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United Community Financial Corp (NASDAQ:UCFC)
Q2 2019 Earnings Call
Jul 24, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the United Community Financial Corp Second Quarter 2019 Earnings Conference Call. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]

I'd now like to turn the conference over to Tim Esson, CFO. Please go ahead.

Timothy W. Esson -- Executive Vice President and Chief Financial Officer

Good morning, and thank you for participating in today's conference call. As always, before we begin, I would like to refer you to the Company's forward-looking statements and risk factors that appear on the screen in front of you. Additionally, the risk factors can be found at our Investor Relations website ir.ucfconline.com. This statement provides the standard cautionary language required by the Securities and Exchange Commission for forward-looking statements that may be included in today's call. In addition, a copy of the second quarter earnings release can be obtained at the same website.

With that said, I would now like to introduce Gary Small, President and CEO of both UCFC and Home Savings.

Gary M. Small -- President and Chief Executive Officer

Thanks, Tim, and good morning to all. Thank you for joining us. We're very pleased to report record earnings for the second quarter of $10.5 million, $0.215 a share for the quarter. Earnings are up about 9.9% over Q2 of last year and EPS number is up 13.2% over the same period last year. We and the industry are managing through a challenging rate environment and our Q2 performance benefited from a diverse business unit mix that provided us with multiple ways to win.

Having said that, loan growth for the second quarter increased a little over 6% versus the same period last year. Commercial growth came in relatively strong at -- north of 8% versus Q2 of last year, then residential portfolio is up 6.4%. Total loans, including our significant held for sale balanced portfolio was up 5.8% annualized on a linked quarter basis, with consumer loans up 6.6% on a linked quarter basis. We've re energized their indirect lending after about a six month pause to work on improving the unit's profitability and see that being a bigger contributor going forward.

Customer deposit growth was, up over 7% versus Q2 of '18. Non-interest bearing deposit growth was just shy of 8% over that period and business deposits were, up 30% year-over-year. Year-to-date, we've expanded our treasury management client roster by 16% and that continues to grow at that pace.

Revenue overall was up 5.8% Q2 to Q2. Margin for the quarter is down 3 basis points from last year same period and down 5 basis points on a linked quarter basis. Out of the 5 basis point linked quarter reduction, lower purchase accounting accretion accounts for 2 bps of the reduction. We lost a bps to our aggressive stock repurchase activity, which used more cash than we had planned originally at the beginning of the year. And another 2 bps was lost to what I'll call the day-to-day rate management process in this volatile environment.

LIBOR loans have already begun to feel the effect of the anticipated move of Fed's lowering the rates, and we felt that a bit in some of our yields over the last six to eight weeks. On the funding side of the balance sheet, we initiated a meaningful rate reduction effort affecting our deposit portfolio repricing scheme and lowering our promotional CD and money market rates that initiative began in mid-May and it was a meaningful move on some of those promotional rates we're moving over 40 basis points versus where we were, when we are trying to attract money. We have sufficient liquidity and funding sources to support our balance sheet growth and that's going to allow us to more moderate deposit pricing positioning in the marketplace through year-end.

Credit quality indicators remain very positive for the quarter, we were in a net recovery position and the slight increase in non-performing loans that appeared as of $6.30 has already subsided due to pay downs received in July, and we had visibility into how that would work at the end of $6.30 and felt very comfortable with our position.

From a non-interest income perspective, the residential mortgage of business has been very strong for the quarter, obviously delivering excellent gain on sale results. We've actually doubled our revenue Q2 versus Q2 and we're up 68% on a year-to-date comparison on just that gain on sale line item.

Last quarter, we incurred a $500,000 MSR mark and thought the worst was likely behind us. Then the 10-year treasury dropped to 2% during the second quarter and we booked another $995,000 MSR valuation adjustment. While we do have the potential to recover the combined year-to-date $1.5 million mark down on the MSR, if the treasury rates bump back up, we're more encouraged by the strength of our gain on sale momentum and our mortgage act -- residential mortgage production activity and expect excellent results in the residential mortgage business for the remainder of the year. On the expense front, we return to a more normalized level for our organization of just under $16 million for the quarter, as we had expected.

I'll turn it over to Matt to cover loan growth in more detail and discuss our commercial and residential businesses.

Matthew T. Garrity -- Executive Vice President, Commercial Lending and Credit

Thanks, Gary. As Gary mentioned our lending businesses performed in line with our expectations for the second quarter. Total loan growth for the second quarter was 5.88% on an annualized basis, when including loans held for sale and deferred loan costs. Commercial loan balances remained flat during the second quarter, which we had expected and communicated on the last call with growth for the period coming from our residential mortgage and consumer lending businesses.

Over the last 12 months, total loan growth, when excluding loans held for sale was 6.17% with commercial growth coming in at approximately 8.2% during this period. As we look to the rest of 2019, we expect that total loan growth for the year will come in at 6% to 8%, with commercial growth coming in at 8% to 10%, representing a 2% decline from our original guidance. I would note that the adjustment is driven by higher planned payoff activities in our commercial business and not origination activity. Lending activity was solid in the second quarter and pipeline levels are providing good momentum, as we enter the second half of the year.

Residential mortgage activity remains very good and we are taking advantage of the opportunities that are available. While planned commercial payoff activity was significant, lending activity during the second quarter was solid and pipeline levels continued to expand during the quarter, which should provide solid momentum heading into the second half of the year.

Commercial loan production increased over 24% in the second quarter versus the first quarter and over 25%, when compared to the second quarter of 2018. C&I production continues to be strong, making up approximately 40% of second quarter originations. In our mortgage business, we had another solid quarter in terms of originations, sales mix and gain on sale. As expected, origination activity ramped up sharply in the second quarter of 2019, when compared to the first quarter, and we continued our first quarter trend of having a higher mix of saleable originations. This improvement provided an offset to this servicing valuation -- servicing rights valuation adjustment that was incurred. When comparing the total of mortgage servicing revenue, rights adjustments and gain on sale activity for the first half of 2019 to the first half of 2018, were up by 13.8%. Balances grew modestly for the second quarter consistent with our strategy for the business.

Overall, we remain very pleased with the performance of our mortgage business and we're well positioned to have a solid second half of 2019. With respect to asset quality, delinquency as a percentage of total loans increased from 0.41% in the first quarter of 2019 to 0.58% in the second quarter of 2019, which is generally in line with delinquency levels in the second quarter of 2018.

Non-performing loans increased $5,765,000 in the second quarter of 2019, but I would note that in early July we resolved a substantial portion of the increase, which puts us back in line with recent quarters. Charge-offs for the second quarter of 2019 resulted in a net recovery of $87,000. While we remain focused on asset quality and signs of increased credit risk at this stage of the economic cycle, we see no signs of portfolio level deterioration and our outlook remains stable.

I would now like to turn the call over to Tim Esson, who'll review our financial performance in greater detail.

Timothy W. Esson -- Executive Vice President and Chief Financial Officer

Thanks, Matt. Let me begin by reiterating Gary's opening comment that Q2 again demonstrated very solid performance numbers, and as far as income concerned, it was a record performance. We saw very positive growth in both loans and deposits in addition to the continuation of a very strong credit performance.

Our quarterly results at $0.215 per share on a fully diluted basis with 13.2% ahead of the same quarter last year and are consistent with our expectations for Q2.

Looking at loans and deposits, we saw the total gross loan portfolio increased to $129.5 million or about 6.2%. The average customer deposit growth, which excludes broker deposits, grew $111.6 million or 5.7%, when comparing current quarter to linked quarter. Year-over-year, the increased aggregate 7.7%. Increases in money market business and non-interest bearing accounts have all contributed to this increase.

We have experienced significant deposit growth in the first half of '19, but would expect more muted deposit growth in the second half of the year. Additionally, we will strive to maintain pricing discipline, but deposits as a flat inverted treasury curve continues to create challenges.

Net interest income for the current quarter totaled $22.1 million, up 3.4% from the second quarter of '18. Essentially, this increase is a result of a 4.3% growth in earning assets tempered with the decline from the benefit of purchase accounting adjustments. The net margin for the quarter was 3.33% on an FTE basis, this would when compared to 3.36% for the same quarter last year. Excluding the purchase accounting adjustments, the margin would be 3.29% for '19 and 3.28% for '18.

Going forward, it would appear that deposit costs have topped and will begin moving lower. The treasury curve, however, remains flat and expectations for the Federal Reserve to lower rates in Q3 and Q4 of this year will result in a net interest margin coming under additional pressure during the remainder of '19. That said, we would expect to see the net interest margin full-year results in the range of 3.33% to 3.34%.

Continuing on, non-interest income was $6.7 million in Q2. This level of performance is approximately 14% greater than Q2 of '18. Mortgage gain on sale income of $1.4 million is the main driver of the increase. This increase in gain on sale income was substantially driven by increased margins, when comparing Q2 of '19 with Q2 of '18.

Going forward, we would anticipate mortgage banking income margins tracking higher than '18 for the remainder of the year. But at a lower rate than seen in the first two quarters. Further complementing this for increases in brokerage and mortgage servicing fees along with trading and security gates. These gains were partially offset with a fairly significant mortgage servicing rate valuation adjustment of approximately $995,000 during the quarter. This adjustment can be credited to a drop in long-term interest rates and the commencement rise in mortgage prepayments speeds.

Non-interest expense was $16 million, an increase of $500,000 over the same period last year or approximately 2.9%. Expenses continue to balance out with plan as the year progresses. Consistent with guidance offered in January of this year, we anticipate there will be an approximately 1% to 2% increase in non-interest expense over the last years level. The efficiency ratio is at 55.4%, as we indicated in our last call, we expect this number to decrease to the mid-50s level for the quarter, which aligns with plan.

During the second quarter of '19, the Company repurchased 817,000 shares for a total of 1.1 million this year. The average cost of repurchases was 9.33% per share for the quarter and 9.36% per share for the year. Recognizing this activity, the estimated diluted share count for EPS calculations as of June 30 would be $48,100,000. One final comment regarding our effective tax rate on an FTE basis for the quarter, the rate was 18.4%.

With that said, I would now like to turn the call back to Gary Small.

Gary M. Small -- President and Chief Executive Officer

Thank you, Tim. New business opportunities for the organization continue to trend up versus the pace at the end of '18 and the first quarter of '19. With that in mind, I do want to take the opportunity to update our guidance for the remainder of the year. As Matt mentioned, we anticipate the commercial growth to be at a minimum 8% year-over-year with earning asset growth remaining in the 6% to 7% range. The commercial pipeline is growing, and commercial consumer activity is picking up in key segments and the residential mortgage business is great.

At some time, the MSR valuation adjustments will be much less of an issue. Regarding margin we had 3.33% for the second quarter, we're going to lose another basis points just to purchase accounting accretion dropping off in the third quarter, but we are firm on our estimate of 3.33% to 3.34% for a reasonable expectation for the full-year.

Expect residential mortgage revenue to continue to outperform the prior year and expect our quarterly expense run rate of $16 million throughout the end of the year. For our organization, from a full-year perspective, we will be lighter on net interest income than we had originally planned at the beginning of the year. The combination of lower average balances and lower margin. Credit is great and our loss provision is going to come in better than we had originally planned. Perhaps stronger fee income, primarily driven by the residential mortgage business and expenses are right on target.

Expect net income to come in as we had planned for the year, which is slightly higher than the current consensus estimates. We had a more robust share repurchase plan over the first six months than we originally planned, and that's adding to the trajectory of EPS. I can't affirm that our expectations of 12% to 15% EPS improvement on a full-year basis versus the same period last year or full-year last year, and that assumes no additional shares to be repurchased over the remainder of the year from a math perspective.

Now, I'll turn it over to the operator to take questions.

Questions and Answers:

Operator

We will now begin the question-and-answer session. [Operator Instructions] The first question will come from Scott Siefers of Sandler O'Neill.

Scott Siefers -- Sandler O'Neill -- Analyst

Good morning, guys. How are you?

Timothy W. Esson -- Executive Vice President and Chief Financial Officer

Good morning, Scott.

Scott Siefers -- Sandler O'Neill -- Analyst

Hey, just want to sort of clarify some of the loan growth guidance. The 6% to 8% is that total growth for the year or is that the annualized rate for the -- that we should expect for each quarter in the second half, and then the pay down activity being elevated unfortunately, kind of, an industry issue, but sounds like it's little bit of a greater headwind than we might have anticipated. I guess just, Gary, any thoughts on, any abatement insight or any relief that you might see? Or how do you think about that dynamic as well?

Gary M. Small -- President and Chief Executive Officer

Great question, Scott. I'm going to turn it over to Matt to get a particular [Indecipherable]

Matthew T. Garrity -- Executive Vice President, Commercial Lending and Credit

Sure, Scott. Good morning. The loan payoff activity in the first half of 2019 was a little bit higher than we had certainly planned for. We had expected a fairly robust amount of that to happen as we've communicated, and we probably saw for the quarter about 20% more than we had anticipated. And what's driving that is, what we had planned for is primarily projects on the commercial real estate side that we would expect to be paid off and refinanced out into the light market or the permanent market, and which we saw plenty of that. But what we began to see additionally in the second quarter, given market conditions where people were just selling their businesses, which were great days for them, great returns, but not something that we necessarily would be able to budget and have plan.

So when we look at our outlook for the year, that really represents that decline from the original guidance. And to your first question about the 6%, that's for the full -- that'll be full year growth, that 6% to 8% loan growth guidance that we gave you is full-year guidance, not trajectory.

Scott Siefers -- Sandler O'Neill -- Analyst

Okay, perfect. Thank you, Matt, I appreciate that. And then let's see, just regarding the repurchase expectation, Gary, give a sense for how aggressive you guys will be? I mean, 2Q was a really big number, sort of a lot of error between what you did in the 2Q. And what a typical quarter is. Just curious as to your thoughts there?

Gary M. Small -- President and Chief Executive Officer

It was, you know, the opportunity was there and we took advantage of it. I think we -- you could take some guidance from the number of shares that we reup with the Board this quarter or another 1 million shares brings us to 1.7 million, that gives us plenty of room to work between now and the end of the year. We're going to continue to be opportunistic, Scott. I wouldn't want to be too directional on whether the velocity will be the same less or more, but it's part of our capital managing strategy. And with the balance sheet being a little bit more crimped by 2% or so than we had originally planned, we're just that much more over capitalized and we'll act accordingly.

Scott Siefers -- Sandler O'Neill -- Analyst

Okay. All right, perfect. Thank you very much.

Gary M. Small -- President and Chief Executive Officer

You bet.

Operator

The next question will come from Michael Perito of KBW.

Unidentified Participant

Hi, this is actually [Indecipherable] on for Mike Perito. Thank you so much for taking my questions. My first question is

Timothy W. Esson -- Executive Vice President and Chief Financial Officer

Good morning.

Unidentified Participant

Good morning. I have a question about the mortgage banking business, you mentioned in the release that margins should be stronger. But do you think this pipeline consisting reason activity, if restarts to decrease?

Matthew T. Garrity -- Executive Vice President, Commercial Lending and Credit

Hi, this is Matt. Yes, we do believe that if rates continue to -- in a decreasing rate environment, we think that's for the -- for our residential mortgage business. That's actually a tailwind for us, it will help spur purchasing activity, as well as refinance activity. And we've seen in our pipelines nice improvement with respect to what makes up refinance activity in our pipeline. So that's a growing piece of our business right now.

Gary M. Small -- President and Chief Executive Officer

One point of clarification on that margin discussion, it's really the gain on sale calculation, the margin related to that, not the margin relative to the portfolio. It is not a great time to be putting 30-year fixed paper or 15-year paper on the portfolio, when we only have modest growth expectations there. Really, the only thing that goes on is what's needed to facilitate the bigger business of originate and sale and that margin on our sell and sold business has been climbing all year.

Timothy W. Esson -- Executive Vice President and Chief Financial Officer

Yes, we -- as I mentioned in my comments we've got a really nice mix of sale originations to total and it's been increasing and it's help drive a lot of the improvement that you're seeing. So to Gary's point, our view of -- use of the balance sheet for residential mortgage is really modest in terms of overall growth. It's -- we're more positioned relative to saleable business in our book.

Unidentified Participant

Okay, great. Thanks. And then could you also give us some more color on how the insurance and investment fee income and the shift are coming along? Like what are some reasonable growth expectations there?

Gary M. Small -- President and Chief Executive Officer

I would say just on the insurance side, we'll have a year that's better than last year. We had better profit sharing so forth. We continue to see sort of a mixed story and the softening from the underwriters as far as price increases and so forth, depending on which industry. So I think we'll continue to move there at modest growth. What we really look for is continued acquisition opportunities to grow that business beyond the -- again gain some scale, and that's probably our fastest path to more meaningful results. But the business does very well, we're very happy with our margin on the line of business and with the investment we've made.

On the investment side, we're having a good year, we've moved some dollars between, say, trusted investments. So we kind of look at both of them. But with the market on the move, that's helpful we have had a little move downward due to a client infection where they aggregated a bit of their trust money with the other organization that they worked with. And it was enough to be noticeable, because our numbers are pretty small, but the business as a whole and the new business origination continues to be strong.

Unidentified Participant

Great. That's all I had. Thank you so much.

Gary M. Small -- 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 Gary Small for any closing remarks.

Gary M. Small -- President and Chief Executive Officer

Again tough quarter for banks in some respects, but I think many have crossed the finish line from an earnings perspective, similar to how we have, great provisions, discussion, managing their expenses and probably doing a little bit better on the fee income side. We do view a couple of basis point movement downward on absolute growth, as an episodic issue this kind of a cumulative force of a weak start to the year.

And then as Matt mentioned, a couple percent loss on sold businesses that weren't expected. But as far as new business growth and our growth thought beyond this year, we still live in the range that we always looked in on the commercial side, which would be in that 10% to 12 %range, and that we'll be back on the table again once we get through this year.

And thank you for joining us, and look forward to the next quarter.

Operator

[Operator Closing Remarks]

Duration: 26 minutes

Call participants:

Timothy W. Esson -- Executive Vice President and Chief Financial Officer

Gary M. Small -- President and Chief Executive Officer

Matthew T. Garrity -- Executive Vice President, Commercial Lending and Credit

Scott Siefers -- Sandler O'Neill -- Analyst

Unidentified Participant

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