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United Community Banks Inc (NASDAQ:UCBI)
Q2 2019 Earnings Call
Jul 24, 2019, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to United Community Banks' Second Quarter 2019 Earnings Call. Hosting our call today are President and Chief Executive Officer; Lynn Harton; Chief Financial Officer, Jefferson Harralson; and Chief Banking Officer, Rich Bradshaw; and Chief Risk Officer, Rob Edwards.

United's presentation today includes references to operating earnings, pre-tax, 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, and both of these 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 should be considered in light of risks and uncertainties described on Page 4 of the Company's 2018 Form 10-K, as well as other information provided by the Company in its filings with the SEC and included on its website.

At this time, I will turn the call over to Lynn Harton.

H. Lynn Harton -- Chief Executive Officer

Good morning, and thank you for joining our call. We appreciate your interest in United and we look forward to our conversation today.

Our second quarter results represent a continuation of great execution by our teams across the Company. We reached an operating return on assets of 150 basis points, the best in our history. Our operating EPS was $0.59, an increase of 11% year-over-year. Our net interest margin increased slightly quarter-over-quarter. Both loan and deposit growth were on target with expectations and our First Madison partnership continues to be on track.

Our markets continue to perform well economically and our credit results reflect that sound economic foundation. Here in Greenville, we sit in the middle of some important international supply chains, and so we are aware of the uncertainty that global growth and trade frictions can have on local companies' decisions to invest for the future. It is unclear today how those uncertainties will develop; however, we believe that we have positioned the Company to be able to perform well in any normal economic cycle.

Over the past several years, we have entered into several new business lines to diversify our revenue sources and leverage our strong brand and local relationships. We have grown historically strong lines of business and expanded our footprint and brand into several new fast-growing markets. These initiatives have enabled us to exit less profitable areas, like purchased indirect auto loans and improve the strength of both our core earnings and our balance sheet. We are a much stronger and more profitable organization and one less dependent on traditional community bank lending alone.

We have continued to enhance our credit culture through process improvements, improved talent and disciplined concentration management by product type, relationships size and geography. Our funding base continues to be one of the strongest in the South, as our service-based culture continues to deliver high-quality core deposit growth, giving us ample liquidity and low cost funding. We continue to keep pace and technology investments, both in digital solutions for our customers and operational improvements for our employees.

But most importantly, we have maintained our focus on the fact that this is a people business. We have an outstanding team that works together to produce great results. We're also able to attract great bankers to join our team and they are drawn in large part to the same attributes their customers value in us. We're small enough that individuals matter, large enough to have the products and services to compete and forward thinking enough to have a promising future.

We're excited about the path that we're on and we appreciate you being here with us. So Jefferson, why don't you give us more details on the results for the quarter?

Jefferson Harralson -- Chief Financial Officer

Sure, Lynn. Thank you. I will begin on Page 6 to discuss our net interest income and margin trends. Our net interest income increased 7.4% annualized versus last quarter and increased 9% year-over-year. Spread income growth did benefit from two months of First Madison in the numbers. Our net interest margin increased by 2 basis points to 4.12% in a quarter, of which 1 basis point came from slightly higher accretable yield versus last quarter. Last quarter, I mentioned on the call that about 3 basis points of first quarter accretable yield would not repeat and the second quarter these 3 basis points in fact did not repeat, but were replaced with some of the initial accretion from First Madison.

Turning to Page 7, we take a look at our deposit base. We are very proud of our core deposit base with a 33% contribution from demand deposits. Our cost of deposits were only up 3 basis points versus last quarter and they continue to be well ahead of our peers in deposit cost.

On Page 8, we were also pleased with the growth in our core transaction deposits so far this year. Core transaction deposits were up 8% annualized year-to-date with $302 million growth which more than fully funded all of our loan growth this year.

On Page 9, you can see our loan portfolio breakout, which is very diversified. We were pleased to grow loans excluding First Madison and indirect auto loans at a 9% annualized pace versus last quarter.

On Page 10, we look at non-interest income, which was up $3.5 million versus last quarter and up $1.2 million versus last year. We experienced good growth in fees across the board with a record mortgage production quarter and higher SBA brokerage and other fees as well.

Expenses on Page 11 were in line with or slightly better than our expectations. Our increase in expenses came mainly from merit increases and higher mortgage commissions. Our operating efficiency ratio came in at 54.4%, which is a new low for our Company.

Credit quality on Page 12 was stable with improved net charge-offs versus last quarter. We recorded a $3.2 million provision that more than covered the $2.4 million in net charge-offs. Our reserve percentage did decline to 70 basis points with the addition of the First Madison loan book.

I'll finish up on Page 13, with capital. Our risk-based capital ratios came in as expected with the all cash First Madison deal while our leverage ratio and TCE ratio saw a slight improvement as we continue to shrink our securities book, which offsets the impact of the deal. We had no buybacks in the quarter and we will look to be opportunistic with the $42 million or meaning on our authorization.

And with that Lynn, I'll pass it back to you.

H. Lynn Harton -- Chief Executive Officer

Thanks, Jefferson. We are pleased with these results and I'd like to close my comments by once again recognizing and thanking the United team. It takes great people to deliver great performance. For those of you who that are listening in, I am proud to work alongside of each one of you, and I thank you all for what you do every day. And now, we'll be glad to answer any questions that you might have.

Questions and Answers:

Operator

[Operator Instructions] And our first question comes from Catherine Mealor from KBW. Your line is open.

Catherine Mealor -- KBW -- Analyst

Thanks. Good morning.

H. Lynn Harton -- Chief Executive Officer

Good morning.

Jefferson Harralson -- Chief Financial Officer

Good morning.

Catherine Mealor -- KBW -- Analyst

Really great quarter. I will start with the margin. You've seen some really nice margin expansion and a lot of this has been from mix shift, but also your assets sensitivity. So just wanted to get an update on how you're thinking about your margin outlook if the Fed does cut later this month or again this year.

Jefferson Harralson -- Chief Financial Officer

All right. Thanks, Catherine. If we get a rate cut, we do have 53% of our loans that are floating. Of that, 62% are tied to LIBOR or $2.9 billion, 38% of those are tied to prime, which is $1.5 billion. So you'd have had some of the impact on our LIBOR loans already. And then you'll get a more full impact on LIBOR and prime with a cut. I think that the margin think of it because we'll still have some positive mix change occurring. We still have flexibility with our lower loan to deposit ratio. But I think of it as down -- a rate cut down 7 basis points to 10 basis points on our margin, offset by some 2 to 3 basis points of continued mix benefit over time -- each quarter.

Catherine Mealor -- KBW -- Analyst

So that 7 bps to 10 bps per quarter per cut?

Jefferson Harralson -- Chief Financial Officer

So that 7 to 10 bps per quarter per cut?

Catherine Mealor -- KBW -- Analyst

Okay, got it. And then and then how -- you mentioned your loan to deposit ratio, I mean, how aggressive do you feel like you could get on lowering deposit costs and then bringing that loan to deposit ratio higher when the Fed cuts?

Jefferson Harralson -- Chief Financial Officer

All right. So I missed part of that question, I might ask you to redo that. I do want to say that when you mentioned 7 basis points to 10 basis points per quarter for each cut, I would make sure you do the offset each quarter for the remix as it continues to occur.

Catherine Mealor -- KBW -- Analyst

Yes, yes. It's 7 basis points to 10 basis points on a core basis offset by the mix. So, you're kind of like 5 bps per cut roughly.

Jefferson Harralson -- Chief Financial Officer

That's right.

Catherine Mealor -- KBW -- Analyst

Okay. That makes sense. And then my other question was, just how aggressive you think you could be on bringing your loan to deposit ratio higher as you push deposit costs down in a rate cut?

H. Lynn Harton -- Chief Executive Officer

Right. So, we do have a nice loan to deposit ratio. We do have a great core deposit base. We have customers. We do want to grow our customers. We can be a little more conservative. We already have lowered our CD rates. We have seen some other competitors do that as well. We have lowered some other rates. And we're going to take another look at deposit rates if we do get a cut on the 31st. So, we do go to be, I guess, I'll use the description aggressive in our deposit rate cuts. So we think we do have the flexibility to do that. And we're not looking to shrink our deposit base. We're still looking to grow our deposit base. But we think we do have flexibility with the loan to deposit ratio and do plan to be relatively aggressive in cutting pricing on some deposit types.

Catherine Mealor -- KBW -- Analyst

Okay, that's great. I think maybe one other one on just growth. The growth is fantastic this quarter. Any update on the back half of this year? And how much of that you think will come from your core businesses versus the new business growth?

H. Lynn Harton -- Chief Executive Officer

All right. Rich, do you want to start with that or I can jump on that too?

Richard Bradshaw -- Chief Banking Officer

You want me to start on how we feel about Q3?

H. Lynn Harton -- Chief Executive Officer

Yeah, sure.

Richard Bradshaw -- Chief Banking Officer

So, Catherine, good morning.

Catherine Mealor -- KBW -- Analyst

Good morning.

Richard Bradshaw -- Chief Banking Officer

Our bank has delivered another strong production quarter. Pipelines for loans and bankers looks good for Q3. However, we have seen lower payoffs in Q1 and Q2 and anticipate more normalized payoffs in Q3, but expect to still be at mid-single-digit growth for the quarter.

Catherine Mealor -- KBW -- Analyst

Okay. Great. And do you think the percentage of Navitas versus kind of your core bank should stay about where it is or do you see that mix shift changing overtime?

H. Lynn Harton -- Chief Executive Officer

Thanks. So we are around 7.5% of our loans being in Navitas loans currently. They have been a good source of growth for us. We're very happy and pleased what that deal is. Now we have imposed a limit of having Navitas loans to total loans of being around 10%. I think we mentioned last quarter that we are planning on in the third quarter to begin selling the Navitas loans. So I think that you're going to see -- the because of the selling of certain of these loans, you're going to see the percentage of growth coming from Navitas decline and you're going to see the percentage of Navitas loans to total loans stay more stable and less than the 10% limit.

Catherine Mealor -- KBW -- Analyst

Great. Awesome. Thank you so much. I'll hop back.

H. Lynn Harton -- Chief Executive Officer

All right. Thanks.

Operator

Thank you. Our next question comes from Brad Milsaps with Sandler O'Neill.Your line is open.

Peter Ruiz -- Sandler O'Neill -- Analyst

Hey, good morning. This is actually Peter Ruiz on for Brad.

H. Lynn Harton -- Chief Executive Officer

Hello, Peter.

Peter Ruiz -- Sandler O'Neill -- Analyst

Hello. So maybe just following up on the NIM. Could you maybe give a little bit of color on maybe the specific impact from Navitas just on the loan yield side with each rate cut and what that is going to look like?

H. Lynn Harton -- Chief Executive Officer

So, I would not expect from the loan yield side a big move from Navitas loans. They are longer term in nature when they are made. So I would not expect as a client Navitas loans, as rates decline. There is some pricing competition in the business, but from the rate cut itself, I don't expect a lot of change there.

Peter Ruiz -- Sandler O'Neill -- Analyst

Got it. Okay. And maybe just on expenses. I mean, you guys maybe came in just below your previous guidance for this quarter. But what are you kind of expecting here as we go into the back half with First Madison kind of integrated and what kind of the runway it looks like going forward?

H. Lynn Harton -- Chief Executive Officer

Yeah. Thanks for the question there. So on Navitas -- on the expenses, we do have a full quarter of First Madison to come in. We have core growth and we've also had some relatively significant hires over the last quarter and we expect more of those to occur. So if you combine the three of those, I think the -- put a number out there of maybe 79.5 [Phonetic] for Q3 and then more of a core low-single-digit growth rate off of there.

Peter Ruiz -- Sandler O'Neill -- Analyst

Got it, makes sense. Thanks so much.

Operator

Thank you. Our next question comes from Tyler Stafford from Stephens. Your line is open.

Tyler Stafford -- Stephens. -- Analyst

Hey, good morning, guys.

H. Lynn Harton -- Chief Executive Officer

Good morning.

Tyler Stafford -- Stephens. -- Analyst

Hey, I just wanted to start on fee income, and congrats on the nice quarter, by the way. But on fee income, can you just give us the mortgage production that you saw this quarter and then the SBA production you saw this quarter?

H. Lynn Harton -- Chief Executive Officer

Yes. So the mortgage production in the form of applications was $410 million, and the SBA production in terms of originations was $31 million.

Tyler Stafford -- Stephens. -- Analyst

Got it. Okay, thanks. I guess one for me just on Navitas. And obviously, credit hasn't started to percolate on -- for at least from what we can tell there, on that portfolio. I'm just curious if you're starting to see any signs of a weakening specifically on that in Navitas portfolio or if everything is still pretty clean.

Robert Edwards -- Chief Risk Officer

Yeah. So, this is Rob Edwards. Hey, Tyler. I would say we have not seen really any change. Really our first quarter of owning Navitas was Q1 of '18 and now it does, you know, the losses do change from quarter to quarter, but it's been right in line with our expectations. In fact, on the loss side, it's been, I would say, a little bit better than expectations here recently. And then we do -- they do have a fairly robust portfolio management process where they're refreshing external scores on the portfolio on a monthly basis and those continue to look very consistent as well.

Tyler Stafford -- Stephens. -- Analyst

Good. Okay. And then just lastly for me. The SNC balances that you guys provided in the deck does decline, call it, 25% from last quarter. I'm just wondering, I guess what drove that decline if it was more of an intentional exit based on kind of what you're seeing on those underlying credits or if that was just normal pay down activity that took those balances down? And if there are any more kind of planned exits over the near term?

Robert Edwards -- Chief Risk Officer

So, I wouldn't define it as planned exits. But I would just say we have been saying that we're sort of lukewarm, maybe I should say, cool in the leverage loan portfolio. A lot of that portfolio is done through the Shared National Credit avenue. And so, I would just say I think we're comfortable where we are there when we're in SNCs, generally they are with local companies where we're close to and know the management team. And so that's the majority of what that book is. And I would expect it to be stable, but not see a lot of growth there.

Tyler Stafford -- Stephens. -- Analyst

Okay. And maybe just last one for me just going back to Navitas. Do you have what the average yields were this quarter?

H. Lynn Harton -- Chief Executive Officer

Think I to, Tyler, see what I have here. I do not, they are relatively stable, but I'll get back to you.

Tyler Stafford -- Stephens. -- Analyst

Okay, great. Nice quarter, guys. Thanks.

H. Lynn Harton -- Chief Executive Officer

Thanks.

Operator

Thank you. Our next question comes from Jennifer Demba from SunTrust. Your line is open.

Jennifer Demba -- SunTrust -- Analyst

Good morning.

H. Lynn Harton -- Chief Executive Officer

Good morning.

Jennifer Demba -- SunTrust -- Analyst

Question, I'm wondering if you can give us an update on your Atlanta progress, specifically with new hires or loan production. And maybe talk about any other hires that you'd want to highlight across the other markets? Thanks a lot.

H. Lynn Harton -- Chief Executive Officer

Sure. Rich.

Richard Bradshaw -- Chief Banking Officer

Hi, Jennifer. In Atlanta, in Q2, we hired a new Market President in Buckhead, Sharon Thompson, who has brought on another lender in Q2 and another lender just started this past Monday. I will tell you that we are looking at additional hiring there and feel very good about that. And in addition, I wanted to highlight Charlotte, we opened up the community banking market there with a new Market President, Charlie Curtis, and he has brought on additional commercial lender. And this is adding to our Charlotte presence of asset-based lending, builder finance, SBA, renewable energy and mortgage. And then lastly, in Columbia, South Carolina, we executed our lift-out late in June. The new Market President is Shannon Stephens and he brought two commercial lenders with him.

Jennifer Demba -- SunTrust -- Analyst

Thanks so much.

Operator

Thank you. And our next question comes from Christopher Marinac from Janney Montgomery. Your line is open.

Christopher Marinac -- Janney Montgomery -- Analyst

Thanks, good morning. Wanted to delve into credit a little bit more, Rich, with rates on the specialty C&I front. And just get a sense of, behind the numbers that we saw, which are very good this quarter, any other trends that you see both inside your portfolio, as well as sort of your loans that you see as opportunities for the future and just in terms of general trends on credit?

Robert Edwards -- Chief Risk Officer

So, Christopher. Hey, this is Rob. Maybe I'll answer the first part of that question just in terms of credit trends. And then if Rich wants to chime in on opportunities on the C&I side in the future, that'd be fine as well. I would say, economically speaking, it just feels like there's a lot of mixed signals out there on the manufacturing side. Of course, the export piece that Lynn mentioned in his opening remarks as well we're paying close attention to. And so we're aware of that and we're watching the portfolio closely. We do have, I would say, relatively conservative project limits at $20 million and relationship hold limits at $35 million. So we don't -- it's a fairly conservative portfolio from that aspect. When we look at our criticize and classified, we're basically flat year-over-year. So there will be some ups and downs quarter-to-quarter, but we feel good about where we are.

Richard Bradshaw -- Chief Banking Officer

And Chris, this is Rich. In terms of C&I, we still are very positive on that asset class and putting a lot of effort and a lot of our hiring is very focused on that.

Christopher Marinac -- Janney Montgomery -- Analyst

Okay, great. And then I guess it's just follow-up for either you Rob or others, there's a scarcity of banks now in North Carolina and I'm curious does that help you on the conversation as United is coming into these markets and ramping up with your production team, and of course, continue to hire as you outlined? Is that sort of scarcity of competition incrementally helping you?

Robert Edwards -- Chief Risk Officer

I would say the answer is yes. In the last -- as you all are aware, in the last two years, there's been a lot of M&A activity in North Carolina and that it always creates opportunity to both the customer and the banking level and we're probably seeing that same thing in Atlanta as well.

Christopher Marinac -- Janney Montgomery -- Analyst

Great. Thanks very much, guys. Appreciate the color.

Robert Edwards -- Chief Risk Officer

Thank you, Chris.

Operator

Thank you. And our next question comes from Michael Rose from Raymond James. Your line is open.

Michael Rose -- Raymond James -- Analyst

Hey, guys. I just wanted to get some color on deposits. It was nice to see brokered come down. I know some of the trends are skewed by the deal, but if you can just give us an update on some of your deposit efforts and if you think that we're at or near peak for costs? Thanks.

Jefferson Harralson -- Chief Financial Officer

I'll get the start. This is Jefferson on the deposit growth. A lot of it has just been blocking and tackling, the new hires and the new markets and the efforts of the last few years. We have been very pleased with that. We have our deposit pricing in the middle of peers right now and our growth rate has been very strong. On the brokerage side that has been an intentional decision to shrink brokered and FHLB and offset that with securities shrinkage that's been a strategy. I do think that Q3, we have rewards on deposit pricing, but we also have probably three or four months of CDs repricing higher. So I think the net of that is going to be a cost of funds that right around here or maybe 1 basis point or 2 basis points higher next year and then improved for the fourth quarter. So I think right at the apex of deposit pricing and Q3.

Michael Rose -- Raymond James -- Analyst

Okay, that's helpful. And then just one separate question for me on capital. Obviously, it was down a little bit because of the deal, but still very healthy. How do you guys think about the buyback at this point?

Jefferson Harralson -- Chief Financial Officer

Right. So, if you think about capital for us, number one, we want to use it for growth. We have had higher growth recently. So we think that that use is increasing. Deals, we like to use it in deals, that's number two use of capital for us and we like to use cash and deals when we can. Two years ago, we were able to put $84 million of cash into the Navitas deal, and were able to put $53 million of cash in the First Madison deal, which has helped. We do have some optimism on our pipeline that we will be able to use cash and deals overtime as well. And then maybe third is buyback. So we are going to be managers of our capital. We do have $42 million of authorization left. So depending on the first two, we would like to be optimistic and perhaps aggressive on the buyback.

Michael Rose -- Raymond James -- Analyst

Okay. That's helpful. And then, actually just one more for me. Just as it relates to CECL, any sort of update there, and as we go through it, any thoughts around potentially changing any portion of the loan mix just given some of the longer data consumer stuff is heard a little bit more through that process? Thanks.

Robert Edwards -- Chief Risk Officer

So, Michael, this is Rob. I would just say we're on track for CECL. We've run our models against the portfolio two quarters in a row now and are increasingly confident with the modeling and the results of those and looking forward to continuing to build the robustness there of that process. And I would say the answer to your second question is that we have not yet really made any decisions around remix based on CECL results.

Michael Rose -- Raymond James -- Analyst

Okay. Thanks for taking my questions.

Operator

Thank you. And I am showing no further questions from our phone lines. And I'd like to turn the conference back over to Lynn Harton for any closing remarks.

H. Lynn Harton -- Chief Executive Officer

Well, great, and thank you all for being on the call and for the questions. Great questions, and we are very excited about where we are and look forward to seeing you next quarter. So have a great day.

Operator

[Operator Closing Remarks]

Duration: 27 minutes

Call participants:

H. Lynn Harton -- Chief Executive Officer

Jefferson Harralson -- Chief Financial Officer

Richard Bradshaw -- Chief Banking Officer

Robert Edwards -- Chief Risk Officer

Catherine Mealor -- KBW -- Analyst

Peter Ruiz -- Sandler O'Neill -- Analyst

Tyler Stafford -- Stephens. -- Analyst

Jennifer Demba -- SunTrust -- Analyst

Christopher Marinac -- Janney Montgomery -- Analyst

Michael Rose -- Raymond James -- Analyst

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