Summary
- UCBI's third quarter results saw above-average spread income growth and operating leverage, with modestly below-average loan growth and strong deposit cost performance.
- Management has continued its acquisitive ways, with a pending deal for an Alabama bank that further extends the company's footprint.
- UCBI has continued to execute well to its plan; the shares look 10% to 15% undervalued, but loan demand is likely to slow and acquisitive banks are frequently out-of-favor.
Banks are not very popular at the moment, and banks that lean heavily on M&A to drive growth are even less popular … and yet, United Community Banks ( UCBI ) shares are up about 5% since my last update , outperforming the regional bank group by around 10%. UCBI management has continued its acquisitive ways, but has also been delivering on strong asset sensitivity and operating leverage, driving better-than-expected results for the year.
I continue to believe that UCBI operates in fundamentally attractive markets, and I like the company’s overall strategy with respect to lending and deposit-gathering, including meaningful operations in “second-tier” metro areas where there is still good population and income growth, but less competition from non-local banks. Valuation is challenged by the reliance on an M&A model, but I do believe the shares are still modestly undervalued.
Another Better-Than-Expected Quarter
Asset sensitivity, operating leverage, and underlying in-market share growth continues to drive better than expected results from UCBI.
Third quarter revenue rose almost 28% year over year and about 9% quarter over quarter, better than the mid-to-high single-digit growth typical of the quarter. Net interest income rose 42% yoy and almost 12% qoq, again surpassing the norm for the quarter. Earning assets declined modestly, but net interest margin expanded 45bp yoy and 38bp qoq to 3.57%; UCBI saw a little better than average spread improvement, while the final NIM was pretty much in line with the average.
Fee income declined 20% yoy and almost 5% qoq, with mortgage banking earnings down 54% yoy and 10% qoq. This decline in mortgage banking was something I expected and something that has happened broadly across the banking sector as higher rates and lower activity lead to a sharp cyclical correction in the business.
Adjusted operating expenses rose about 17% yoy and fell 2% qoq, a better-than-average performance, and the bank’s 47.9% efficiency ratio was better than expected and better than average as the company executes on cost synergies from past deals. Pre-provision profits rose 41% yoy and more than 22% qoq, on the very high end of bank performances for the quarter.
Average-ish Loan Growth, Decent Credit Quality, And Well-Controlled Deposit Costs
UCBI reported about 2% sequential loan growth on both an end-of-period and average balance basis. While that was a little soft compared to smaller bank peers (as opposed to the giants like PNC Financial ( PNC ), et al), it was on the higher end of management’s prior guidance range.
CRE and C&I lending was pretty soft on a relative basis, growing less than 1% from the prior quarter, while mortgage loan balances increased almost 8% as the bank put more loans on the balance sheet. The Navitas equipment finance business is still seeing good growth, with loans up 6% qoq and originations up 4%. Loan yields improved 17bp yoy and 38bp qoq to 4.71%; UCBI loan yields are a little better than average, but improved less than what other banks saw this quarter.
Credit quality looks okay, though the bank is upping its reserves in response to a weakening macro outlook for 2023. The bank’s allowance for losses increased 13bp yoy and 7bp qoq to 1.12%, inline with the average, but management did say that they’re not seeing significant consumer or business stress in their operating footprint yet. Charge-offs remain fine, as does the ratio of non-performing loans, though there was a sizable sequential uptick in non-performing C&I loans.
UCBI saw deposits decline almost 3% sequentially, with management attributing about half of that decline to a seasonal decline in public deposits. Non-interest-bearing deposits rose slightly on an end-of-period basis and about 2% on an average balance basis, outperforming the average regional/community bank by a healthy margin (the average bank saw a small sequential decline).
Deposit costs increased just 11bp yoy and qoq to 0.19, comfortably below the group average (around 30bp), and the bank’s cumulative interest-bearing deposit beta is only 9% - well below average and on par with a rare few banks like Commerce Bancshares ( CBSH ) and Umpqua ( UMPQ ). Management did warn that deposit costs are likely to accelerate from here, but I would note that the bank has an uncommonly strong non-interest-bearing deposit base (close to 40%) and a very comfortable 73% loan/deposit ratio.
A Deal In The Hopper, And More To Come
Management is awaiting regulatory clearances for its proposed acquisition of Alabama’s Progress Financial , but I see no reason to expect problems here. Although regulators have been dragging their feet with larger bank M&A approvals, it hasn’t impacted smaller bank deals to quite the same extent.
Progress brings $1.3B billion in loans and $1.7B in deposits across Alabama and into the Florida panhandle, with a top-10 market share in the Huntsville market. UCBI is paying 1.65x tangible book, where the underlying financials would argue for something closer to 1.5x as “fair”, but I think the premium is fine when factoring in cost synergies. Likewise, the mid-single-digit deposit premium doesn’t seem unreasonable to me. In my last article on UCBI I wrote that I thought Alabama/Florida panhandle could be a target for management. I still expect more deals in the future, and I think acquisitions in North Carolina and Virginia would make sense.
The Outlook
UCBI’s reliance on M&A does add to the modeling challenges; ignore M&A and you don’t really get a good sense of the actual potential value, but modeling in M&A can lend itself to working backwards from a predetermined conclusion. On its own, I think UCBI could generate long-term core earnings growth in the high single-digits to low double-digits, but I expect M&A to drive reported long-term growth into the teens.
On the basis of discounted long-term core earnings, I think UCBI is around 10% to 15% undervalued today. Likewise with a forward P/E approach, though I will note that UCBI carries a higher forward P/E than I’d typically give to most other smaller banks at this point.
The Bottom Line
I do think UCBI is undervalued, but I think that about a lot of banks these days. I like UCBI’s demonstrated operating leverage and its strong deposit position, as well as its attractive geographic footprint. On the other hand, I’m not as fond of growth-by-M&A stories, and I do see intense competition in UCBI’s markets, as well as a lot of other cheaper bank stories. I lean “Buy” here given demonstrated execution on the stated plan, but this is one of my less adamant buy calls on a relative basis, as there are other bargains out there worth a look.
For further details see:
United Community Banks Combines Solid Execution With An Ongoing M&A Growth Story