UCBIO - United Community Banks: Market Chaos Priced In Rated Buy

2023-10-13 10:14:44 ET

Summary

• United Community Banks, Inc. has faced pressure from a tough macro situation, causing its stock to fall nearly 30% in the past year.
• The bank has seen mixed operational metrics, but its asset quality has held up well.
• Despite lower margins and income power, the bank has experienced growth in loans and deposits.
• The yield has pushed higher, paying you to wait.
• There is merger activity for future growth.

Our coverage of the regional banks and the current state of the market continues today with a small banking network out of the Southeast. The bank in question is United Community Banks, Inc. (UCBI). The company does its banking in several southeastern states, and has slowly been in growth mode over the last few years, but has run into a tough macro situation which has added pressure. In turn, the stock has been crushed, but we think the market chaos and risk is priced in after has fallen nearly 30% the past year.

Initially, the rising rate environment had a favorable effect on net interest income in most banks. Here in 2023, the competition to attract customer deposits has weighed on the cost of funds, and in turn, put pressure on net interest margins. Further, the deposit base of many banks has suffered, but mileage varies depending on the bank and region in question. For the most part, loan activity remains robust, and for United Community Banks, asset quality has held up, though softened modestly.

The play

Target entry 1: $24.80-$25.25 (30% of position)

Target entry 2: $23.50-$23.65 (33% of position)

Target entry 3: $22.75-$23.00 (34% of position)

Target exit: $27

Stop loss $19.75.

Discussion

The stock is far less expensive on a valuation basis than it was to start the year. Operational metrics are a bit mixed, but is the bank is holding up well. The yield, while not high, is getting more attractive to wait at over 3.5%, though we realize income investors may shun this in favor of cash, money markets, bonds etc., which offer higher yield for almost no risk. But a moderately high dividend yield of over 3.5% is nothing to thumb one's nose at, either, especially as you wait for a turnaround. The company recently grew through some merger activity, and recent performance has been respectable. We especially like the asset quality metrics.

Top line figures for United Community Banks

In the most recent quarter , United Community Banks, Inc.'s operational results were weak, and the headline results missed expectations. Thanks to continued loan growth, United Community Banks saw revenues continue to improve once again. With Q2's revenues of $213.9 million, the company registered a 3.5% increase in this key metric year-over-year. With the other regional banks we have covered recently, we have seen mixed revenues versus last year. The result was a miss versus expectations of $27 million . That is a strong miss. What is more, we saw weaker performance on earnings due to this result, and margins have narrowed. However, market pain, and fear of banking slowdowns, is priced in here in our opinion.

Margins and income power

The increase in revenues year-over-year was once again led by loan growth, though deposits were down. Margins weakened as well. United Community Banks saw Q2 net income of $63.3 million, or $0.53 for the quarter, which represented an increase of $0.01 or 2% from the sequential first quarter of 2023 and a decrease of $0.08, or 13%, from the comparable year-ago quarter.

As we mentioned above, financial sector deposit interest payment competition drove increased deposit costs, leading to an $11.2 million decrease in net interest income for the quarter, driving much of the perceived weakness. United Community Banks saw its net interest margin decrease by 24 basis points to 3.37% from the sequential quarter, lending evidence to our assertion that we have seen peak margins in the space. This margin stemmed from an average yield on United Community Banks' interest-earning assets increased by 21 basis points to 4.97%, but its cost of deposits jumped by 54 basis points to 1.64%, so we saw a decline in the net interest margin result.

Loans and deposits grew

Despite the concerns in the space, both loans and deposits grew. Q2 annualized loan growth was 12%. Loan production was $1.5 billion, resulting in organic loan growth of 6.3% annualized for the quarter. Total loans grew to $17.4 billion, up from $17.2 billion to start the quarter. This is very strong growth in this climate. Further, while many banks are losing deposits, United Community Banks saw an increase in this critical metric. Deposits rose by 4.5% annualized to $22.3 billion versus $22.0 billion to start the quarter. These are the kinds of trends we like to see for a bank, even if we are at peak margins for the industry.

Asset quality strong, but declined

Asset quality is a strong gauge for banks. Overall, this bank enjoys strong asset quality, but we saw some deterioration in key metrics here. We saw growth in loans and deposits, but a narrowing of margins that hurt overall revenue and earnings. We should add that the provision for credit losses was $22.7 million in Q2, a slight uptick from $21.8 million to start the quarter. What about non-performing assets? Well, they increased from Q1. They were 0.40% of assets, up from 0.28% of assets to start Q2. This stemmed from some added nonperforming loans and a tick up in net charge-offs, but credit remains strong. Net charge-offs ticked up 3 basis points to 0.2%. While we do not like this trend, in this macro environment it is not unreasonable. Further, this is more than priced into the stock in our opinion.

Return metrics were hit by a decrease in efficiency, which is no surprise given the reduced margins. The efficiency ratio was still as strong, 55.7% overall. The return on average assets was 0.95%, while the return on average tangible equity was 11.4%, down from 11.02% sequentially. The return on assets was flat from Q1, while the return on equity ticked down 28 basis points. Despite these trends, we think the bank's earnings power will improve now that interest rate hikes appear to be coming to an end, and the industry can adjust to a new normal.

Take home

Overall, Q2 was mixed for United Community Banks, Inc., but we like the loan and deposit growth on display. While margins were down due to paying more for customer deposits, the average yield on loans and other assets did increase, just not at as high of a rate. This led to lower efficiency, returns on equity, and of course margins and income power.

However, the stock is down tremendously this year. We think that earnings are bottoming. Further, added merger activity that occurred in Q3 will add to long-term performance. The yield, while nothing to write home about, pays you 3.5% to wait for a turn. We have outline a trade above that we think works well over the next quarter, and consider United Community Banks, Inc. shares a buy as prescribed.

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