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United Financial Bancorp (NASDAQ:UBNK)
Q2 2018 Earnings Conference Call
Jul. 18, 2018 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the United Financial Bancorp Inc. Q2 earnings call. [Operator instructions] Please note, this event is being recorded. I would now like to turn the conference over to Marliese Shaw, the executive vice president for investor relations.

Please go ahead.

Marliese Shaw -- Executive Vice President for Investor Relations

Thank you, Debbie. Good morning, everyone. Welcome to our second-quarter conference call. Before we begin, we would like to remind you to read our safe harbor advisement of forward-looking statements on our earnings announcement.

Forward-looking statements, by their nature, are subject to risks and uncertainties. Certain factors could cause actual results to differ materially from our expected results. Our comments today are intended to qualify for the safe harbor afforded by that advisement. And now, I would like to introduce Bill Crawford, our chief executive officer and president.

William H. W. Crawford IV -- Chief Executive Officer

Thank you, Marliese, and thank you to all of you for joining us on today's call. Today, I'll make a few high-level comments and then turn the call over to our CFO, Eric Newell, who will take you through the details of the quarter. I was pleased with the linked-quarter loan, deposit, and checking account growth. Additionally, United Financial Bancorp annually saw its net interest margin expand during the second quarter.

And asset quality, liquidity, and capital remained strong and stable. Furthermore, we're seeing robust commercial loan pipelines heading into the third quarter of 2018, which is typically our strongest quarter for loan growth, and tangible book value per share increased to $11.40 after paying out 39% of our earnings via cash dividend to our shareholders. I want to take this opportunity to thank our United Bank employees for their steadfast focus on serving our customers and communities. I'll now turn the call over to Eric Newell, our CFO.

Eric R. Newell -- Chief Financial Officer

Thanks, Bill, and good morning. The company's performance during the second quarter of 2018 resulted in $0.31 per diluted share of earnings, with the main drivers of this consensus beat provided by a stronger NIM driving linked-quarter growth and net interest income and lower-than-anticipated provision in tax expense, which was somewhat offset by lower-than-expected fee income and higher expenses. The company had some one-time items in its expenses in the second quarter. We had more aggressive on-boarding costs for mortgage loan officers' recruitment that we did not anticipate going into the quarter.

We had some true-ups to incentive plans due to stronger loan growth and improved wealth management performance in the second quarter than what we realized in the first quarter, and we started to recognize an expense associated with annual carryover of paid time off due to the materiality of that expense as our workforce grows. These items each attributed considerably to the consensus mix on non-interest expenses and my expectations going into the second quarter. Given the challenging revenue growth environment, our management of expenses has been in the forefront of the company's attention. Balancing regulatory requirements and investment in areas of the company that can drive revenue growth in the face of the flat yield curves is challenging at best and we continue to scrutinize expenses for savings throughout -- through seeking ways to better utilize our retail footprint, to drive toward higher vacancy rates in our shared service departments, and taking a more aggressive posture toward negotiation of third-party vendor contract renewals and to employ a higher level of scrutiny over our discretionary expenses, including raising the internal rate of return required for projects that may show elongated periods until breakeven.

The NIM expanded by 7 basis points from the second quarter of 2018 from a linked period. This is primarily attributed -- attributable to the intense focus on booking, earning assets that support or are accretive to the company's existing earning asset yields. We continue to experience a high level of prepayments in our commercial books due to spread narrowing and there are times when we deem it more appropriate to allow the asset to move off of our books because it is not supportive of our ROA and ROE goals. Within our commercial portfolio, we're looking at twice as many deals this year over last year to book the same amount of production.

Some good news, though, is that our pipeline is the largest it's been this year and in fact since third quarter 2016, and we expect that in the second half of 2018, we will grow earning assets to support our 2018 growth forecast. The third quarter of the calendar year is generally a seasonally favorable period for commercial bookings. In terms of pricing, we frequently see spreads of 140 to 160 basis points over the index, which is pricing that we would typically not book on our balance sheet without a considerable deposit relationship, which would result in an accretive ROE. We're booking spreads of about 180 to 220 basis points over the index at this time.

Deposit costs are continuing to see pressure. As you would expect in New England, the loan growth markets where deposits in this geography are growing around 1% to 2% annually. We frequently look at the delta between our pricing, along with our competitors to wholesale market pricing such as FHLB, and over the last several quarters, we've seen top of market pricing get close to alternative wholesale market pricing, indicating an increased level of competitiveness in the market. There are parts of the curve where top-of-market pricing is, in a comparable duration, is within 50 basis points of FHLB funding.

Coming into this period, we are generally observing 100 to 150 basis points below comparable wholesale funding for top-of-market pricing. As I stated earlier, I attribute our 7 basis points of NIM expansion to a slower and more thoughtful growth on the earning asset side, and I would additionally attribute it to the company balance sheet positioning, whereby net interest income is largely neutral to interest rate changes. For the second half of 2018 and into 2019, I believe we will have a flat NIM without any significant change from where we are now, though we may have a quarter here and there where there is some fluctuation due to timing of fed interest rate moves. I'll remind you, our forecast slide does not consider future fed rate moves.

Fee income did come in lighter than expected and declined from the first quarter, primarily attributed to mortgage banking revenue. Mortgage servicing rights valuation declined by $1.4 million pre-tax between the two periods. Despite the 12 basis point increase in the 10-year treasury yield, which is a proxy to MSR valuation, our valuation agents have seen industry costs increase per servicing, which is an important input into our MSR valuation. While we do hedge a portion of our mortgage servicing rights valuation, this hedge cannot protect us from valuation input changes such as servicing costs.

I'd like to comment regarding our effective tax rate for the quarter. You'll note that our rate is much lower than anticipated. As we all know, tax modeling is based on annual assumptions, and when those assumptions change, there's an adjustment that must be made to catch up to the last actual period as if the model had the adjusted assumption for the entire year, and this adds some volatility to our forecast. Three areas that drove our effective tax rate down was lower-than-anticipated pre-tax income for the full year due to lower loan growth than we had initially forecasted, a higher level of tax credits than what we originally anticipated and, finally, a higher level of option exercises which under the new accounting guidance is treated as a discrete item, which can impact our quarterly tax rate.

In our forecast slide, you'll note that for the remainder of 2018 and 2019, we're not reflecting the Webster branch acquisition and assumed deposits. In 2019, we estimate there is no incremental impact due to the acquisition of the branches and assumed deposits and this is due to the anticipated deploying of assumed deposits into higher-cost borrowings initially. We believe that as we deploy assumed deposits into earning assets incrementally above the current loan growth forecast, it'll more than cover the incremental expenses of the next three branches we will add to the franchise and associate staff, as well as incrementally improve net interest income. There will be some lease extinguishment expenses in the fourth quarter of 2018 once the deal is closed, which will be one-time in nature, and we're still working through the accounting of that expense, so I have nothing to share with you today.

Thank you for your time this morning, and the management team and I will answer your questions.

Questions and Answers:

Operator

We will now begin the question-and-answer session.[Operator Instructions] The first question comes from Mark Fitzgibbon of Sandler O'Neill and Partners. Please go ahead.

Mark Fitzgibbon -- Sandler O'Neill and Partners -- Analyst

Hey, guys. Good morning.

Eric R. Newell -- Chief Financial Officer

Hey, Mark.

Mark Fitzgibbon -- Sandler O'Neill and Partners -- Analyst

It looked like you didn't change your fee income guidance even though mortgage was down a bunch this quarter. Are you assuming a big rebound in mortgage later in the year? Or is there going to be an uptick in some other fee income line?

Eric R. Newell -- Chief Financial Officer

Technically, you're normally asking about limited partnership expense, and so I, actually, was looking at that. I think that...

Mark Fitzgibbon -- Sandler O'Neill and Partners -- Analyst

That was actually my next question.

Eric R. Newell -- Chief Financial Officer

So if you look at our year-to-date limited partnership expense, I would estimate about 75% of what we expect to recognize for the year has been already recognized in the first half. So you have that benefit for the forecast in '18. We have been working on on-boarding some loan officers that we had some turnover in the New England market, and so we do expect that as these loan officers come on, that we probably will be showing more gain on sale in the mortgage line. So I wouldn't characterize it as a large pick-up.

Certainly, the MSR valuation was a headwind for us this quarter. We generally -- annually, we reassess our deposit fee structure and every summer, we come out with a generally 2% to 3% to 4% increase in fees, so that's an expectation that we have for the back half of '18. And also, we have some -- our wealth management group generally does seasonally well in the third quarter, which also would support the unchanged fee, the income forecast for the year.

Mark Fitzgibbon -- Sandler O'Neill and Partners -- Analyst

OK. And then it looked like there was a pretty big uptick in service charges and fees this the quarter. Anything unusual in there?

Eric R. Newell -- Chief Financial Officer

I wouldn't characterize it as unusual. I think that there was a lot of -- one thing that does pop into my mind immediately is wealth management, there was a lot of volatility in the first quarter of the year. Market volatility, which I think really dampened their performance, and they were able to rebound in a pretty strong fashion in the second quarter.

Mark Fitzgibbon -- Sandler O'Neill and Partners -- Analyst

OK, and lastly, it looked like C&I business loan -- or business loan yields were up about 45 basis points from the linked quarter. And I know, obviously, you get the benefit of the fed hikes, but was there any prepayment penalties or loan recoveries or anything in there that move that number up.

Eric R. Newell -- Chief Financial Officer

No.

Mark Fitzgibbon -- Sandler O'Neill and Partners -- Analyst

OK.Thank you.

Operator

The next question comes from Collyn Gilbert of KBW. Please go ahead.

Collyn Gilbert -- Keefe, Bruyette & Woods -- Analyst

Thanks. Good morning, guys. Just a follow-up on the loan discussion. So loan growth, obviously, is good, and Eric, you alluded to a strong pipeline going into the third quarter.

Can you just talk about sort of where you're seeing the growth and kind of what's driving that, and just kind of your -- yes, what's sort of the composition of the pipeline?

Eric R. Newell -- Chief Financial Officer

I think if you look at the growth that we've shown year-to-date in the categories, I know Investor CRE is one area that we've been growing more aggressively this year than we had in previous years. I think that's probably an indication of what we would be doing in the back half of the year. But in terms of -- I don't think you're going to see a lot of significant growth in consumer relative to the growth that you would see on the commercial side. The residential portfolio did grow a little bit in the first half of the year.

We generally like to kind of keep that portfolio, as a percentage of total, where we've had it. So there could be some timing there where we might have in the portfolio but then end up selling it. But I think we're -- obviously, the C&I is certainly an area that we want to -- or we'll continue to grow, and there's generally a longer selling process when trying to convince those potential COIs to come over to United, and I think we're going to continue that focus on that. But certainly, you've seen that Investor CRE has been more of a growth area for us this year.

Collyn Gilbert -- Keefe, Bruyette & Woods -- Analyst

OK, OK. And have you seen pricing within that segment improve -- or relative to where you've seen rates go. But just curious competitively, what pricing within that segment is doing.

Eric R. Newell -- Chief Financial Officer

Yes, I think back to my prepared commentary, no, we haven't. I think spreads have come in dramatically over the first half of the year. And so there are times where we're competing against others that are willing to offer down to 140 basis points over the index. And if that asset is sitting on our balance sheet and something that's obviously higher and they're repricing, we oftentimes let that asset go away from us, or we're seeing a lot of prepayment occur because they're able to get a lower rate than where they're currently at, not because of the interest rate, but just because the spreads have come in a lot.

So that's one of the reasons why we're looking at a lot more deals, a lot more flow is coming into our pipeline because we want to ensure that we're booking assets that are supportive or accretive to our NIM and our ROA and ROE goals.

Collyn Gilbert -- Keefe, Bruyette & Woods -- Analyst

OK. OK, that's helpful. And just tying also to your comments on the funding side and the competitive pressures that you guys are seeing there on the deposit side, are you able to extend duration at all? Like if you are going to maybe start to look at the FHLB as an alternative, can you get a little bit more duration on some of those funding vehicles? Or how are you thinking about duration on the funding side?

Eric R. Newell -- Chief Financial Officer

Yes, we -- I know I didn't talked about it in my prepared commentary but on the FHLB portfolio, if you look at the swap curves in the first half of the year, there was some dislocation between the FHLB and the swap curve, so we were actually able to take I think it was over $100 million of notional and use -- and really put some duration on, that was much cheaper in the swap market than the FHLB market. So incrementally, we definitely seek ways to add duration to our funding portfolio. So that's one example of what we did in the first half of the year, I believe that was in the second quarter. And also on the deposit side, we, the management team, we spent a lot of time looking at what competitors are doing and what's working in terms of some special pricing, and it seems where there's kind of a sweet spot, at least for now in our markets that consumers are willing to go out to about 19, 20 months, something that kind of roads even if you have a pretty high rate out there, even if you're top of market at 20 months, the consumer doesn't generally seem to bite.

So we are -- again, has driven incrementally, but we are playing in that 15 to 18 months area to try to ever so slowly add some duration to our CD portfolio.

Collyn Gilbert -- Keefe, Bruyette & Woods -- Analyst

OK, that's very helpful. And then just one last question. In the guidance tables that you guys provided in the slide deck, I just was curious, it looks like you've perhaps removed your second half 2019 ROA target, or there's an NA there where you would have had a 1% previously. What's causing that removal?

William H. W. Crawford IV -- Chief Executive Officer

Collyn, this is Bill. We remain committed to achieving that. That's just -- whatever, we didn't have it down, but we remain committed to our 1% ROA back half of '19 at 10% effective tax rate.

Collyn Gilbert -- Keefe, Bruyette & Woods -- Analyst

OK. OK. Got it. OK.

That's all I had. Thank you.

William H. W. Crawford IV -- Chief Executive Officer

Thanks.

Operator

[Operator Instructions] The next question comes from Brody Preston with Piper Jaffray.

Brody Preston -- Piper Jaffray -- Analyst

Good morning, guys. How are you?

Eric R. Newell -- Chief Financial Officer

Good.

Brody Preston -- Piper Jaffray -- Analyst

Eric, just to clarify. So there was no prepay or anything like that in the overall NIM number?

Eric R. Newell -- Chief Financial Officer

No. I mean, they're very de minimis. It wasn't something that would impact our NIM.

Brody Preston -- Piper Jaffray -- Analyst

OK. OK, great. With the loan growth guidance, I guess you touched on Investor CRE sort of maybe driving the back half of the year. But I just want to get a sense for where you're seeing sort of the best opportunities from a geographic standpoint, and I guess, where you're seeing the most competition.

Eric R. Newell -- Chief Financial Officer

I would say, in any of the geographies that we play in, we're definitely seeing competition. So -- but obviously, our legacy Massachusetts and Connecticut, we're very focused on that as well vetted and known that we participate in our regional commercial real estate portfolio, we'll do deals in Upstate New York, Pennsylvania, down in little -- into the Mid-Atlantic. We don't have a significant New York City exposure portfolio. I think we're not really focused on any specific -- it's not like we're doing multifamily in New York City.

We don't have a material exposure to that. So I think anywhere that we're really playing, we're seeing competition. Because everyone's going after the same high-quality assets that we're going after.

Brody Preston -- Piper Jaffray -- Analyst

So I guess, in terms of pricing, could you give us a sense about what's driving, I guess, maybe that spread compression that you noted earlier, specifically within the Investor CRE market?

Eric R. Newell -- Chief Financial Officer

I think if you look at collateralized loan obligations, CLOs, if you -- because there's a lot of visibility into that market because of trades, the AAA tranches there this year, the spread that were being done were sub-100 basis points for the first time, and it's probably ever. And a lot of that's being driven by insurance companies. I think we're seeing very similar behavior in the whole loan market as well and the commercial real estate market, whereas insurance companies are willing to -- because they have obviously very different duration -- or liability duration profile than a bank does, they're willing to accept lower spreads fee for high-quality assets. And also, you have some larger bank players that have a deposit profile that is -- the cost of those deposits are much lower than what we could -- are currently experiencing, so they're willing to reduce their spread count to what we're seeing from time down to 140 basis points.

Brody Preston -- Piper Jaffray -- Analyst

OK, great, that's good color. And then I guess, switching gears a little bit. On the securities portfolio, just let me get a sense for the strategy there. Should we model again up, down, flat, any changes?

Eric R. Newell -- Chief Financial Officer

I would say that on a notional basis, it's flat and so as the balance sheets are growing, you're seeing that that percentage of the investment portfolio of the total assets is declining. And it actually affect, I would probably say, even if you look at year-to-date experience, I think you may have seen, it's actually the notional shrunk, probably just keep that trend going.

Brody Preston -- Piper Jaffray -- Analyst

OK. I just want to touch base on Connecticut, the real estate market there, and thoughts of the impacts from SALT so far?

Eric R. Newell -- Chief Financial Officer

Yes, I think it's a little early yet. I don't know if we've really seen anything materially change in valuation in Connecticut due to the tax reform. I know that some papers have said that Connecticut might see 1% to 2% decline in valuations over 10 years. Since we're only in year one, not even really, we haven't really seen anything.

Brody Preston -- Piper Jaffray -- Analyst

And I guess, on [Inaudible, I just wonder now if you guys have any updated thoughts there, if you could share anything.

Eric R. Newell -- Chief Financial Officer

We have been working on [Inaudible] for the last two years, and there's a team of us that are working -- or there's a committee of us that meet frequently and we actually have a couple of folks that are working on it full time. And we expect that we'll probably be offering some type of disclosure early in 2019.

Brody Preston -- Piper Jaffray -- Analyst

OK, and then -- you talked about, I guess, maybe commercial loans sort of carrying the day for the rest of the year. And I know it's such a small portion of your book, but I just want to get a sense for your consumer installment loans, it's the sixth straight quarter that you've seen pretty strong double-digit annualized growth. So I just want to get a sense for what's driving that.

Eric R. Newell -- Chief Financial Officer

Well, I mean, we've been investing in our consumer origination team, is it better -- if you're pricing better execution in cross-selling efforts where -- or either trying to -- we're talking to customers that have a mortgage but don't have a home equity with us. We also are doing better execution and utilization. So while utilization as a portfolio, I don't know if it's really gone up tremendously, maybe a little bit. We weren't really ever talking to our home equity customers that we did have say "Hey, why don't you use your home equity?" So we're starting to market to those customers a little bit more.

And we also, from time to time, augment that portfolio with some other home equity loans from other geographies just to get some exposure outside of Massachusetts and Connecticut.

Brody Preston -- Piper Jaffray -- Analyst

All right. Great. Thanks very much, guys.

Eric R. Newell -- Chief Financial Officer

Thank you.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to Bill Crawford, CEO, for any closing remarks.

William H. W. Crawford IV -- Chief Executive Officer

OK, well, thank you for your interest in our company, and we're always available to take questions. So thanks again. Have a great day.

Operator

[Operator signoff]

Duration: 26 minutes

Call Participants:

Marliese Shaw -- Executive Vice President for Investor Relations

William H. W. Crawford IV -- Chief Executive Officer

Eric R. Newell -- Chief Financial Officer

Mark Fitzgibbon -- Sandler O'Neill and Partners -- Analyst

Collyn Gilbert -- Keefe, Bruyette & Woods -- Analyst

Brody Preston -- Piper Jaffray -- Analyst

More UBNK analysis

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