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United Financial Bancorp (NASDAQ:UBNK)
Q3 2018 Earnings Conference Call
Oct. 17, 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. third-quarter 2018 earnings conference call. [Operator instructions] Please note, this event is being recorded. I would now like to turn the conference over to Betsy Wynnick, executive vice president.

Please go ahead.

Betsy Wynnick -- Executive Vice President

Thank you, Gary. Good morning, everyone. Welcome to our third-quarter conference call. Before we begin, we would like to remind you to read our safe harbor advisement on 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 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.

Bill Crawford -- President and Chief Executive Officer

Thank you, Betsy, and thanks to all of you for joining us on today's call. In the third quarter of 2018, we generated 91-basis-point return on assets and 11.30 return on tangible common equity. We continue to grow revenue, core deposits and tangible book value. In terms of risk management, credit strong and stable and we're positioned to handle raising rates with a flat yield curve.

Liquidity remained strong. Loan growth is slower than we would like, but now is the time to maintain credit and duration discipline. Our banking teams are focused on initiating and growing relationships which add value. We are seeing growth opportunities in some of our core markets due to some market dislocation.

Last week, and not in our Q3 '18 numbers, we added about $110 million in core retail deposits on three net new branches we acquired from Webster Bank. We also have new branches coming online later in the year in Greenwich and Fairfield, Connecticut. We're seeing very nice deposit growth in our Hartford office with the relocation of our corporate headquarters last year. Management will continue to focus on growing revenue responsibility while improving expense control and operating efficiency, continuing to grow net new checking, relationship blending, core deposits, and tangible book value, all this will create value over time.

We're also working to balance growing earning assets, growing net interest income and preserving margins in this difficult operating environment. I'll now turn the call over to our CFO, Eric Newell, for some more details on the quarter.

Eric Newell -- Chief Financial Officer

Thanks, Bill, and good morning. Yesterday, we announced third-quarter earnings at $0.32 per diluted share, which is $0.01 better than our linked quarter of $0.31 per diluted share and $0.02 better than our third quarter last year. Compared to the linked quarter, net interest income before and after provision expense moderately improved due to average asset growth despite net interest margin compression. Fee income improved due to lower loss on partnerships and an increase in mortgage banking, and our noninterest expense increased moderately due in part to salaries and employee benefits increasing over the linked quarter.

Our net interest margin declined 5 basis points during the quarter but our cost of interest-bearing liabilities increased 17 basis points, and our interest-bearing deposits increasing 19 basis points in the quarter. Our deposit pricing approach has largely been a defensive strategy to date this year, responding to competitive pricing in our markets through proactive and reactive approaches. We tested some offensive strategies during our third quarter in our time deposits with maturities and customer behavior [Inaudible] to accept and competition generally responds in kind. We're pleased to have successfully integrated the six branches we purchased from Webster Bank over the Columbus-Day weekend as this adds to our franchise value as building core deposit funding with incrementally lower betas.

Interest-earning asset yields increased 9 basis points during the quarter, with most earning asset segments contributing to that increase. Contributors to our improved fee income from the second quarter are higher fees from service charges and fees due to our annual fee increase that went in place -- went into place on August 1, higher mortgage banking revenue due largely to a higher mortgage servicing rights valuation, and a lower loss on limited partnerships. Contributors to our higher noninterest expense from the second quarter are higher health insurance expenses. As more of our plan participants meet their deductible, that cost shifts to the company in the back half of the year.

Some increased temporary help that was seasonal in nature and some production-based true-ups for commission and incentives. Our actual salary line declined in the third quarter from the second quarter, and there were no other meaningful contributors to linked-quarter change. As we normally do, we provide forecast for our fourth quarter. You'll note that we've taken 2019 off the slide as we're in the middle of the budgeting process for that period.

For the fourth quarter, I'd look to results in the third quarter as a guide. You'll note that our loan growth forecast is lower than we talked about earlier in the year. We've been quite principled about our approach to the market pricing that we've been seeing in the market and that has consequently caused us lower level of growth. Loan pricing is generally well below our hurdle rates for aspirational ROA and ROE's.

However, we have to defend our absolute net interest income dollars so we've recently taken a more defensive approach for our pricing, which will better position us for defending against loss of absolute net interest income dollars. I wouldn't interpret this as a signal that our NIM will decline notably in the future. However, as some adjustments to production that maintains our margin versus improving it. I know our strict coverage will be looking at our 2019 estimates and in the interim until we discuss more fully on the next earnings call, I will direct them to our second-half 2018 as an indication of what to expect in 2019 as it pertains to NIM and loan growth.

And now we'll take your questions.

Questions and Answers:

Operator

[Operator instructions] Our first question comes from Collyn Gilbert with KBW. Please go ahead.

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

Thanks. Good morning, guys. Maybe if we could start with just the NIM discussion, Eric, and understand the comments obviously on the competitiveness on the loan side and the asset side. But switching to the funding side, because it seems like where that's where a lot of the pressure came in the NIM this quarter.

Couple of things, one is can you just talk about what you're seeing there? It looks like you may also be replaced slug of borrowing this quarter with deposits. Kind of where you're seeing that repricing dynamic happening within each of those funding buckets? Secondly, then to just talk about what sort of supporting your comment that you're anticipating the betas to be lower on the Webster deposits that you acquired versus what you're seeing within the organic organization. And maybe I'll stop there and I'll follow up.

Eric Newell -- Chief Financial Officer

Sure. I'll take the last one first. I think some of the branches that we acquired are in less competitive areas in Connecticut, and we've modeled and looked at that and we feel that we're not going to have to necessarily respond as aggressively or quickly to our pricing strategy down there. And so that's kind of the basis of the thought of the lower betas as well as the fact that the composition of those deposits are a little more transaction oriented than what you would see kind of at that top of the house at United.

So incrementally there's just more transaction related to deposits within that branch acquisition. In terms of the -- in terms of the pricing on the funding side, I think we certainly have -- obviously, we're showing lower loan growth than what we normally have been used to in the third quarter. Third quarter generally is seasonal, where municipal deposits come back to us in the third quarter and we could see again, so that's why you're seeing deposits increasing and the wholesale borrowings declined on a linked basis. But I would note that our municipal deposits are -- have much higher beta than our other sleeves.

So therefore, if you look at the composition of the deposits and how municipal contributed in the quarter, you're seeing a higher cost there, and that's one of the reasons why you saw an increase in the cost of funds in the linked period.

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

Got it. OK. And then -- and then just you said in terms of your outlook for NIM, strategically, the objective is to try to keep the NIM stable, is that right? So it is -- are we to assume then that this 292 is kind of a new stable run rate that you're going to hope to preserve?

Eric Newell -- Chief Financial Officer

Yeah. When I look at our forecast and all the modeling we do for the interest rate risk and the balance sheet positioning that we have, everything really indicates that. We're fairly neutral to interest rates. So as the rates move up, there is some timing impact.

So last quarter, we obviously were 5 basis points higher, and I said we'd be stable. And then I think I've been kind of using that mantra for several years now, and we've kind of bounced back and forth. So I don't want to necessarily call on that I think that our NIM will go up next quarter, but I think there's some phenomenons that were occurring in the third quarter, particularly on the wholesale funding side, where we noticed the FHLB curve pricing early in the quarter to September and as well as the December rate hike because of the market expectation that those, the Fed was going to move those two rates up. So we started paying for that in our FHLB borrowings at the beginning of third quarter.

So that obviously put some pressure -- funding cost, but we don't really necessarily enjoy that on the asset side. So I think that we'll have more -- we'll get the benefit of the September rate hike on the asset side in the fourth quarter. So my expectation is when -- when everything sells out, I think that will be fairly stable. I mean, we might see basis points up and down from quarter to quarter, but I'm not -- the way our balance sheet is structured, it's fairly neutral to our interest rates.

Bill Crawford -- President and Chief Executive Officer

Yes, Collyn, I think the last four quarters we proved that out. If you look at it certainly the last four quarters, we're between 3% and 290, and we bounced around in there. So we're pretty fairly stable considering all the short-term increases in funding.

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

OK, OK, that's helpful. And then just on the loan side. So obviously right, third quarter came in lower than you were expecting. Is that -- you talked again due to pricing pressure but just curious sort of paydown activity and any other dynamics that might be playing into the slower loan growth.

Or is it really all just the pricing -- a phenomenon pricing and you're just stepping away from it versus demand falling off?

Bill Crawford -- President and Chief Executive Officer

No. Demand is not falling off. We're actually -- we've looked at a lot more this year than we have last year, so it's not -- it's not getting a look. We're definitely getting a look.

It's just we're walking away. And as you can -- probably -- 75% to 85% of the time we're walking away because of the pricing. And we have a -- and I think I've talked about this in the past, we've -- we've institutionalized many years ago a rate rock model that the producers looked at and our hurdle rates there were driving toward the aspirational ROA, ROE that we were looking at and we've noticed that we were often times -- sometimes 50 to 75 basis points out of the market. And so we're looking at that now to say, OK, rather than look at our aspirational ROA, ROE, why don't we look at just defending the NIM or NII dollars that we're seeing now? So while we have paydowns, so the second part of your question, our paydown activity, particularly in commercial real estate, is significantly higher this year than it was last year, so we had that headwind as well.

So what we frequently are looking at what the yield of the paper that's paying off on the book, if we actually took that yield and reported in our rate rock model number, it wouldn't hurdle. But what was -- what's happening is if we just don't originate, then all of a sudden our NII dollars will start declining and that's not good either. So when I charged production folks on wholesale banking as well as consumer groups, is to what's -- make sure that we're trying to defend the NII dollars that we have on the balance sheet and try to maintain our NIM versus growing it.

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

OK, OK, that's very helpful. And then lastly and then I'll just hop in later in the queue. Just discussion around the tax, maybe what you're thinking for the tax rate and how you see some of the dynamics within that business going forward?

Bill Crawford -- President and Chief Executive Officer

I'm not ready to talk about the tax rate too much in 2019. We'll talk about that in the next earnings call. But I think that the tax rate that you're seeing for the third quarter is -- will repeat in the fourth quarter.

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

OK. And just curious, kind of the big variance is, I guess, in your tax rate from what you anticipated when you started the year versus kind of now where you're shaking out ending the year. I mean, it's been volatile and obviously difficult to model. So just trying to understand that a little bit more.

Bill Crawford -- President and Chief Executive Officer

Yeah. I think this year was a little bit more challenge because when we talked to you in January, we were still flushing out some of the impacts of tax reform, and I think that we still haven't actually or we're just recently or this week filing our tax return for '17. So I think having that happened as well as some of the assumptions that we were under or using January had more validated as the year went on. It was driving -- it's driving a lower tax rate.

But I think once we get beyond this initial 2018 year, we'll have more stability in '19.

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

OK. And just strategically, though, the intention is still be as aggressive utilizing these tax savings businesses as much as you have in the past?

Bill Crawford -- President and Chief Executive Officer

Well, we constantly assess our -- that business, line of business, and we will look at the returns on that relative to where we can put capital in other parts of our balance sheet, and we might make a decision that would rather put our capital somewhere else that's more efficient for us to drive returns. So I don't necessarily want to say yes, but I'm committed to it, but we're constantly looking at the returns in that business.

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

OK. That's helpful. I'll leave it there. Thanks, guys.

Operator

[Operator instructions] The next question comes from Brody Preston with Piper Jaffray. Please go ahead.

Brody Preston -- Piper Jaffray -- Analyst

Good morning, everyone. How are you?

Bill Crawford -- President and Chief Executive Officer

Good.

Eric Newell -- Chief Financial Officer

Good.

Brody Preston -- Piper Jaffray -- Analyst

Eric, I just want to go back real quick. I know you're not giving 2019 guidance, but I think, did you say you would point people toward what you've done in the back half of 2018 so far as sort of a rough guide?

Eric Newell -- Chief Financial Officer

Correct.

Brody Preston -- Piper Jaffray -- Analyst

All right. And just going back to your earlier comments demand hasn't off in the loan side and 70% to 80% of the time you're walking away due to pricing and you've experienced higher paydown activity this year relative to last year. I was just want to know what was driving that. Like who -- I guess, who or what is making you walk away? I'm assume -- assuming there's some competitive pressures but I'm trying to better understand who's the competition.

Bill Crawford -- President and Chief Executive Officer

There's a lot of banks right here in New England and we also, in some bigger deals, we're competing with folks in Metro New York or mid-Atlantic. Many of them have better costs structures, funding cost structures than we do on a relative basis. So therefore, they are able to put up a narrower spread in terms of our price quote to our customer or our prospective customer. And for us, it's just really looking at how do we drive improved returns whether it's pre-tax, pre-provisioned, ROA, ROE, and we want to, again, look at how do we deploy our finite amount of capital in a way that is going to enhance our returns as much as possible.

The other thing [Inaudible] was just waving at me and all of the things that phenomenon that we're seeing particularly in the commercial real estate space is that the light companies are coming in and competing with us, and they obviously have a much longer liability structure than our bank does, so therefore, they're able to be much more competitive on the pricing side.

Brody Preston -- Piper Jaffray -- Analyst

OK, that's great color. Thank you. I guess, sort of sticking with that deployment of capital fee in here, in the face of slower loan growth and margin compression. What do you folks see as your other options? When you consider in driving EPS growth in PPR growth, is there expense initiatives in place or could you do share repurchases or changes in securities portfolio?

Bill Crawford -- President and Chief Executive Officer

Sure. The investment portfolio is certainly an area that we leaned on in the past for earning asset growth. We've seen that decline over the years. And I think that on an absolute basis, we're probably going to maintain that portfolio in the future but it's not going to -- I don't see it being a significant increase in percentage or earning assets.

On the expense side, certainly our NII to average assets has increased over the years. So we're going to constantly look -- we're going to be looking at that to improve that metric. And then share repurchases, we constantly are looking at where's the deductible. I mean, that's a risk-free purchase of our shares, so we're constantly looking at the payback of that and comparing it to other initiatives that we might be looking at and determine whether or not it makes sense to maybe step in and buy some of our shares.

So we're kind of looking at all three of those levers to assist in PPPP growth.

Brody Preston -- Piper Jaffray -- Analyst

OK, great. I guess, just sticking with the margins, I want to get a sense for how much your loan portfolio is tied to LIBOR. And I think you mentioned earlier that FHLB started pricing with rate hikes and ahead of time but LIBOR got -- LIBOR sort of went up ahead of the third quarter as well. So I figured in a sense that impacted your margin at all this quarter?

Bill Crawford -- President and Chief Executive Officer

So when I -- I've been looking at it as one month LIBOR. I think it's three months LIBOR but it's not, it's not. One month is more prevalent than three months and Prime. When you add those three, I believe we're at close to 47%.

I don't actually have the breakdown of what LIBOR is, so I'd have to get back to you on that.

Brody Preston -- Piper Jaffray -- Analyst

All right, great. And then I guess, I wanted to go back to Collyn's question about the deposit beta. I know that 3Q is a seasonal high point for you guys for municipal deposits and that those deposits are pricier. But when I look at your quarter-over-quarter deposit beta in 3Q '18 related to 3Q '17, you see a sizable sort of pick up in it? And I wanted to, I guess, maybe better understand, if the year-over-year trend is still increasing, I just wanted to get a better sense for why that would change moving forward?

Bill Crawford -- President and Chief Executive Officer

I think there's a couple psychological on the consumer side, there's a couple psychological things that have started to occur in the last -- definitely in the last quarter, I don't mean the last two quarters, and that would be that there's a lot of our competition has a three-handle on their offerings. And I can think of -- and actually, we have a couple people that have some -- I mean, it's very limited but they have some four-handle on their offerings and I think that that really does -- it piques the customers' interest and they're more willing to move their money for that. And so that's just something that we have to make a decision. Are going to match that? Are we going to react to that? Are we going to be defensive or offensive on it? To date, we've been defensive on it.

So I think when it comes to the consumer, I think they're starting to wake up a little bit more in our footprint. Obviously, it is pretty 100% beta and they'll call us, a couple of our relationships will call us up in anticipation of a rate hike the next day asking what we're going to do for them. So I mean, there's not even a lag there. And then I think you're also starting to see it in the corporate -- what we call wholesale banking but the commercial space, some of the treasurers of those, of our customers, are starting to look at what they can put their funds in that overnight, and has a two-handle on it.

So I just think that that's one of the reasons why we're having the in cost -- the cost of our funds increasing, is there's a lot more attractive rates out there at least in our footprint.

Brody Preston -- Piper Jaffray -- Analyst

OK. And then I guess, I'll circle back to the, I guess, maybe overall economy, just wanted to get a sense if you're seeing. Any impact from Connecticut the changes from reductions so far?

Bill Crawford -- President and Chief Executive Officer

No, we have not. I mean, I think that our -- we -- one thing we probably have seen is lower home equity originations this year over last year because of the inability or the unfavorable change on the tax deduction of that interest on home equity. And I believe -- but we've also communicated that. We were not really driving customers to use the lines they had through direct mail in previous years and we've started to actually view that.

I think we've seen some early indications that when we actually pay much of them is that, hey, you have home equity, won't you try to use it, they do.

Brody Preston -- Piper Jaffray -- Analyst

OK. Great. Thank you very much.

Operator

The next question comes from Kevin Swanson with the Hovde Group.

Bill Crawford -- President and Chief Executive Officer

Hey, Kevin.

Kevin Swanson -- Hovde Group -- Analyst

Good morning. Hi, How are you?

Bill Crawford -- President and Chief Executive Officer

I appreciate the comments on competition, but can you talk a little bit about the dynamics in terms of competition from non-banks on mortgage lending? Maybe in terms of structure and if somebody's rate hikes [Inaudible]in mortgage lending, how that competition changes in the near term.

Mortgage lending in terms of commercial mortgage?

Brody Preston -- Piper Jaffray -- Analyst

In terms of -- just kind of talking specifically about kind of fee income from mortgage banking services.

Bill Crawford -- President and Chief Executive Officer

So just so I'm clear, the question is more or it's asking about mortgage banking revenue forecast or the structure that -- or competition of structure on mortgages?

Kevin Swanson -- Hovde Group -- Analyst

Just kind of how you see the competition evolving in the near term from non-banks and other banks in the market given the potential slowing from increasing rates?

Eric Newell -- Chief Financial Officer

Actually, there's two questions.

Bill Crawford -- President and Chief Executive Officer

I think that we're -- obviously, we're primarily a purchase shop. So with higher rates and the pace of the rates that -- how they've increased, has certainly slowed our production numbers this year. I think we're about 15% to 20% lower this year than we were last year. I think that that is on par or that's pretty close to what we're seeing nationally.

So there's no surprise there. I wouldn't necessarily say that we're seeing any impactful competition from non-bank lenders on that space at least from what we're seeing.

Kevin Swanson -- Hovde Group -- Analyst

OK, thanks. All my questions are answered. Thank you.

Bill Crawford -- President and Chief Executive Officer

Thank you.

Operator

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

Bill Crawford -- President and Chief Executive Officer

OK, well, thanks, everyone, for joining us on today's call, and we look forward to speaking with you again soon. Take care.

Duration: 28 minutes

Call Participants:

Betsy Wynnick -- Executive Vice President

Bill Crawford -- President and Chief Executive Officer

Eric Newell -- Chief Financial Officer

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

Brody Preston -- Piper Jaffray -- Analyst

Kevin Swanson -- Hovde Group -- Analyst

More UBNK analysis

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