UNIVEST FINANCIAL Corp Q2 FY2021 Earnings Call

Good morning and welcome to the Univest Financial Corporation Second Quarter 2021 Earnings Conference Call. Please note this event is being recorded. I would like to turn the conference over to Jeff Schweitzer, President and CEO of Univest Financial Corporation. Please go ahead.

Thank you, Debby, and good morning and thank you to all of our listeners for joining us. Joining me on the call this morning is Mike Keim, President of Univest Bank and Trust, and Brian Richardson, our Chief Financial Officer. Before we begin, I'd like to start by saying I hope everyone listening is staying safe and you and your families are healthy. I also need to remind everyone of the forward-looking statements disclaimer. Please be advised that during the course of this conference call, management may make forward-looking statements that express management's intentions, beliefs, or expectations within the meaning of the federal securities laws. Univest's actual results may differ materially from those contemplated by these forward-looking statements. I will refer to the forward-looking cautionary statements in our earnings release and in our SEC filings.

Thank you, Jeff. And I would also like to thank everyone for joining us today. In addition to demonstrating our continued ability to grow loans, we continue to have strong performance in our core business. During the first six months of the year, we produced a pretax pre-provision ROAA of 1.72%. I would like to touch on four items from the earnings release. First, reported margin of 3.15% was up three basis points compared to the first quarter. Reported NIM was negatively impacted by 10 basis points of excess liquidity, which averaged $175 million for the quarter. PPP loans increased NIM by 11 basis points and contributed $4.8 million to net interest income. Core margin, excluding excess liquidity and the PPP impact, was 3.14%, a decrease of five basis points when compared to the first quarter. Core margin excluding excess liquidity and the PPP impact is expected to expand slightly in the third quarter. This reflects quarterly savings of approximately $850,000 from the $75 million subordinated debt redemption at the end of the second quarter. As it relates to PPP, as of June 30th, $6.4 million of net deferred fees remained on the balance sheet, which represents approximately 35% of the initial deferred fee amount. Second, during the second quarter, we recorded a reversal of provision for credit losses of $59,000, which was driven by a $2.8 million benefit due to favorable changes in economic-related assumptions within our CECL model, primarily offset by reserves attributable to our 15.4% annualized loan growth during the quarter. The allowance for credit loss coverage ratio excluding PPP loans was 1.41% at June 30, compared to 1.46% at March 31 and 1.94% at June 30, 2020.

The first question comes from Frank Schiraldi with Sandler.

Hey, guys, wondering about the strong loan growth — you obviously increased the guidance here. What would you say the primary driver is? Is it some of the teams you guys have added ramping up faster than you expected? Is it better demand in your market? Or maybe some of the M&A deals out there are just providing a greater amount of opportunity?

So, good morning, Frank. The first and foremost driver is the quality of our teams and the fact that we never stopped lending during the pandemic. We kept momentum. We did get more conservative in our underwriting guidance, but we kept the lending momentum going, so customers and prospects knew that we were going to continue to lend and have done that. So that's helped us. The quality of our teams has been outstanding. And yes, we have seen pickup from some of the folks that we've hired. So it's all of the above. But the real secret sauce continues to be just the strength and quality of the overall team.

Okay, and then just trying to drill down into some of the fee income drivers of the guide, Brian, I was wondering if you could give your thoughts on a fair growth rate for the investment advisory business over the next 12 months or so, especially given some of the potential opportunity in the market related to deals.

Yes, on the investment advisory side, of course there's the market consideration. But assuming that markets stay flat, we'd expect kind of double-digit to mid-double-digit growth from a full-year perspective, year-over-year from 2020 to 2021.

Okay, great.

Yes, that would be driven by improvement of AUM from a valuation perspective, as well as new business and continuing to expand customer relationships.

Yes, we've been added to the Schwab referral network as one of the RIAs in that network and have, I believe, 50 branches that have been assigned to us in the Mid-Atlantic area. We haven't even started that yet; we are getting all the documents in order. So that'll help on top of our normal organic growth.

Okay. And then the other piece of fee income for me that's more volatile and difficult to model is the mortgage banking business. Last quarter you talked about the pipeline remaining strong and moving more to purchase activity as opposed to refinance because that wave wanes. Any expectation you can share on that side in terms of thoughts, given where margins are now and where volumes are, what we could see in the back half of the year in terms of mortgage banking revenues?

Yes, overall pipelines are still strong. What has happened is that margins, which on a gross basis were nearing 4% last year, have pulled down to the 2.75%–3% range. We expect that to continue. Absent anything else, I would tell you that the third quarter will be fairly strong. And unless—and I hope this doesn't happen—rates drop dramatically again and refis resurface, the fourth quarter cyclicality should come into play. Our pipeline right now is slightly more than 50% purchase, which reflects the new hires and the strength of their relationships with realtors and the like as we move forward.

Okay, so would you expect the third quarter to be stronger than the second quarter?

I wouldn't necessarily say stronger than the second quarter just because the second quarter is elevated; margins at the beginning of the second quarter were closer to that 3.5%–3.75% range. So we could see a pullback a little bit in the third quarter from where we were in the second quarter, which would be a reasonable expectation. Historically, the third quarter would be strong relative to other historical third quarters, but relative to a refinance-dominated 4% margin environment, it will look different.

The next question comes from Tim Switzer with KBW.

Good morning. This is Tim Switzer on for Mike Perito. You had several expense items that you touched on that look pretty temporary, such as PPP origination comp, DE&I training, and you also have some variable compensation. Can you help quantify how many of these expenses this quarter are transitory, and help us figure out what's going to exit the expense run rate going into 2022?

From an expense run-rate perspective, if we look at the full year, that updated guidance that I provided of 4% to 6% is reflective of the one-timer in the quarter and the additional one-timers we expect related to those initiatives in the back half of the year. We're not in a position at this point to give guidance for full-year 2022 expense growth; we'll be going through that budget process later this year and will communicate thereafter. But I do expect things to normalize overall from an expense growth perspective as we get this handful of items behind us.

Okay, and as these more temporary costs come out, will you replace those with other growth investments or allow that to flow to the bottom line?

Those are case-by-case decisions depending on the environment. Digital and technology investments continue to evolve and sometimes incremental investments are required. However, we understand the importance of operating leverage, and we'll be focusing on maximizing that to the extent possible.

Okay, great. And if I can move on to capital really quick: you have really strong capital levels, generating good returns, but also grew your loan book quickly here. What are your capital priorities? Do you have any plans for excess capital deployment and how would you like to deal with that?

On the capital front, everything is on the table right now. We want to make sure we have strong capital to support the loan growth that we're continuing to see, which is exciting and positive for the long term. As we've said in the past, we're actively looking for opportunities in wealth management and insurance from an M&A standpoint. Beyond that, depending on how things go, we would look at dividends, buybacks, etc. That's all on the table. But right now, our focus is on organic growth, supporting that, and keeping some dry powder in case attractive M&A opportunities arise.

The next question is from Matthew Breese from Piper Jaffray.

Thank you. Good morning. I was hoping to learn a little bit more about the loan pipeline, maybe get a sense for your size and how it's changed over the last six months. Also some insight as to which geographies are showing strength or which product sets are driving the growth.

Good morning, Matt. In terms of the pipeline, the second quarter and what projects to be the third quarter pipelines continue to look strong. The biggest issue with regard to loan growth going forward is whether we get unanticipated payoff activity. Those unanticipated payoffs are largely coming because the market is very hot, and our customers have opportunities to sell their businesses or, if it's a CRE deal, sell properties—warehouse facilities and the like—which are very hot and can produce sizable gains. In terms of geography, we continue to perform across all of our markets. The Lancaster market and Central Pennsylvania continue to be strong, and we continue to perform well there.

Understood. And you mentioned competitive conditions — could you give a sense for what incremental blended new loan yields are and where competition is?

From production for the quarter, our traditional C&I and CRE loans averaged around 3.21% from a new production standpoint, up from around 3.0% in the first quarter. You have various loan types that can lower or raise those yields, but our traditional C&I and CRE production for the quarter was around 3.20%. From a competitive perspective, there are still players doing things we won't match, and there is some craziness out there. There are levels on the fixed-rate side—whether it's five, seven or ten years—that we just will not go to.

Got it. Could you provide the percentage of your loan portfolio that's floating rate and unencumbered by floors at this point? I want to get a sense for how responsive loan yields would be if rates hike.

Overall, our loan book is 43% fixed, 20% adjustable, and the remainder, 37%, is variable. From a loan floor perspective, as of the end of the second quarter, we had $346 million of loans that were at their floors and in the money. They're in the money by about 70 basis points. So two to three rate moves would be what it would take to get lift on those. The rest of the book that is variable or adjustable, depending on reset dates, would have more immediate impact in a rate-increase environment.

Okay. On expenses, you mentioned you'd expect an additional $680,000 of training fees in the back half of the year. Professional fees are a bit higher already; should we expect that level to continue or ramp up for that $680,000? Just wanted clarification.

To clarify, it's $650,000 in the back half of the year, related to DE&I, our treasury and management product enhancements, and training. So it wasn't simply just training. I would not expect there to be an incremental lift solely related to that $650,000 from the second quarter to the third quarter. If you look at the all-in guidance of 4% to 6%, you'd expect expenses to be pretty level on a quarterly basis now.

Understood. One last question: the last couple quarters the tax rate has been a touch higher than my projections. Is 19% the new normal, or should we expect a reversion back to around 18%–18.5%?

As we continue to have income coming from PPP forgiveness and the like, that is providing upside in taxable income, which translates to an increased effective tax rate. In the near term, I would think that the current effective rate is a good indicator. To the extent PPP income starts to wind down, you'd expect a reversion back to historical norms.

At this time, there are no further questions. This concludes our question-and-answer session. I would like to turn the conference back over to Jeff Schweitzer for any closing remarks.

Thank you, Debby, and thank you to everybody for participating today. We appreciate your participation and your good questions. We look forward to talking to you again at the end of the third quarter. Have a great day and stay safe.

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