Uscb Financial Holdings, Inc. Q1 FY2024 Earnings Call

Good day and welcome to the First Quarter 2024 USCB Financial Holdings, Incorporated Earnings Conference Call. All participants will be in listen-only mode. Please note this event is being recorded. I would now like to turn the conference over to Luis de la Aguilera, President and CEO. Please go ahead.

Good morning. And thank you for joining us for the USCB Financial Holdings first quarter 2024 earnings call. With me today reviewing our Q1 highlights is CFO, Rob Anderson; and Director of Credit, Sergio Garrido, who will provide an overview of the Bank's performance, the highlights of which commence on Slide 3. Our Chief Credit Officer, Bill Turner is not with us today as he is accompanying a family member who is undergoing surgery this morning. Bolstered by the strength of Florida's economy, USCB came off the blocks in the New Year posting strong growth in assets, deposits, diversified quality loans, and profitability. Our results reflect the diligent execution of a business plan that focuses on organic growth supported by diversified commercial banking initiatives designed to deepen existing relationships and develop new ones. In 2023, we sourced new production hires, expanded our business lines, and added deposit aggregating verticals while carefully controlling expenses. These efforts have delivered results and have well positioned the Bank in 2024. In reviewing our press release and noted Q1 highlights, I will comment on a select few as CFO, Anderson will further detail our growth, profitability, capital, and liquidity positions. Net income was $4.6 million or $0.23 per diluted share, an increase of $1.9 million compared to the fourth quarter of 2023. Also, average deposits increased by $204.3 million or 11.1% compared to the first quarter of 2023. Multiple deposit-focused initiatives continued to deliver results as deposits grew $165.7 million on an end-of-period basis this past quarter. While growth in deposits has rebounded, we judiciously priced deposits based on relationships and profitability. This past quarter, we completed a comprehensive review of the deposit portfolio taking actions that would immediately improve net interest margin. We will discuss these actions as we go through today's presentation. Average loans increased $234.1 million or 15.1% compared to the first quarter of 2023. Our loan growth has moved in line with accretive quarter-over-quarter improvement on average loan coupon, which contributes to net interest income. To this end, the weighted average coupon on our quarterly loan production over the past six quarters has increased from 5.68% to 8.16%. This will be detailed shortly. During the quarter, the company paid its first cash dividend to shareholders with an aggregate amount distributed being $1 million. The cash dividend program is an important driver of shareholder value, and the Board of Directors is committed to returning capital to our investors while maintaining a strong balance sheet. As mentioned in the press release last night, the Board of Directors approved a new share repurchase program of up to 500,000 shares of Class A common stock or approximately 2.5% of the company's issued and outstanding shares of common stock. The stock repurchase program will provide flexibility in the event of market volatility, keeping in mind forward earnings, risk, and capital levels. Our intention and practice are to run a safe and sound institution, always maintaining well-capitalized levels. As of April 22, 2024, 572,980 shares remained authorized for repurchase under the company's share repurchase program. Moving on to Slide 4. The following slide is self-explanatory, directionally showing nine select historical trends since recapitalization. Profitable performance based on sound and conservative risk management is what our team is focused on consistently delivering. So let's now turn our attention to our specific financial results and key performance indicators, which will be reviewed by our CFO, Rob Anderson.

Okay. Thank you, Lou, and good morning, everyone. Overall, I would characterize Q1 as a solid quarter for USCB despite a tough economic backdrop. As you look at Pages 5 and 6, there are some positive trends to keep in mind when reviewing the quarter, including the following. Net income was $0.23 per share and higher than the past three consecutive quarters demonstrating an upward trend. As it relates to the balance sheet, loans, deposits, and total assets were all up approximately 15% from the prior year. Deposit growth was up 34% annualized from the prior quarter. This growth allowed us to pay down high-priced overnight FHLB borrowings and reprice higher-cost deposits at quarter end. While we won't see the benefits until the second quarter, we do expect our net interest income and net interest margin to improve from this point. During Q1, we purchased an additional $34 million in securities with a yield of 5.85% and a duration of 2.08. The intention was to provide and support the NIM while maintaining sound liquidity practices. Depending on the interest rates, we expect to receive $30 million to $35 million in cash flows from the securities portfolio during 2024, which will be used to support loan growth. In Q1, net interest income increased $782,000 or 21.8% annualized compared to the fourth quarter 2023. This is due to a larger balance sheet. Noninterest income was up 19% over the prior year. Expenses were up in Q1 due to new hires, seasonal FICA taxes, and some operating expenses, but remained low for our asset size, which is shown on Page 6. We initiated and paid our first dividend starting at $0.05 per share. Intangible book value per share grew to $9.92. AOCI was up slightly from the prior quarter. NIM was 2.62% and down 3 basis points from the prior quarter, driven by excess liquidity and higher funding costs. I'll discuss what we did and will continue to do with any excess funding in a bit. In terms of soundness, our credit metrics remained strong and our loan loss reserve coverage remained at 1.18%. So let's discuss deposits on the next page. While we present this page on an average basis, a big part of the story for the quarter is what happened in the last month of the quarter. First, our sales team delivered strong deposit growth in Q1 evidenced by both our average deposit growth and on an end-of-period basis. Deposit balances at the end of the quarter were $2.103 billion, which is $54 million above the average of $2.049 billion. More specifically, while our average noninterest bearing deposits saw a slight decrease in the first quarter of 2024, our end-of-period DDA balance increased by $23.9 million or 17.4% annualized. While we expect rates to remain higher for longer, our ability to attract and retain DDA will be the focus of our sales strategies and bank officers. As Lou mentioned, we are gaining traction in our new business verticals, which we expect to attract additional operating accounts. The additional deposit growth in Q1 put $126 million of cash on our balance sheet at quarter end, which negatively impacted our NIM in the quarter but positions us well for Q2. With this additional funding, we paid down all high-priced overnight FHLB borrowings and rationalized some higher-priced public fund money. Furthermore, because public funds require collateral, reducing balances in this funding bucket also helped our liquidity. So with that, let's turn the page and look at our loan book. Average loans increased by $82.9 million or 19.6% annualized compared to the prior quarter and $234.1 million or 15.1% compared to the first quarter of 2023. On a spot or end-of-period basis, we ended the quarter at $1.821 billion, which is $39 million above our average loan balance for the quarter. Loan coupon increased by 22 basis points compared to the prior quarter and 87 basis points compared to the first quarter of '23. Our loan book will continue to grind higher but much depends on our new loan originations as the refinance volume is minimal. As for the guidance, we expect loan growth to continue in the low double digits. Turning to Page 9, you can see for the past three quarters, we have originated loans above 8%. We expect a similar amount of loan originations in Q2 with yields above 8%, given the current pipeline. Additionally, our loan book has transitioned over time and is more diversified. As of quarter end, non-CRE loans are 29% of the total loan portfolio. With that, let's take a look at the margin on the next page. For the first quarter of the year, our NIM contracted compared to the previous quarters. However, our net interest income increased $782,000 or 21.8% annualized compared to the fourth quarter of 2023. This is a direct result of a larger balance sheet. As discussed on the deposit slide, the cost of funds remains one of the biggest challenges this year. Although we grew deposits in the first quarter, the majority of the growth was in interest-bearing deposits, which resulted in higher than expected interest expense. As a response, we have adjusted deposit pricing and reduced higher priced public funds. We expect the changes will have a positive impact on our NIM going forward. And in short, we have several reasons to believe the NIM will improve. Since the end of the quarter, we have reduced our dependency on public funds by over $100 million, which are rate-sensitive deposits. We have adjusted money market rates additionally. Currently, we don't have any money market deposits paying above 5%. Deposits have already adjusted to a higher rate environment, so we don't expect material jumps in our interest expense. New loan production has been above 8% for three straight quarters and we expect this trend to continue in '24. With a higher for longer rate environment, we expect our interest rate swaps to generate $2 million of additional interest income for the year. Finally, with a strong liquidity position beginning in Q2, we can pass on non-relationship rate-sensitive deposits. The Bank is well positioned for rates to be higher for longer.

Thank you, Rob. Please turn to Page 12. As you can see from the first graph, the allowance for credit losses increased to $21.5 million. This was due to a $410,000 first-quarter provision, and the ratio remains unchanged at an adequate 1.18%. The provision was driven by the $40 million net increase in the loan portfolio. Net losses remain near zero for the quarter. The remaining graphs on Page 12 show the nonperforming loans as of the quarter end were unchanged at 0.03% of the portfolio, and classified loans improved from the fourth quarter to 0.44% of the portfolio. No losses are anticipated from these classified loans. Additionally, the Bank continues to have no other real estate owned. On Page 13, the first graph shows the loan portfolio mix at 3/31. The portfolio increased by $40 million on a net basis in the first quarter to a little more than $1.8 billion. The composition continues to be well diversified. Commercial real estate represents 58%, a little over $1 billion. Commercial real estate is segmented between retail, multifamily, owner-occupied, and office properties. The second graph represents a breakdown of the commercial real estate portfolios for the non-owner occupied and owner-occupied loans, which also demonstrates this portfolio's diversification. The table to the right of the graph shows that the weighted average loan values are at 60% or less, and the debt service coverage ratios are adequate for each portfolio segment. The loan quality and payment performance are good for all segments as the past due loan percentage remains less than 1%. On Page 14, we discuss the Bank's office portfolio. Our portfolio at quarter end consists of 128 loans totaling $187 million, with almost all being B and C properties, with over 75% located in South Florida. The average loan amount is $1.5 million with an average loan to value of 57%. The average debt service coverage stands at almost 2 times. The first graph shows that owner-occupied office makes up 34% of the office segment, with 63% of those loans being occupied by professional and medical businesses. The second graph represents the non-owner occupied office loans, which comprise 66% of the office portfolio, with 84% of their use being multitenant and medical. The quality of the office portfolio is satisfactory with all loans paying as agreed with no classified loans. We're especially vigilant of the upcoming 2024 loan repricing and assuring schedule. We monitor and model the loan repayment and the ability to service our loans to proactively act as needed. Overall, the quality and performance of the loan portfolio remains pristine.

Okay. Thank you, Sergio. Let's go to Page 15. A couple of items to point out here. First, you'll notice the nice upward quarterly trend in service fees. We have been speaking for some time that we are gaining traction differentiating ourselves from our competitors and becoming our clients' go-to bank for their operational wire needs. We are gaining new foreign correspondent banks, doing more business with current clients, and modifying our approach to wire fees with clients across the board. All these strategies have yielded new business. Other noninterest income increased due to the BOLI restructuring we did last year, increases in treasury management fees, and an increase in swap fees with clients. On a go forward basis, we believe a $2.5 million or slightly higher is a good quarterly run rate for the noninterest income line item. So with that, let's take a look at expenses on the next page. Our total expense base was $11.2 million and up from the prior quarter. Salaries and benefits are up due to three net new FTEs, seasonal payroll taxes, and stock-based compensation. Other operating expenses were up $271,000 due to a $67,000 increase in promotional expense to support our business verticals, a $60,000 increase in force-placed insurance, and a $40,000 increase in property insurance. I would note that the noninterest expense to average assets improved by 11 basis points year-over-year and has been below 190 basis points for three quarters in a row. Going forward, we expect the quarterly expense base to grind upwards from this point. So with that, let's take a look at capital. USCB capital levels remain comfortably above well-capitalized guidelines. Also worth noting is the company repurchased 7,100 shares of common stock at a weighted average price per share of $11.15 during the quarter. As mentioned in the press release last night, the Board of Directors approved a new share repurchase program of up to 500,000 shares or approximately 2.5% of the company's issued and outstanding shares of common stock. So as of the end of April 22, 2024, 572,980 shares remain authorized for repurchase under the company's share repurchase programs. So with that, let me turn it back to Lou for some closing comments.

Thanks, Rob. U.S. Century's performance this past quarter is clearly on track with our expectations and budget. Five new production hires brought on board in late 2023 and early 2024 are hitting their stride and contributing to both loan and deposit growth. This past January, we launched another business line branded MD Advantage, a new deposit aggregating vertical focusing on servicing medical professionals and led by two experienced bankers with over 30 years of combined experience in the field. We now have seven non-CRE business lines, including Association Banking, SBA Lending, Yacht Lending, Foreign Correspondent Banking, Private Client Group, as well as our Jurist and new MD Advantage initiatives, which respectively focus on supporting both the attorney and medical professionals market. Collectively, these business lines account for $554 million or 26% of total deposits. These business verticals have also contributed greatly to the diversification of the loan portfolio, of which 29% of $528 million is now non-CRE. By comparison, only 9% of the Bank's loan portfolio was classified as non-CRE as of June 30, 2020. Furthermore, these business lines have driven noninterest income, which was 14% of total income this past quarter, up from 11.5% of total income in Q1 2023. Growth in wire activity, gain on sale of SBA 7(a) loans, swap fees, as well as greater demand for treasury services have steadily contributed to increases in noninterest income. The Bank's performance is supported by the overall robust economy of Florida, which is forecasted to grow by a solid 3% in 2024, more than double the projected national economy's growth of 1.4%. Florida's statewide unemployment rate has been lower than the national rate for 39 consecutive months. The national unemployment rate was 3.7% for January 2024 or 0.6 percentage points higher than Florida's rate. In short, Florida's strong economy serves as a foundation from which we continue to grow our franchise. These factors, along with longstanding draws of low taxes, warm weather, and housing that's more affordable than in the Northeast, are expected to contribute to another solid year of population gains for the state and further growth opportunities for the Bank. With that said, I would like to open the floor for Q&A.

The first question comes from Michael Rose with Raymond James.

Just wanted to dig into the deposit growth and expectations. Obviously, very good this quarter and it was good to see DDA balances up, which is good. And Luis, you talked about one of the newer verticals, the MD Advantage coming online. And just wanted to get a sense for now that the loan to deposit ratio is kind of back in the mid-80% range after this quarter's growth, and it sounds like there's some hopeful remixing opportunity as we move forward. Can you just talk about expectations for the need to continue to grow deposits? It seems like you could probably dial back on some of the higher-cost funding as some of the specialty verticals and their deposit growth kind of ramps. Is that the way to think about it? And then, I know given this quarter’s start, you're going to probably blow past the 10% that you had talked about last quarter. But just wanted to kind of see the expectations for measured growth as we move forward?

Well, as I reported in the last quarter, and I'm reemphasizing in today's call, we hired two teams that came in late 2023, early 2024 and then again hired one that joined us in February of this year. These teams are very much focused on deposits. They are coming in from other banks where they no longer had any kind of non-compete situations. Collectively, these teams handled about $350 million in a deposit book and they are really focused on bringing in their clients without any real issues. So all of these are part of these verticals, the MD Advantage, the Jurist Advantage, and the private client group. They are moving very established relationships that we don't believe are going to be subject to high interest rates. They're coming over with bankers that have served them for many years, and we are taking advantage of that.

And as it relates, Rob, to how the margins should trend from here, obviously, bringing on the deposit growth this quarter was a step down. But I think you did a really good job kind of pointing out all the factors that will help support margin expansion from here. Can you just talk about expectations with and without rate cuts and what the delta could be just as we move forward as you continue to grow deposits, but also have continued pretty healthy loan growth above 8% ongoing coupons?

And just picking up on what Lou mentioned with our deposit aggregating teams that came on. Typically, what would happen is that as they bring customers on, they're bringing over the money market first and then the DDA comes a little bit later as they move those funds. So you did see the DDA come in towards the end of the quarter. With that additional funding, we did reprice down some high-priced public funds, which is collateralized. We will see some of that move off our balance sheet in April, which we fully expected that and that was not a surprise, but we are bringing in lower-cost funding. So if we can replace $100 million to $200 million of funding from, let's say, something above 5 million with something with a 4 handle on it in the mid-4s with some DDA, that's going to help the margin. Plus multiple quarters with loans above 8%, those originations will start helping the NIM. I think what we're anticipating absent any rate cuts is that the deposit cost will start to plateau, the loan yields will continue to grind higher, and we could be anywhere up 5, hopefully 10 basis points. We'll know in April. But we're very optimistic about the things we did in early April and the end of March on the deposit side to curtail the deposit cost, and I think you'll see the loan yield continue to pick up. I mean, if you look at the slide on Page 8, you can see the loan yields are increasing at least 20 basis points per quarter. We expect that to continue. If you go back to Page 7, we're going to stop the deposit cost going up 20 basis points a quarter or so. So that will help the margin and we'll know within the next week how we did in April. We've got another round of deposit cuts coming because we still have the cash on the balance sheet, which is good.

Just to clarify, Rob. Is that 5 to 10 basis points in the second quarter, or is that through year-end…

No, just in the second quarter. I'd conservatively say 5, but we could see on the upper end of it, maybe 10.

And then just, I'm sorry to drop this home, but if we do have rate cuts, maybe 1 or 2, well, I think that's where the forward curve is now. It's changing by the minute it seems. And then if we don't, how big is the delta? And I understand that you have some NII sensitivity, but I know it's static, so things change.

I think with rate cuts, if you get 1 to 2 depending upon when they come, that could help us maybe another 5 to 10 basis points above what we just mentioned. It could be in the low teens, but it depends on when they come. If they come in like November and December, then it's going to be higher. It's going to be harder to get the margin back up. It should grind higher. We believe that we have our $1 billion plus money market book, and there are some opportunities there with rate cuts to have a more aggressive beta that I think we can outperform.

And maybe just finally for me, the expenses were roughly in line with what you kind of talked about last quarter. I'm sorry if I missed it in the preamble. But Luis, maybe how do you think about balancing what looks to be a pretty good NII margin inflection point here with also controlling costs, which I think you've done a really good job at despite the growth? Are there incremental opportunities now that it looks like NII is going to inflect decently higher to go out and continue to press in terms of hiring now that the run rate for revenue looks to be a little bit stronger?

I’ll begin with that, Michael. I believe our expenses will gradually increase, and we are consistently focused on bringing in skilled salespeople. There has been considerable disruption in South Florida due to several acquisitions, and we are actively engaging with various candidates. We have also managed to add a few small teams recently, having brought in around five people over the past six months. Our search for strong sales talent continues. We are starting to make progress with our verticals on MD Advantage, which is gaining momentum, and we anticipate further growth. While we expect a slight uptick in our expenses, we will remain vigilant about it. Additionally, when it comes to noninterest expenses relative to average assets, achieving a figure below 2% is typically viewed positively. We are currently at 184%, which I believe is favorable, and I'll leave it at that for now.

The next question comes from Woody Lay with KBW.

So I believe you touched on it in the opening remarks. So how much of the deposit growth in the first quarter was related to these deposit verticals that you've added over the past couple of months?

I'd say it was maybe $40 million to $50 million in that first quarter, kind of contribute from the private client group, the Jurist Advantage, and the new hires. So we're very bullish on that. There have been a couple of new hires that have come in here roaring. We are very excited to see that continue. The response from their clients has been better than expected. So we think we're very much in line to continue hitting our numbers.

And how do those deposit pipelines look heading into the second quarter? I mean, they obviously had larger books of business. It feels like you could continue to make headway in those verticals?

I think, we're going to in the second quarter, I mean, even as of, we still have plenty of cash sitting on the balance sheet and we've had some higher-priced public funds move off. So those teams will continue to bring good solid deposits in. I think we have the right teams to support the loan growth that we have. I think the loan to deposit ratio will tick up as we're pricing down some of the higher-priced non-relationship funding. If you recall, when we were back in December of last year, we had probably over 100 million of funding in December alone. To fund that, we had to, one, get on some borrowings but also get some higher-priced public fund money to do that. Now that we have the teams generating relationship funding, we can let that other stuff go. I think what you're going to see is that we have the teams capable of supporting the loan growth, which has been robust here over 15% per year and then we're supporting that with deposits around the same number.

And then I did want to shift over to loan growth and just interested in how the pipelines were looking into the second quarter. Are there any specific segments that you expect to drive the strong growth in the year?

I believe we consistently monitor our pipelines. Management collaborates closely with the lending teams, conducting weekly deep dives. Currently, the pipeline is well-positioned to meet our quarterly targets. We anticipate ongoing robust activity, particularly in our HOA and Yacht Lending sectors. On the multifamily side, we have a diverse approach, with about 40% of incoming business coming from non-CRE sources. I expect this trend to continue. I am very excited and pleased with how we've transformed the portfolio over the past three and a half years. We are nearing 30% non-CRE, while at one point, this bank was nearly 98% in CRE. Moving forward, we can expect more of the same, with significant contributions from our diverse business verticals. Of the seven verticals we operate, four were established as deposit aggregators, with the HOA segment particularly generating substantial loan business as well.

The next question comes from Feddie Strickland with Janney Montgomery Scott.

I would like to begin by discussing the cash used to pay off some of the wholesale borrowings and its impact on earning assets. I understand that we are going to experience continued strong loan growth. However, could we expect the growth of earning assets to be somewhat slower or possibly even decline in the next quarter due to the repayment of those wholesale borrowings?

I don't think you're going to see it go down, Feddie. I think it might slow on the earning assets. The growth will slow a little bit. Like I said, we had some of the public fund money run off in early April. But we quickly got client money in to replace that probably at an 80 basis point spread improvement. So if you think about that over $100 million, $125 million on a big balance sheet, it takes a lot to move the numbers there, but it's the little things that really matter. But I think the overall average earning assets will continue to grow, but maybe at a little bit slower pace.

Rob, did I hear correctly that you were discussing with Michael a decrease of 5 to 10 basis points? Was that a result of your efforts to lower the cost of funds, or could you clarify what that conversation entailed?

I think if you look at Page 7 and just the general trend on our cost of funds, or in cost of deposits, what I think is going to happen and what we're modeling with the changes is that you're going to see that deposit cost start to plateau. Every quarter, it's been going up approximately in the last few around 20 basis points. If we can hold that at 2.75% and then on the following page the loans continue to go up, grind higher about 20 basis points, then that will impact the NIM positively an additional 5 basis points. We're saying 5 to 10 on the range. So I think it's not necessarily deposit costs going down but plateauing and hopefully leveling off.

So you're talking about the actual potential upside of the margin, that makes sense…

Yes.

And then just lastly, I know it's not a huge contributor today, but I know maybe in the future, particularly after we get rate cuts, SBA could present a potential opportunity. I was wondering if you could talk a little bit in more detail about just what you're seeing there, both in terms of credit and in terms of potential future volume and where we could maybe see that go if we get a little bit more favorable environment down the road?

We're putting a lot of emphasis on our SBA activities and actually have the largest pipeline that we've ever had in the first quarter. As a matter of fact, if we close what we have in the first quarter, we beat what we did in the entire year last year. So we have contributions from all our lenders. I believe that we will see, in the second quarter, really strong activity, looking to close what we have, and we are very focused on it. I think that’s going to be the plan for the rest of the year. Our typical SBA 7(a), they're capped at about $5 million. I think ours is about $2 million on average. But we also launched last year a program with a digital partner to source a small ticket SBA. It was launched in September. Our banking centers are very active with it. So that's also going to be contributing. So the entire Bank is really, really focused on the opportunity for 7(a).

And just one more for me. Just curious on the deposit front. Are you seeing anything incrementally different from competitors? Has the market gotten a little bit less competitive for deposits, or is it still pretty intense competition?

I would say, it's pretty sporty. Our banking centers report on a daily basis what's happening as far as the competition. And also on the loan side, we're seeing deals with 6 handles where our average coupon is in the 8s. There's a lot of business that we turned down. We're being very disciplined in our lending. Our team understands it. We source relationships, not transactional deals. But it's serving us well, and we're going to keep that discipline. But the market here in South Florida is very competitive. It's competitive on loans and deposits, and that hasn't changed.

The next question comes from Ross Haberman with RLH Investments. Ross, your line may be muted. All right. This concludes our question-and-answer session. I would like to turn the conference back over to Luis de la Aguilera for any closing remarks.

Thank you. So on behalf of the U.S. Century team, I would like to thank you all for your attendance. And look forward to meet again in our next earnings call in July. Have a great day.

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