UNIVEST FINANCIAL Corp Q2 FY2022 Earnings Call

Good morning. And thank you for attending today's Univest Financial Corporation to hold Second Quarter 2022 Earnings Call. My name is Austin, and I'll be your moderator for today. I would now like to pass the conference over to our host, Jeff Schweitzer with Univest. Jeff, you may proceed.

Thank you, Austin, and good morning, and thank you to all of our listeners for joining us. Joining me on the call this morning is Mike Keim, our Chief Operating Officer and President of Univest Bank and Trust; and Brian Richardson, our Chief Financial Officer. Before we begin, I 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 you to the forward-looking cautionary statements in our earnings release and in our SEC filings. Hopefully, everyone had a chance to review our earnings release from yesterday. If not, it could be found on our website at univest.net under the Investor Relations tab. We reported net income of $13.2 million during the second quarter or $0.45 per share. Our net interest income increased 10.3% from the first quarter of the year as we benefited from rising interest rates due to our asset sensitivity. Additionally, we continue to have very strong loan growth as loans grew $265.9 million or 19.6% annualized, excluding PPP loans during the quarter. This strong loan growth resulted in an increased provision for loan and lease losses under CECL during the quarter, which Brian will go into more detail on in his comments. We are happy with our results for the quarter. And while there is volatility in the provision for loan and lease losses due to CECL as a result of our strong loan growth, our pretax pre-provision income continues to be solid and increased 6.4% from the first quarter. Additionally, while mortgage banking and wealth revenues have been negatively impacted by increasing rates and decreasing margins for mortgage banking, along with the decline in financial markets impacting assets under management supervision for wealth management, the growth engine we have established across all of our lines of businesses continues to set us up for future and continued growth. Before I pass it over to Brian, I would like to thank the entire Univest family for the great work they do every day and for their continued efforts serving our customers, communities and each other. I will now turn it over to Brian for further discussion on our results.

Thank you, Jeff, and I would also like to thank everyone for joining us today. We are very pleased with our continued ability to generate strong loan growth during this rising rate environment. During the quarter, loans increased by $265.9 million or 19.6% annualized, excluding PPP loans. For the first six months of the year, loans have increased by $378.2 million or 14.4% annualized. I would now like to touch on four items from the earnings release. First, the reported margin of 3.19% increased by 30 basis points compared to the first quarter. The reported net interest margin was negatively impacted by 23 basis points of excess liquidity, averaging $434 million for the quarter compared to $693 million in the first quarter. However, our excess liquidity diminished during the quarter, and we ended with a $93.6 million borrowing position, primarily due to strong loan growth, seasonal public fund declines, and a large outflow in June for one commercial customer. During the quarter, PPP loans increased net interest margin by 1 basis point and contributed $154,000 to net interest income. The core margin, which excludes the effects of excess liquidity and PPP, was 3.41%, an increase of 27 basis points compared to the first quarter. Net interest income increased by $4.8 million or 10.3% compared to the last quarter. On May 4, the company entered into a four-year $250 million interest rate swap, where the bank receives a fixed rate of 5.99% and pays a variable rate based on prime. This notional amount equates to about 13% of our variable loans, and we see this as an opportunity to secure a portion of the benefit indicated by the forward curve. Second, during the quarter, we recorded a provision for credit losses of $6.7 million, which was mainly driven by a $5.5 million provision due to our strong loan growth and a provision of $1.8 million related to two non-accrual loans. Our coverage ratio, excluding PPP loans, was 1.27% on June 30, consistent with March 31. During the quarter, we experienced net charge-offs of $1.7 million or 12 basis points annualized, primarily driven by a charge-off related to one non-accrual commercial loan. For the first six months of the year, net charge-offs totaled $1.8 million or 7 basis points annualized. Despite the event-driven provision and charge-off related to non-accrual loans, we are not observing signs of widespread credit quality deterioration in the portfolio. Third, non-interest income decreased by $1.2 million or 6.1% compared to the second quarter of 2021, driven by a $2.1 million decrease in net gains on mortgage banking and a $915,000 decrease in BOLI income, mainly due to an $893,000 debt benefit claim in the second quarter of the previous year. Increases in our insurance and investment management lines of business and other service fee income streams helped offset these decreases. Fourth, non-interest expense increased by $6.1 million or 14.7% compared to the second quarter of 2021. This includes $1.4 million related to the digital transformation project, $511,000 due to the inclusion of the Paul I. Sheaffer Insurance Agency, $322,000 in guarantees paid to recently hired mortgage producers, and $291,000 related to our expansion into Western Pennsylvania and Maryland. Excluding these items, non-interest expense increased by $3.6 million or 8.7% compared to the second quarter of 2021. I believe the remainder of the earnings release is straightforward, and I would like to provide an update on our 2022 guidance. First, as a reminder, in 2021, net interest income totaled $173.4 million, excluding PPP income of $15 million. On last quarter's call, I guided loan growth of 9% to 10% for 2022. Based on our strong growth during the quarter, we are raising this guidance to 10% to 11%. We anticipate this will result in net interest income growth of approximately 21% to 23%, off the base of $173.4 million in 2021. This includes the impact of a 75 basis point rate increase yesterday and an assumed 50 basis point increase in September. Second, our provision for credit losses will continue to be influenced by loan growth, changes in economic-related assumptions, and the credit performance of the portfolio, including specific credits. Third, excluding $1.1 million of BOLI debt benefits, 2021's non-interest income totaled $82.1 million. Last quarter, I indicated that non-interest income would be flat to slightly down in 2022. We expect additional pressure on non-interest income due to reduced saleable volume in our mortgage banking line and equity market volatility impacting our wealth management assets under management. Consequently, we expect non-interest income for 2022 to decline by 5% to 8%, based on $82.1 million. Fourth, our non-interest expense growth guidance of 10% to 11%, off the 2021 base of $167.4 million, remains unchanged. This includes our investments in Maryland and Western Pennsylvania expansion markets and our digital transformation. Excluding these investments, expenses are expected to rise by approximately 7% for the year. Lastly, regarding income taxes, based on our increased pretax earnings from the guidance updates, we expect our effective tax rate to be around 20% for the full year of 2022. The cumulative impact of this guidance for 2022 results in a core pretax pre-provision increase of 15% to 17% compared to 2021. We often emphasize the strength of our diversified business model, with approximately 29% of our year-to-date revenue being non-interest income. This diversification served us well during the pandemic and the last declining rate cycle. While certain fee income lines are under pressure, this is more than offset by the benefits we are experiencing in net interest income from our asset sensitivity. This concludes my prepared remarks. We will be happy to answer any questions.

Thank you. Our first question is from Tim Switzer from KBW. Tim, your line is open.

Hey, good morning. Thanks for taking my question.

Good morning, Tim.

Good morning, Tim.

With the increase in loan guidance, it seems that much of it is likely driven by the strong performance in Q2. I'm curious if you are still being cautious about the outlook. While there is still strong loan growth expected moving forward, do you anticipate any moderation in the second half of the year due to the Federal Reserve tightening and related factors? I’m interested in your thoughts on this.

So, this is Mike Keim, Tim. So, we feel comfortable with the guidance that Brian gave. The two things that have us kind of moderating guidance for lack of a better term because we don't believe we will continue the same pace that we did, obviously, in the second quarter is we continue to see some payoff activity with our customers. So, that's always kind of pulling us back a little bit. And I think to the heart of your question is, the question would be is loan growth being pulled forward as a result of what people see the Fed doing from an interest rate perspective. And that we don't have a definitive answer for, but those are 2 cautionary things relative to the pace of growth that we've had previously and driving the guidance that Brian gave everybody.

Okay. It’s clear that we’re still experiencing strong growth. My question is whether there is potential for further upside if the economy improves, especially after the recent negative GDP growth figures. If we avoid a hard landing, could there be more growth? Have you noticed any slowdown in loan growth at the start of Q3?

No. We have not seen any demand for loans slow down, but we do always have the risk for payoff activity that we manage. And like I said, while we haven't seen it, there is the possibility that some activity has been pulled forward as people reflect on the fact that the Fed continues to raise interest rates.

Right. Okay, that all makes sense. And on your NII sensitivity, I think last quarter, you guys mentioned there was about $4 million to $4.5 million of annual NII for each 25 basis points. How does the swap impact that? And just given that we're deeper into the rate cycle, rates are higher, that should probably lessen the impact as well. If you could maybe update us on the sensitivity.

Correct. And this is Brian. Yes. It was a little bit higher when we had given last quarter. However, you would expect, clearly, the swap has an impact. But also, as you said, as we move through this rising rate environment, we said the initial handful of 25 basis point moves were expected to contribute kind of in that $4 million range. Considering that we've kind of migrated forward here, had some increases up to this point as well as the impact of the swap, we expect each incremental 25 basis point after the 50 in September to contribute in that $2 million to $3 million range on an annualized basis.

Okay, that's great. That's all from me. Thank you, guys.

Thank you.

Thank you.

Our next question is with Frank Schiraldi from Piper Sandler. Frank, your line is open.

Good morning, guys.

Good morning, Frank.

On the liquidity front, you mentioned you're getting back to pre-pandemic levels. And obviously, you have some seasonal swings in deposit balances. I was just wondering what a good target you might be for where you targeting or where you expect the loan-to-deposit ratio to trend here in the coming quarters.

Pre-pandemic, we managed to maintain a loan-to-deposit ratio in the range of 100 to 105. We expect to continue that trend moving forward. Although we experienced a reduction in excess liquidity, it was mainly confined to a few specific areas mentioned in the earnings release as well as in my prepared remarks. To be frank, we saw personal accounts decrease by about $13 million on a $2.3 billion base for the quarter. Therefore, the overall decreases were not significant; the drop was primarily due to a seasonal decline in public funds and one large commercial customer outflow.

Right. Yes. That was my follow-up on the large outflow. Any more color there? Was it all rate? And have you gotten any more aggressive in maybe defending these relationships?

It wasn't rate-driven at all, quite honestly. It was funds that had been held by a fund that were ultimately deployed for investment purposes. So, it was just kind of capital calls that have been funded up and then deployed subsequently.

Okay. And then in terms of the buyback, you bought back, I think, like 300,000 shares. You have a little bit, I guess, more than that under the current authorization. I know it's a board decision, but just trying to think about buybacks here going forward. Is that something you think you continue to utilize in the coming quarters?

Yes. Similar to what we announced last quarter, we continue to plan to buy back 150,000 shares each quarter until we use up the current authorization. After that, we will discuss with the board whether to provide additional authorization to continue going forward.

Okay. And then just lastly on that specific reserve related to the commercial real estate loan that was put on non-accrual, any color you can give there in terms of geography or any further detail on that one?

Yes. The specific reserve, not the charge-off, but the one placed on non-accrual when we recorded the $1.1 million reserve. It's related to a mixed-use commercial real estate property in our core market. There have been some occupancy challenges and delinquent taxes that led to this decision to place it on non-accrual and to create the reserve. However, we are addressing the situation and have ongoing discussions with the borrower, and we will continue to do so. We believed it was prudent to classify it as non-accrual for the quarter.

Okay. So, is that retail mix with multifamily?

Yes.

Okay, great. Thank you.

You are welcome.

Thank you.

Our next question is from Samuel Varga from Stephens. Samuel, your line is open.

Good morning.

Good morning.

I wanted to ask just one more question on the loan growth front. Could you give some color on the C&I utilization rates at this point?

Is that line utilization rates that you're asking about?

Yes, that's correct.

So, our commercial line utilization is somewhere around 38% to 39%.

So, do you expect to see any sort of the attention?

The 38% to 39% is kind of in that historical range as it has been for us.

Pre-COVID.

In the COVID cycle, it did decline. This is a jump back a little bit. So, we did benefit somewhat in our loan growth in the second quarter from line utilization, but these are at historical levels.

Understood, thank you. And then my last question is just on the public funds. Could you give some specific color on kind of the size of what sort of inflows you're expecting in the second half of this year as those return?

Yes. We always kind of see that build with tax collections and the like kind of anywhere from that $200 million to $500 million range in the third quarter into the fourth quarter is what we normally see out of the public funds build.

And I guess just as a follow-up to that, if I can sneak one more in. We've heard some commentary this quarter around these relationships being slightly more rate-sensitive. Could you give some color on what you're seeing specific to your relationships?

Sure. On the public fund side, they tend to certainly be more rate-sensitive. Largely, as they build on an annual basis, you see pretty close to, give or take, 100% beta as you look at it overall. So, there'll be certainly some pressure there. In the last rising rate environment, we saw a 45% beta on deposits. We expect that to kind of play through here through this rising rate cycle. There will be just based on the timing of the build and the like, that there could be some volatility in beta quarter-to-quarter, but we expect these things to normalize over the coming quarters or coming year that will end through this cycle. We'll see that 45% beta on the rising rate environment.

Understood, thank you for taking my questions, I appreciate it.

At this time, there are no further questions registered. There are no further questions. So, I would like to pass the conference back to the management team for any closing remarks.

Thank you, Austin, and thank you everyone for joining us today. Our growth engine continues to deliver benefits that will support our future initiatives, especially as we navigate through this period and invest in technology and new markets. We are satisfied with our performance this quarter and we look forward to discussing our progress again at the end of the third quarter. Have a great day.

That concludes today's call. Thank you for your participation. You may now disconnect your lines.