UCBIO - United Community Banks Inc. (UCBI) Q3 2022 Earnings Call Transcript
United Community Banks, Inc. (UCBI)
Q3 2022 Earnings Conference Call
October 19, 2022 11:00 AM ET
Company Participants
Lynn Harton - Chairman and Chief Executive Officer
Jefferson Harralson - Chief Financial Officer
Rich Bradshaw - President and Chief Banking Officer
Rob Edwards - Chief Risk Officer
Conference Call Participants
Kevin Fitzsimmons - D.A. Davidson
Brad Milsaps - Piper Sandler
Michael Rose - Raymond James
Catherine Mealor - KBW
David Bishop - Hovde Group
Christopher Marinac - Janney Montgomery Scott
Presentation
Operator
Good morning, and welcome to United Community Banks Third Quarter 2022 Earnings Call. Hosting the call today are Chairman and Chief Executive Officer, Lynn Harton; Chief Financial Officer, Jefferson Harralson; President and Chief Banking Officer, Rich Bradshaw; and Chief Risk Officer, Rob Edwards.
United's presentation today includes references to operating earnings, pretax, 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 are included on the website at ucbi.com. Copies of the second 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 [Technical Difficulty] filings with the SEC and included on its website.
At this time, I will turn the call over to Lynn Harton.
Lynn Harton
Good morning, and thank you for joining our call today. While I have concerns about the pace of the Fed tightening and the impact of a potential overshoot, our southeastern economies are performing well and we had a very strong quarter that demonstrated momentum in several key areas of our business. First, our net interest revenue grew at an annualized rate of 47% [Technical Difficulty] driven by loan growth at the upper end of our target range and a 38 basis point expansion in our margin.
While we did see deposit outflows, and we expect the pace of deposit rate increases to accelerate, the strength of our core deposits will continue to give us an advantage in this environment. Our loan to deposit ratio remains low at 73%, providing us ample liquidity to fund growth at reasonable cost. Our operating return on assets improved to 1.34%. Our return on tangible common increased to 15.6%. Our pretax, pre-provision return on assets reached 1.97% and our efficiency ratio reached an all-time low for us at 48%. Credit continues to perform well with very low net charge offs and only nominal increases in both non-performing assets and special mention credits.
We are not seeing significant signs of consumer or business stress. While inflationary pressures are impacting both consumers and businesses, both groups exited the pandemic in stronger than normal financial shape, enabling them to continue to perform well to date. Employment activity continues to be strong in our markets with labor shortages continuing to be common for many of our business customers. We are seeing slowdowns in our mortgage market, as well as slower turnover in our builder finance business as home sales slow, both of which would be expected giving higher mortgage rates.
We increased our loan loss reserve this quarter as Moody's economic forecast weakened due to their anticipation of higher unemployment and reduced residential sales and home improvement activity in the future. Loan growth was at the higher end of our target range with commercial increasing by $100 million, led by equipment finance at $70 million, residential mortgage grew by $152 million as more of our closed loans were adjustable rate, which we hold on balance sheet rather than sale. Our commercial growth was negatively impacted by runoff in Tennessee. This was not unexpected and we believe we're making great progress in implementing a growth plan in that outstanding market.
We continue to look forward toward closing our acquisition of Progress Bank. Progress has outstanding bankers with strong momentum and will be a great addition to our franchise. We've been working closely with them as we anticipate becoming one team early in 203.
And now, Jefferson will share more details on the quarter.
Jefferson Harralson
Thank you, Lynn, and good morning to everyone. I'm going to start my comments on page eight and go into some details on deposits. We are proud of our core deposit franchise, and we think it will serve us well as rates move higher. 40% of our deposits are demand deposits, which grew by $48 million in the quarter. That said, total deposits shrunk by 2.5% or $552 million this quarter, about half of that decrease was in public funds deposits, which are typically seasonally weak in the third quarter. That said, we are also in a higher rate environment where customers have a lot of attractive options outside the baking industry, which is creating headwinds for our deposit growth and the industries.
Still, our transaction deposits were up $406 million or 4% year over year, excluding acquisitions. Our cost of deposits was up 11 basis points in the quarter and helped drive our margin expansion that I will talk about on a later page. On page nine, we talk about our diversified loan portfolio. We grew loans at a 9% annualized pace. Lynn mentioned the drivers of the loan growth in his opening, so I'll move on to page 10.
On page ten, we highlight that we believe we are in a very good position when it comes to balance sheet strength and flexibility. The combination of loan growth and deposit shrinkage this quarter took our loan to deposit ratio to 73% up from 70% last quarter, again, giving us a lot of flexibility to fund future loan growth. Our TCE ratio improved in the quarter to 7.7%, despite higher unrealized bond losses, due to good profitability and a smaller balance sheet.
More on capital on page 11. Our ratios improved and are above peers. Our tangible book per share decreased by $0.16 in the quarter, as the higher unrealized bond losses drove $0.68 of headwind in the quarter. Moving to page 12, we discuss our net interest margin. As Lynn mentioned, we had 38 basis points of margin expansion in the quarter, 33 basis points of which came from the impact of higher rates and seven came from the positive mix change in the form of lower cash on the balance sheet and the higher loan to deposit ratio I mentioned earlier.
Page 13, we talk about fee income. It was down from last quarter. Our mortgage business was a driver of the decrease with rates rising and rate lock volumes declining 24% in response. The mortgage line had a $2.4 million MSR gain that will most likely not repeat in Q4, and the other income line had a $650,000 BOLI gain, that is also unlikely to repeat in the fourth quarter.
Moving on to some of the other fee income categories. We also had $1.5 million in gains on SBA loans and just under $700,000 in Navitas loan sale gains in the quarter. Moving to page 14 and expenses. Operating expenses were improved by $2.6 million in the quarter. The lion share of the improvement was due to lower mortgage commissions and we got the final cost savings from the Reliant acquisition. With the help of higher rates and the expense improvement, our efficiency ratio came in just under 48%.
Moving to credit on page 15. We had strong credit results in the quarter with 3 basis points of net charge offs and continued low levels of problem loans. On page 16, we show our waterfall chart on the allowance for credit losses, while net charge jobs were $1.1 million, we provided $15.4 million into reserve and have built our reserve for three consecutive quarters. Part of that reserve increase is due to our solid loan growth. But Lynn mentioned the main drivers in his remarks, which was anticipated higher unemployment and reduced future investment in residential [Technical Difficulty] at year end.
With that, I'll pass it back to Lynn.
Jefferson Harralson
Thank you, Jefferson. And many thanks to the United team. You all continued to deliver outstanding performance that you should be very proud of. And finally, I'd like to welcome George Bell to our Board of Directors. George and I met in the BV&T training program as we both began our careers in the early '80s. He's an experienced information technology executive with more than 35 years in large financial institutions with a specific emphasis on customer information management. He brings an incredible depth of knowledge and leveraging technology to improve products and services, to enhance the customer experience and increase organizational productivity. George, welcome to United. It’s an honor to have you on the team.
I'd like to now open the line for questions.
Question-and-Answer Session
Operator
We will now begin the question-and-answer session. [Operator Instructions] And up first is Kevin Fitzsimmons with D.A. Davidson. Please go ahead.
Kevin Fitzsimmons
Hey, good morning, everyone. Just very impressive margin expansion. So just trying to get a little -- dig a little deeper in terms of looking out at the next quarter or two with the anticipated further hikes from the Fed. Jefferson, wondering if you can -- if you have handy what for the month of September, the margin, the loan yield, cost of deposits might be just to help guide us on that trajectory for each of those? Thanks.
Jefferson Harralson
Yes. Thanks, Kevin. Thanks for the question. I appreciate it. How I'm thinking about the margin next quarter, I want to start with the cost of deposits and the deposit beta there is that, it was only 8% last quarter. I think from the rate changes that we've already made, it's -- you're at 10% for the fourth quarter. And then I think with rate hikes that are expected, I expect us to raise deposits on that too. So I'm using a 18% cost of deposits and -- or 18% deposit beta were cost of deposits in my model. On the entire margin, I think you are seeing, with that increased deposit betas a little less asset sensitive as we go forward, but I think with our -- expect some mix change to help us. I expect that our loan beta should stay relatively stable as rates continue to rise. And also to bring it all together, I'm expecting about 20 basis points of margin enhancement next quarter.
Kevin Fitzsimmons
Okay. Thank you. And just one quick follow-up. So on the comments that it's been three consecutive quarters of building the reserve, given the uncertainty and the headwinds out there, should we expect that [indiscernible] based on what you can see now? Thanks.
Rob Edwards
Yes. So thanks Kevin, its Rob. There is really three things that play into that. This quarter, it certainly was the change in the economic forecast, but of course loan growth and asset quality will also play a role in the future. So we've been -- I don't think loan losses are going to be 3 basis points forever and it would seem that likely they would return to more normalized levels and, of course, that will play a role I think in the provisioning and the allowance going forward as much as anything else. The Moody's economic forecast is less easily predictable.
Kevin Fitzsimmons
Okay. Thanks very much.
Operator
Our next question will come from Brad Milsaps with Piper Sandler. Please go ahead.
Brad Milsaps
Hey, good morning, guys.
Lynn Harton
Good morning, Brad.
Brad Milsaps
Hey, Jefferson, you talked about some mix change in the fourth quarter and maybe beyond. Can you talk a little bit about the bond portfolio and sort of how you balance the aspect of that rate continue to move higher since 25% of it is variable, it would almost seem like the yield maybe on the bond book going forward would move up maybe more than what it would cost you to go out rate deposits. Just kind of wanted to hear your thinking on maybe shrinking versus keeping the bond book the same and how that plays into your kind of margin and balance sheet guidance?
Jefferson Harralson
Yes, great. Thanks for the question. I believe our securities portfolio is most likely hit its peak and you'll see it shrinking for the fourth quarter and into next year. It spits off about, call it, $60 million to $90 million of cash flow per quarter, depending on the quarter a little higher in the near term and decreasing a little bit into next year. And I'm expecting to use that to help fund the loan growth in 2023. So I think if you're modeling the securities portfolio, I would model it smaller as time passes.
On the funding side, I expect the deposit -- it is a tough environment. I think you are seeing deposits stabilize a bit, but it could be down again next quarter as there is a lot of competition out there from short term money market, institutional money market funds, short term bond funds, that kind of thing. So I wouldn't be surprised to see if the deposits were down, not as much as Q3, but if they were down in Q4. It's a seasonally stronger quarter for public funds in the fourth quarter, which helps out a lot as well. But either way, my kind of short to medium term plan is to fund a lot of our loan growth with securities portfolio runoff and that should help that mix change and help increase the margin next year.
Brad Milsaps
And maybe just one quick follow-up to that. As you use those cash flows, does most of that come out of the fixed piece or do you expect the variable piece to kind of stay static in terms of its -- in dollars of the bond book?
Jefferson Harralson
I think it would stay -- that mix will stay relatively the same.
Brad Milsaps
Okay, okay. And then my second question, Jefferson. You guys have done a great job managing expenses, benefited from cost savings from deals, lower mortgage commissions this quarter. And I know you put in some new merit increases mid-year in addition to what you did earlier. Just kind of curious how you're thinking about expenses going into next year, obviously, a lot of inflationary pressure out there, but just wanted to get your thoughts around your ability to continue to control costs.
Lynn Harton
I'll start on that and see if anybody else wants to jump in there. So we did do a midyear increase to employees under $75,000. That run rate is in this Q4 number -- Q3 number. So you'll see maybe a little increase in the fourth quarter carryover for that, because that was done kind of early Q3. So there'll be some increase from that midyear increase. In total, we're doing our budget for next year. We're going to be budgeting some operating leverage into all of our budgets. It is a tough year with inflationary pressure. So it's hand to hand combat with -- as invoices come in or vendors and others want to raise pricing, it's a battle. And so I think that there is pressure on expenses to move higher. We do have the $3 million a quarter of cost savings from Progress, that's going to help a little bit in 2023. So that's helpful. I think that kind of -- I'm starting with a mid-single digit thought on expense growth in 203, but we're -- again, we're in the budget process currently.
Rich Bradshaw
Excuse me. This is Rich. With regards to mortgage, we continue to rationalize our headcount with the change in volumes, so we've taken that down accordingly.
Brad Milsaps
Great. Thank you. I'll hop back in queue. Appreciate the color.
Operator
Our next question will come from Michael Rose with Raymond James. Please go ahead.
Michael Rose
Hey, good morning. Thanks for taking my questions. I just wanted to dig into the SBA and Navitas businesses. I know spreads on SBA have been under pressure. It looks like you guys are portfolioing more of those. Can you just give us kind of an outlook as we kind of look forward? And then on the Navitas side, obviously, yields are very consistent as you've kind of outlined, but looks like credit is maybe beginning to normalize here. If you can just give an update on kind of what you would expect for kind of a cumulative losses through the cycle in that business and maybe other -- maybe versus last cycle on how maybe you've changed some of the underwriting there to help the loss [indiscernible] as you move forward? Thanks.
Lynn Harton
Okay. I think there's two, maybe three questions in there. And do you want to start that, Rich?
Rich Bradshaw
Yes. I'll start on the SBA side. So -- it’s okay. That's all good. On the SBA side, premiums are down a little bit. So that fourth quarter is traditionally a stronger quarter for us, so we are expecting to be up on fee income this quarter. And then just a quick [indiscernible] just we have -- out of 20,000 PPP loans, we have 12 left that we're administering. So we're pretty happy about that.
Jefferson Harralson
I would say strategically on the SBA side, some quarters over the last couple of years, we have held back and kept some of those loans in portfolio. I think our strategy is depending on the pricing out there is most likely changing to what we're going to sell, what we originate. So with the fourth quarter being a seasonally strong quarter and with the new strategy of not holding loans back, I would expect that SBA loan sale gain line to be about $0.5 million or maybe a little more higher in the fourth quarter.
Yes, we have been selling loans consistently over each quarter. I remember on last quarter's call I was mentioning that we may not sell them every quarter with rates moving higher and that being a fixed rate business. I could see that if the gain on sale there is not attractive, there could be a quarter in here where we don't sell Navitas loans. So what I would say is, most likely expectation is another small Navitas loan sale and more normal higher SBA loan sales. But again, there could be a quarter in here where we don't sell these loans if we don't like the pricing.
Lynn Harton
And it's the same thing on SBA. There's kind of an over under when we hold and sell based on what the sale of -- dollar amount would be. Now normalized Navitas credit loss part of that question, let me pass it over to Rob.
Rob Edwards
So in the first quarter this year we had 9 basis points of losses. I think we've been saying they are going to increase. They have increased to 35 basis points this quarter. Prior -- if we go back in time, our losses were as high. I think in 2020, we were at 78 basis points. So I think we will see that normalize. I'm not sure we're going to get back to 78 basis points. We do feel like we have, I think you sort of pointed in the direction that I would agree with is, it's a better book today than it was in 2020. We've sort of upscale some of the customers that we're dealing with through the approval process. So I don't know that we'll get back to 78 basis points, but I do think it'll increase. Although I wouldn't say that we're seeing it yet, the difference between 30 basis points and 35 basis points. So I'm watching the early stage delinquencies, pre-pandemic they were running 1%, in early stage delinquencies, we're not anywhere near that number at this point. So not really seeing much of a change there yet either.
Michael Rose
Okay. Very helpful.
Rob Edwards
Credit changes, but the portfolio has been upscaled. So all things equal, it's a lower risk portfolio we believe when we bought it in 2018.
Michael Rose
Makes sense. Maybe just a follow-up. I'm sorry if I missed this, but any update on the progress deal and getting kind of approval there? And then if you can just remind us Jefferson, you've obviously had a couple of deals, this one pending here recently. As we go into next year, what is the pool of accretable yield that you'll have to realize over the next couple of years? And do you have an initial expectation for next year for scheduled accretion? Thanks.
Lynn Harton
Yes. So, this is Lynn. And on the Progress deal, we continue to work with FDIC and Fed toward approval and are optimistic toward getting that done so that we could close in the early part of next year, but we're just continuing on the process with them.
Jefferson Harralson
Yes. I don't have the exact number of accretion with me. Let's talk afterwards, I'll give you the accretion numbers. The pool of accretion numbers coming through.
Michael Rose
Perfect. Thanks for taking my questions.
Operator
Our next question will come from Catherine Mealor with KBW. Please go ahead.
Catherine Mealor
Thanks. Good morning. Just wanted to ask a question on credit. We saw a higher provision this quarter, obviously, largely from the better growth and then the macro changes. So as you sit here today, how do you -- what's your kind of outlook for the likelihood that we'll see more reserve builds over the next couple of quarters, just given how you think kind of the macro factors have the potential to change and where your reserve sits today?
Rob Edwards
It's an interesting question. I think both Lynn and Jefferson mentioned in their comments two of the drivers, one being change in unemployment. Unemployment plays a role in basically all of our models. So how you think about the future of unemployment will drive that factor. And then the other one is new home sales. The models -- new home sales and home improvement monies and the models were driven this quarter, particularly our residential portfolio driven by that variable. So we're already seeing in the market declines in new home sales year-over-year and specifically in September. So I think it's happening already. So to the extent that it happens, you won't be predicting more of it than it would be less likely. But if you begin to see further tightening and further negative views on unemployment, then I think you could see the reserve build.
Jefferson Harralson
I'll just add. It's really sensitive to this Moody's model if weather is getting better or worse. So it's just so hard to make that -- to give you the answer that I think you might be looking for. Because the Moody's -- it's just so sensitive to this model that is subject to change and sometimes it can be outside of consensus. So it's a very difficult question to answer.
Catherine Mealor
And then on the loan growth, I mean, the loan growth has been so strong and we've had the view that as you -- after you incorporate Reliant, you'll see stronger growth just because of the [indiscernible] of the national market. But the economy is also a little bit weaker today than it was when you first did the Reliant deal. So maybe just big picture comments on what loan growth could potentially look like as we move into next year?
Rich Bradshaw
Yeah. Catherine, this is Rich. Thanks for the question. So yes, it certainly has changed a little bit with next year. So we're thinking about -- first of all, we're still the best market, so that's very positive. We're not -- we're still seeing pipelines be strong, but you've got to think that with labor supply chains and interest rates that that has an impact next year. So we were high single digit this year and we're expecting that to be down a little bit next year kind of mid-single digit.
Catherine Mealor
Great. Everything else has been answered. Thanks so much.
Lynn Harton
Thank you.
Operator
Our next question will come from David Bishop with Hovde Group. Please go ahead.
David Bishop
Yes, good morning, and thanks for taking my question. I think Lynn or Jefferson in the preamble, you noted there were some headwinds in the Nashville market [indiscernible] like maybe on the low front. Just curious, you're seeing any sort of rationality in the market on the loan to deposit side and maybe when you expect and how to resume growth in that market? Thanks.
Rich Bradshaw
Hi, this is Rich. Yes, [indiscernible] and obviously Tennessee was down. I will tell you, part of that credit appetite. We had a large -- made up primarily of two loans of subprime, auto paper and a land loan. I’m not -- we haven't gotten through all kind of what didn't meet our credit appetite. We've gotten through most of it. So maybe just a little bit more in Q4 and then we really feel good about where we're moving to and the team. Also, I will tell you some of our hiring discussions. There's a lot of emphasis in Nashville. We have some very positive momentum on the hiring front there and feel good about that as well. So that market is such a strong market. We feel very positive about it going forward.
Jefferson Harralson
And I might just overlay that. It's pretty typical when we buy a bank to see loan strength for a quarter or two or maybe even sometimes three as we're overlaying our box, there's a conversion, there's some distraction sometimes. But either way, we feel really good about the team, we feel really good about the market and we feel -- and this vary within our expectations of what we're seeing.
David Bishop
Got it. Appreciate that color. Then one follow-up Jefferson on the mortgage banking front. I know it could be volatile source of revenue. It sounds like there were some -- you mentioned some noise in there. Can you go over that again? And I don't know if you have a sense of where that could normalize into 2023? Thanks.
Jefferson Harralson
Yes, I'll start with the noise and Rich can talk about the business a little bit. So the accounting noise in the quarter was the MSR gain, which was $2.4 million. I don't expect that to repeat. So I'd take that out the start and Rich can talk about the pipelines and volumes and expectations for locks in Q2 and such -- for Q4?
Rich Bradshaw
Yes, we do expect Q4 to be down about 20% from Q3 and probably a little bit more mix move to arms as well. And we're expecting the margins to be down just a little bit as well.
David Bishop
Got it. Appreciate the color.
Operator
Our next question will come from Christopher Marinac with Janney. Please go ahead.
Christopher Marinac
Hey, thanks. Good morning. Jefferson, I wanted to ask about the increased use of the held to maturity securities. And I'm wondering if that taps some of the excess deposits that you already have on the balance sheet and does that become a factor and how you think about funding the next several quarters?
Jefferson Harralson
Thanks, Chris. It’s a great question as we're thinking about next year and planning out the balance sheet. So I mentioned the cash flow that I'm expecting to come from both the HTM and the AFS portfolio. Obviously, we're not planning on selling that 40% or about four billion of -- I'm sorry, $3 billion of held to maturity securities. But if -- but the cash flow itself will fund a lot of the loans. If we're not planning on selling AFS securities either, we can borrow against both AFS and HTM securities. So I think about if that our portfolio went from $2.5 billion to $7 billion during the cycle. I think that could be down to $5 billion or $6 billion or even $4 billion, I think will be a more normal loan to deposit ratio for us. So the amount of HCM securities fits in line with the size of the portfolio, I think we're always going to have. So that the combination I believe of letting the portfolio shrink and the ability to borrow against both AFS and HCM, it's not really having those HCM securities is not affecting our strategy for liquidity or the size of the portfolio.
Christopher Marinac
Got it. That's very helpful. Thanks. And perhaps a question for Rich or whoever, are there any new pools of deposits that you can tap or that perhaps you are tapping or just what could be a greater generation. I'm just curious if there's incentives for teams of people that can focus more on deposits than you that was necessary the past year?
Rich Bradshaw
That is a great question. I'll start with it and maybe I'll pass it around to anybody else who wants to join. So I wouldn't -- I don't know if I would say there's new pools necessarily that's coming to mind, but what I would say is that, with us and I imagine most banks are changing their energy associated with deposit growth and how we think about it. We're using rate more. You'll see that out there as well. We are -- I would envision -- if you talked to our bankers before, I think they use rate defensively. I think they use rate to keep customers. But I can imagine campaigns happening in the future. I can envision compensation for deposit growth increasing in the future and just changing the energy to where we had excess deposits before and now we want to grow our deposit base. And so I think you're going to see an organizational energy change around the need to grow deposit.
Lynn Harton
And real focus on our core customers. That's really where we want the emphasis and more so than public funds. It's really protecting the core customers and that's where our state presidents are putting a lot of energy in our teams.
Christopher Marinac
Great. Thanks again for the background. It's super helpful. I appreciate it.
Lynn Harton
Thank you, Chris.
End of Q&A
Operator
And this concludes our question-and-answer session. I'd like to turn the conference back over to Lynn Harton for any closing remarks.
Lynn Harton
Great. Well -- and once again, thank you all for joining the call. We talked a little bit about the economic environment and it's really hard to know where we're going to go into. The Fed tightening seems to make -- seem like there'll be a recession, the strength of the consumer and business customer though and strength in the employment market would seem to argue that it would be mild if anything. Regardless, I think what you got to focus on is the amount of shock absorbers that the company has built in. When you think about shock absorber of pretax, pre-provision ROA that we have today, the liquidity and core deposits that we have, the capital strength and credit culture, I'm really excited about what's going to happen as we go into 2023.
And so anyway, I appreciate everybody being on the line and supporting us and feel free to reach out with any other questions that you have. Thank you.
Operator
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.
For further details see:
United Community Banks, Inc. (UCBI) Q3 2022 Earnings Call Transcript