford from Stephens. You may begin.

Tyler Stafford, Analyst

Hey guys. Good morning.

Lynn Harton, CEO

Good morning, Tyler.

Jefferson Harralson, CFO

Hi, Tyler.

Tyler Stafford, Analyst

Hi. I wanted to start on fees, Jefferson, so, I guess, what do you expect the impact of the PPP, I guess, distraction to get beyond just the normal SBA gain sale revenue over the near-term to be?

Jefferson Harralson, CFO

Yeah. I might pass that over to Rich on…

Rich Bradshaw, CBO

Sure. We had an existing pipeline rolling into Q2; currently, 95% of our efforts are focused on PPP. I can say that the secondary market has improved a bit since the first quarter, with about half the buyers active and gain-on-sale ranges currently between 106 and 107.

Jefferson Harralson, CFO

And do not sell loans that, you noticed, probably, in the first quarter, and we had $25 million origination, so there’s a bit of backlog for Q2.

Tyler Stafford, Analyst

Okay. So you would expect to sell SBA loans, but not Navitas loans?

Jefferson Harralson, CFO

Correct.

Tyler Stafford, Analyst

Okay. And why not sell Navitas loans at this point…

Jefferson Harralson, CFO

I'm uncertain about the market for Navitas loans. We'll be monitoring the market and the credit environment to see what opportunities arise. The advantage of having flexibility in our balance sheet is that we can retain these loans if we choose. We successfully sold loans towards the end of last year and earlier this year with a 6% gain. The current gain is uncertain, but for now, we're planning to hold onto these loans, and if the gain stays in the 5% to 6% range, we might rethink our position. Additionally, we currently have 8.5% of our loans in Navitas. We expect to have at least $1 billion in PPP loans for a limited time, which will reduce that 8.5% figure significantly. This gives us ample opportunity to reach our 10% target as well. Therefore, while we may consider selling, we are not under pressure to do so for a 10% gain.

Rich Bradshaw, CBO

And I was going to add, we are expecting another good performance for mortgage.

Jefferson Harralson, CFO

Right.

Lynn Harton, CEO

And back on Navitas just for natural condition of what’s going on is, their volumes down about 30% anyway and they are really looking at either to come as an opportunity to up credit quality during this time. There’s a lot of their competitors, as Jefferson said, don’t have a balance sheet. So we expect volume to be down anyway. We expect credit quality to be up, in terms of the new originations. So that’s part of it as well.

Tyler Stafford, Analyst

Okay. That’s helpful. Maybe sticking with Navitas, do you know how much of that portfolio today that equipment is idle right now versus being actively used?

Lynn Harton, CEO

The best way to assess the situation is by looking at the deferral aspect. In the deferral segments, you can see what you'd expect; for instance, fitness and beauty salons can't operate. However, there is still considerable activity among businesses like landscapers and short-haul trucking companies. These businesses need equipment, and this equipment is essential. It's challenging to provide a clear picture of our deferral efforts, but we have established an automated portal for deferral requests and are reaching out to clients. The initial deferral is for 90 days, during which we ask for small payment touches to maintain engagement with clients. We are in a wait-and-see mode, as these customers want to resume operations, but they often need government permission to do so. We anticipate that after the 90 days, many of these deferrals will be extended, and we may increase the touch payments to help reconnect clients as they transition back to recovery.

Tyler Stafford, Analyst

I appreciate the details regarding the Navitas breakdown for hotels and restaurants. Shifting to my last question, I recognize that you are entering this recessionary environment with a much stronger capital position than many of your peers. However, when I review the reserve ratio you've established at 99 basis points, along with the various portfolios mentioned in your presentation—Navitas at 8.5%, hotels at 3%, restaurants at 3%, senior care at 5%, and retail CRE at approximately 3.5%—it seems that around 25% to 26% of the total portfolio comprises these high-risk areas. I'm not suggesting that you are under-reserved, but I am trying to understand the factors that influenced your CECL calculations and assumptions. Why do you feel confident that 99 basis points are appropriate, particularly in comparison to some of your peers who have established higher reserves at this time?

Rob Edwards, CRO

Yeah. So, Tyler, it's Rob. I want to highlight a few points. First, it's important to recognize that our models are based on correlations from past experiences, as Jefferson mentioned. This means there could be instances where the models don't align perfectly with reality. Additionally, we usually receive economic forecasts from Moody's once a month, but now we're getting them weekly. CECL is based on future expectations and past performance, and the influence of deferrals and government stimulus makes it difficult to predict future outcomes with certainty. At the end of the quarter, we evaluated our position in the hotel sector, where we operate at a 50% loan-to-value ratio with strong operators and solid liquidity, which is reassuring. We're also involved in the leveraged loan market, but only to a minor extent with $70 million. While that is leveraged, it's typically at less than four times based on commitments rather than outstanding amounts. If we assessed true leverage, meaning outstanding debt relative to cash flow, most of our leverage would be significantly lower. Overall, that $70 million is minimal in our portfolio, and we have no exposure to oil and gas, giving us confidence in the components we've discussed. It's also worth mentioning that some of the concerns others are facing do not apply to us at all.

Tyler Stafford, Analyst

Okay. That’s very helpful. Maybe just one more on that, could you provide the new CECL reserve for the Navitas portfolio?

Rob Edwards, CRO

So it’s $15 million.

Tyler Stafford, Analyst

$15 million. Perfect. All right. Thanks guys. I appreciate it.

Lynn Harton, CEO

Yeah. Thanks, Tyler.

Operator, Operator

And our next question will come from the line of Kevin Fitzsimmons from D.A. Davidson. You may begin.