Earnings Call Transcript - UVSP Q3 2020

Operator, Operator

Good day and welcome to the Univest Financial Corporation third quarter 2020 earnings conference call. I would now like to turn the conference over to Jeffrey Schweitzer, President and CEO of Univest Financial Corporation. Please proceed.

Jeffrey Schweitzer, President and CEO

Thank you, Grant, 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 would like to start by saying I hope everyone listening is staying safe and that 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 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 can be found on our website at univest.net under the Investor Relations tab. We reported net income of $18.1 million during the 3rd quarter or $0.62 per share. As our local economy reopened during the end of the second quarter and into the 3rd quarter, we have seen more activity and opportunities to grow our lines of business. We experienced strong loan and deposit growth during the quarter as loans increased $257.4 million and deposits increased $342.3 million. Our mortgage banking unit continues to set internal records with net gain on mortgage banking activities up $4.2 million or 260% compared to the same quarter in the prior year. Additionally, as detailed in our release, we continue to see improvement in our modified loans as the economy has reopened with the percentage of modified loans as a result of COVID-19 decreasing to $191 million or 4.1% of our loan portfolio. We continue to be pleased with the performance of our core diversified business model as our pre-tax pre-provision income during the quarter increased $4.2 million or 18.1% compared to the 3rd quarter of the prior year with our pre-tax pre-provision return on average assets for the quarter being 1.73%. Additionally, on October 19th, we announced the consolidation or relocation of 8 financial service centers or 20% of our centers as we continue to enhance our digital offerings, focus on efficiency, and adapt our business to changing customer preferences. Before I throw it over to Brian, I just want to thank the members of the Univest family. I continue to be very proud to be a part of this team; they have adapted to a new working environment while continuing to serve our customers, our communities, and each other while growing the business and moving the Corporation forward. I will now turn it over to Brian for further discussion on our results. Brian.

Brian Richardson, Chief Financial Officer

Thank you, Jeff. And I would also like to thank everyone for joining us today. As Jeff mentioned, we reported earnings of $0.62 per share for the quarter with the return on average assets of 1.15%, return on tangible common equity of 14.82%, and an efficiency ratio of 58%. I would now like to touch on 4 specific items related to the earnings release. First, our provision for credit losses was $3.9 million for the quarter, which was primarily driven by the $257.4 million increase in loans. During the third quarter, we saw stabilization in the economic assumptions used within our CECL model. As of September 30th, our allowance for credit losses was 1.95% of total loans and leases when excluding PPP loans. This represented an increase of one basis point compared to June 30th. Second, as expected we experienced net interest margin compression during the third quarter. Reported NIM of 3.02% decreased 16 basis points when compared to the second quarter. Reported NIM was negatively impacted by 18 basis points of excess liquidity, which averaged $329 million for the quarter and 10 basis points due to low-yielding PPP loans on the balance sheet. Core margin excluding excess liquidity and the PPP impact was 3.30%, a decrease of 13 basis points when compared to the second quarter. As a reminder, third quarter NIM was reduced by approximately 6 basis points due to the $100 million sub-debt issuance on August 5th. Third, as it relates to non-interest income, our mortgage banking business continues to have a great year. For the quarter, our net gain on mortgage banking totaled $5.9 million, which represented a year-over-year increase of $4.2 million. For the 9 months ended September 30th, 2020, our net gain on mortgage banking totaled $12.1 million, an increase of $9.2 million when compared to the same period in 2019. Additionally, noninterest income included swap fees of $2.3 million for the third quarter, which was an increase of $2.2 million compared to the third quarter of 2019. For the 9 months ended September 30th, 2020 swap fees totaled $4.1 million, representing an increase of $3.4 million when compared to 2019. Fourth, noninterest expense was slightly elevated due to compensation costs associated with the strong performance of the mortgage banking business. Variable compensation costs for this business totaled $830,000 for the third quarter. This is an increase of $535,000 versus the third quarter of 2019. When you normalize expenses for these variable compensation costs and the FDIC assessment credit, which was recognized in the third quarter of 2019, expenses are up 1.98% year-over-year. As Jeff mentioned, on October 19th we announced the plan to close or relocate 20% of our financial centers. Pretax one-time costs associated with this plan are estimated to be $1.7 million, which will primarily be incurred during the fourth quarter of 2020. The estimated pre-tax annualized savings are approximately $2.4 million. It is important to note the plan includes 2 phases. As such, the expected pre-tax savings for 2021 is approximately $1.8 million. In closing, our strong performance during the third quarter highlights the value of our diversified business model. This diversification enabled us to produce strong results despite the inherent headwinds from COVID-19 and the current interest rate environment. That is it for my prepared remarks. We will be happy to answer any questions. Operator, would you please begin the question-and-answer session.

Operator, Operator

At this time we will pause momentarily to assemble our roster. Our first speaker is Michael Perito with KBW.

Michael Perito, Analyst

I had a few questions. I want to hit quickly, one just on the fee income side, obviously some environmental factors that you guys mentioned on the mortgage side. But what I'm pretty sure is a record revenue quarter for you guys in the history of the company. Just any thoughts on how that run rate could trend in 4Q? My guess is there's still some room for elevation and as we look out to next year what are some of the core growth rates we should be thinking about for some of the lines of business?

Unknown Executive, Executive

On the mortgage side of the equation, Mike, the pipeline was still strong at the end of the third quarter, and we believe we will also set another record for monthly funded volume internally this month, so that will continue. You're seeing a mix of that business now going from a funded basis in the third quarter that was almost 50 - 50 between purchase and refinance. We dipped down a little bit here, so we picked up a little bit on the refinance side again over the last week or two. But refinances are eventually going to dry up; it's just the fact. You'll see some seasonality with regard to purchase. I would expect that will be strong through November and start to fade somewhat. But we're going to get a good start on the first quarter as well, just because of the pipeline that we have in place. Ultimately, on the mortgage side, you're going to lose the refinance volume next year, but the purchase market, given the rates, I think will still be strong. It really comes down to what the purchase inventory is available for borrowers in our footprint. So, we feel good about it. We've done a really good job in terms of recruiting additional loan officers, and we continue to grow that operation. While we will lose on the refinance side and margins will return to a more normalized basis, we do feel good about growing that business longer term. Yes, and on the wealth side, we've seen customers coming back and being more open to talk. The second quarter was a low point for us on production; we're probably 75% of the way back on what we're adding from the new asset perspective on a quarterly basis right now as things have opened up. With that said, we have seen some headwinds when it comes to the TD branches that we have that arrangement with as they remain closed, and the disruption of Schwab acquiring TD has really slowed that down significantly. But as things start to clear up there and hopefully as we head into next year and things open up a little, we should start to ramp that production back up. However, with the market having recovered a decent amount, although obviously recent selloffs, we priced off quarter-end balances in a big way. So we expect that the fourth quarter for wealth will be pretty comparable, maybe a little better than the third quarter. Insurance, for whatever reason, customers are more reluctant to change brokers of record right now, so we've had some slowdowns as far as building pipelines combined with impacts to premiums from employees being laid off from customers or workers' compensation from employees being laid off. So we've had some headwinds there that we're trying to work through; it seems to be a little slower in coming back.

Michael Perito, Analyst

But do you think if we try and normalize for the security gains, I think you guys are on pace to do about, call it $75.5 million give or take in 2020 on the non-interest income side. Do you think that that will be in the ballpark similar next year, even with the mortgage environment and normalizing?

Unknown Executive, Executive

Now, we are currently going through our budget process and are not prepared to give specific guidance as it relates to 2021. However, there was favorability on the mortgage side of things, as well as on the swap fee income side of things. The environment this year lends itself nicely to that line item. I think there'd be a little bit of pressure on noninterest income overall if you look at it from a year-over-year basis going into 2021.

Michael Perito, Analyst

Okay, helpful. And then Mike, you talked about the mortgage pipelines or about the commercial pipelines, the growth looks, as the PPP looks really strong in the third quarter. Curious if you could provide a little bit more color on that and what you guys are expecting from a growth perspective going forward given what you see in the environment today.

Mike Keim, President of Univest Bank and Trust

Yes, sir. So when you look at our third quarter growth, I think you need to look at it in terms of some level of pent-up demand that was second and third quarter related. Our pipelines at the end of the third quarter were still good; traditionally, our third quarter is our lower quarter with the fourth quarter being stronger. I would see that we will still have a very good fourth quarter by anybody's measure, but it will not be the same historical bump over the third quarter if you do that, quite frankly. Yes, we feel good about what we're doing here, Mike. This is a testament to a couple of things: the investment that we've made in our teams and the quality of those teams over the last couple of years. We've also made sure that people know that we’re still lending. Now we've used our COVID-19 guidelines, so we've pulled back; we've been more conservative with regard to LTVs and making sure that the borrowers' guarantor has a strong track record of operation and if it's commercial real estate, that the underlying tenant is a strong tenant that we believe can continue to thrive as we hopefully emerge out of this COVID-19 scenario at some point in early 2021. But overall, we feel good about what we've done obviously and I feel good about where we're going. It will just be more of a normalized run rate from what you've seen from us in the fourth quarter on an overall basis; not traditionally what we've done in the fourth quarter, but still solid.

Michael Perito, Analyst

Okay. And at this point, as you said here today, I mean, I think they have been a bit more conservative on loan growth until we get into next year depending on the pace of the economic recovery, but it would seem like you guys think there's enough activity in pipeline and market share opportunities to drive some level of consistent and meaningful growth next year.

Mike Keim, President of Univest Bank and Trust

We do. Look, right now, we're seeing a resurgence of cases. But I don't think that we're going to see a complete shutdown like we did early in the second quarter into the early part of the third quarter. So you have to have some level of caution with regard to how case counts go. But as we get closer to a vaccine, and I don't think there is a political will to completely shut down the economy, we'll continue to grow as we've said in different settings. We look at this and we are open, willing, and looking to lend, but we're also looking to lend on our conditions with more conservative underlying factors as we move forward, and the good news is our team is incredibly good and has contacts, and we're able to continue to have that momentum and move forward under those conditions.

Michael Perito, Analyst

Great. And then just lastly, Brian, can you repeat the variable component of the Q3 expense number; I'm sorry I didn't catch that.

Unknown Executive, Executive

No problem, Mike. As it relates to simply the mortgage business, the variable comp for the quarter was $830,000 that represented an increase of $535,000 versus the third quarter of last year with just the inherent seasonality in that business. I thought the most relevant reference point would be the third quarter of 2019.

Michael Perito, Analyst

And so as we think about expenses moving forward, I mean, as you mentioned, to say so call core expenses in the third quarter that we call it 37.7 million really makes an assumption on variable mortgage comp and then later in the 2.4 million annual savings over the course of next year with a little inflation growth. Do you think that generally should capture how you guys are seeing it today or are there other things we could consider?

Unknown Executive, Executive

Yes, I mean. Well, that was a full variable comp cost of $800. So I think when you want to normalize, you might want to take the $500,000 out. So you could be around $38 million. Then you can kind of normalize from there.

Operator, Operator

Our next question will come from Frank Schiraldi with Piper Sandler.

Justin Crowley, Analyst

It's actually Justin Crowley on today for Frank. So just building off the expense commentary, I guess when you look at the consolidation plan and the savings, is there anything you're sort of seeing that would, I guess what I'm asking is, how much of that savings should we kind of expect to see drop to the bottom line or are there other things, whether it be on the digital side or what have you, that this pandemic has caused you to take a harder look at places that you think might be worthwhile investing in, just in light of the changing environment that we're in?

Mike Keim, President of Univest Bank and Trust

On an overall basis, we will continue to invest in technology, but we've made a significant investment already. So the incremental investment going forward isn't at this point overly significant. I would just not look at it as there’s going to be a big step-up on the data processing line for us; given that some things will fall off, we’ll make additional investments as we move forward; it will be incrementally picking up a little bit, but nothing of any magnitude. So when we look at the financial service centers, the majority of that savings that Brian referenced will fall to the bottom line, but it's also important to note, and we've announced this that we've added and/or expanded our footprint in Mechanicsburg, which is in Cumberland County and Berks County, as well as in York, as we continue to grow the business. So we will have expenses related to that expansion.

Justin Crowley, Analyst

Okay, that's helpful. And just as part of this consolidation, are you modeling or expecting any sort of attrition, or is that just going to be a small number in your eyes, just given the nature of the locations that you're consolidating?

Mike Keim, President of Univest Bank and Trust

Look, anything could happen. But historically, our attrition rates have been very low. Our increased investments in digital and the adoption by our customers coupled with the proximity of other financial center locations, we do not expect to see a significant amount of attrition.

Justin Crowley, Analyst

Okay, and then just circling back to the loan growth discussion, it was helpful commentary there. I guess I was just curious if you had any detail on the geography breakdown. Perhaps, you know how much of that with Lancaster, I know you spoke to that on the call last quarter, I believe you called out the agricultural team that was getting up and running, had some good production on the way. So, I wasn't sure if that was a factor at all in the growth that we're seeing this quarter.

Mike Keim, President of Univest Bank and Trust

Yes. We now refer to Central Pennsylvania, and the Ag team that operates in Central Pennsylvania continues to move forward in the Ag business — was, and continues to be solid. So that was a good portion of what we did, but quite frankly, we grew loans across the entire footprint. We did CRE deals, like I said, that met the criteria when I discussed and answered to my previous question that in terms of the quality of the deals themselves and in the guarantor, borrower, the underlying tenants, etc. So it was a good mix, a solid mix across our footprint and across our diversified loan book. We feel really good about that and we believe that that will continue. Great. I appreciate it.

Operator, Operator

Our next question will come from Matthew Breese with Stephens.

Matthew Breese, Analyst

Just a few from me, one on the new cost plan. The 2 phases. What should we expect from Phase I and what should we expect from Phase II?

Mike Keim, President of Univest Bank and Trust

Yes, the overall blended impact of that that you would anticipate for next year will be $1.8 million of savings. So full annualized impact is $2.4 million when you incorporate the fact that Phase I is at the end of January, and Phase II is at the end of June. When you look at those specific items, it comes out to the net savings for next year of $1.8 million on a pre-tax basis.

Matthew Breese, Analyst

Okay, and then just on the new pipeline of loans. What's the blended yield, and how does that compare to what's on the books today?

Mike Keim, President of Univest Bank and Trust

As you look at new production for the quarter, you kind of have to break it down between fixed and variable. On a fixed-rate perspective, our average rate was 3.68%; our books are around 4% currently. As it relates to variable, you've got to split that out between swap loans and non-swap loans. On non-swap loans, we're seeing an average rate of about 2.90%, which is roughly 260 to 270 over one month LIBOR. On swap loans, we saw a spread of about 2.20% and we also received average fees of about 20 basis points, which helped drive that fee income line item that I spoke about. Yes, you're looking at a 2.37-2.45 aggregate spread; however, that is split between our net interest income and the fee income side of things, and you pull forward largely into the current quarter.

Matthew Breese, Analyst

Okay, so not knowing the breakdown of the pipeline between fixed rate and variable swap or non-swap, how would you characterize where loan yields are heading? Do you feel like they can stabilize here or head lower?

Mike Keim, President of Univest Bank and Trust

Loan yields overall would continue to slide a little bit inherently. I think kind of that 3 mark — just go with 3s would be where production will be at. Inherently when your books at 4%, you're going to have continued pressure on the portfolio yield as we progress forward.

Matthew Breese, Analyst

Okay, and then on the liquidity side, could you just remind us how much excess liquidity you think you're holding onto and what's the plan for deployment and over what timeframe?

Mike Keim, President of Univest Bank and Trust

Yes, for the quarter, we had $329 million of excess liquidity, that's up from roughly $250 million during the second quarter. So we expect that to continue to run out; of course, we have a public funds book which built during the quarter; it contributed some to that. Adding on $100 million of sub debt additionally added to that. But as we have loan growth and normal deposit outflows, we expect that to continue to diminish; it will still be elevated in the 4th quarter. The $329 million, quite honestly, is a peak; I think it will continue to trend down from there over the coming quarters.

Matthew Breese, Analyst

Okay, and then just tying this all together, it’s a challenge in this environment. But how would you characterize or what kind of NIM guidance would you provide for the coming quarters?

Mike Keim, President of Univest Bank and Trust

For the 4th quarter, I think it would be reasonable to expect low to mid-single-digit compression on a reported basis and slightly more as it relates to a core basis. Just simply again, you get a benefit of reduced excess liquidity on a reported basis but you're not going to get that benefit on the core basis. I think that would be the guidance here for the 4th quarter and continue to see how things move forward as we get into 2021.

Operator, Operator

At this time, I have no further questions. Therefore, we will conclude our question-and-answer session. I would like to hand the conference back to Jeffrey Schweitzer for any closing remarks.

Jeffrey Schweitzer, President and CEO

Thank you, Grant, and thank you everyone for participating today. We feel really good about how the quarter ended. Obviously, also with our decrease in modified loans that's trending in a positive direction, really good as things open up. Look forward to speaking to everybody at the end of the 4th quarter. Please stay safe, and I look forward to speaking to you in another 3 months. Have a good day.

Operator, Operator

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