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United Community Financial Corp (UCFC)
Q3 2019 Earnings Call
Oct 23, 2019, 10:00 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good morning and welcome to United Community Financial Corporation Third Quarter 2019 Earnings Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note the event is being recorded. I'd like now to turn the conference over to Mr. 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 third 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
Thank you, Tim, and good morning to all. We appreciate you joining us this morning. We're very pleased to report third quarter earnings of $10.5 million or $0.218 per share for the quarter. Earnings were up 10.2% versus Q3 of last year, and the EPS improved 14.7% over the same period of last year.
The interest rate environment during the quarter certainly had been challenging to say the least. Assets were repricing more quickly, with -- while the funding costs reset takes just a bit more time. In our organization, we usually lag the quarter -- by about a quarter with equilibrium coming in at the six-month mark following a rate -- Fed rate reduction, and we anticipate margin will stabilize through year end.
Loan growth on a linked-quarter basis grew 6.1% annualized with linked quarter commercial growth in at over 8%. The residential portfolio was up over 5% over the prior year in spite of what's been a very busy period for refis and so forth.
Our commercial clients continue to cash flow nicely and remain thoughtful regarding capex and expansion commitments as they head into 2020. Total loans, including held-for-sale balances, were up 6.7% versus last year. The loan provision for the quarter did spike on the resolution of the single commercial credit. We still expect the full year net charge-off position to be 5 bps or less. The residential real estate and commercial loan portfolios are performing at unprecedented levels and the falling rate environment will only continue to provide a tailwind to each of these factors.
Customer deposit growth was up 7.2% versus Q3 of '18. Non-interest-bearing deposit growth was 7.6%, and business deposits were up 28% versus again the third quarter of '18. Average customer deposits, and when I say customer, I mean, excluding broker deposits, remain flat on a linked-quarter basis. We have plenty of funding to get us through the foreseeable future of our loan demand. We're always on the hunt for non-interest-bearing and business deposits, but the flatness reflects us taking a more moderate position from a pricing position in the market.
From non-interest income perspective, the residential mortgage business is performing exceptionally. Gain on sale income is up 78% versus the same period last year, and the business as a whole provides an excellent earnings hedge against the unfavorable net interest income margin issues that were all being driven by the inverted curve and the lower rate environment. So it's a great oar to have in the water in times like this. It's worth mentioning that we have a $1.8 million year-to-date unfavorable mark on our mortgage servicing rights in the portfolio. That $1.8 million is recoverable to the extent the 10-year treasury increases in the future.
With the current environment challenging revenue growth in the near term, we remain very focused on expense management. Quarterly expense run rate fell to $15 million, and we continue to take steps to maintain our positive operating leverage as always for the organization, so that we can guarantee improvement for the shareholder under any scenario.
Now I will turn it over to Matt Garrity to cover our commercial and residential real estate businesses in more detail.
Matthew T. Garrity -- Executive Vice President of Commercial Lending & Credit
Thanks, Gary. As Gary mentioned, we're very pleased with the performance of our lending businesses in the third quarter. Loan originations in both the commercial and residential mortgage businesses were strong. Mortgage gain on sale income was excellent, and commercial balance growth was solid in spite of a very heavy quarter of planned payoffs. Our outlook for both business lines remains positive.
Commercial third quarter originations were the strongest yet, up over 65% when compared to the second quarter of 2019. Year-to-date, loan production is up approximately 8% when compared to year-to-date 2018. C&I production remained good at over 35% of total originations. Pipeline levels remain good and solid production for the fourth quarter is expected.
With respect to balance activity, we achieved balance growth of a little over 2% for the third quarter in spite of a significant ramp-up in planned payoff activity when compared to prior quarters. Our view for the fourth quarter is for payoff activity to remain elevated, although not to the degree of the third quarter and for full year commercial balance growth of approximately 8%.
In our mortgage business, we had another great quarter in terms of loan production as originations were up over 12% in the third quarter compared to the second quarter and are up over 15% when compared to the third quarter of 2019 to the third quarter of 2018. Pipeline levels remain strong, and we are well positioned for a very good fourth quarter.
Mortgage banking income was excellent in the third quarter and was up approximately 78% when compared to the third quarter of 2018. While rights adjustments were again significant in the third quarter, when comparing the total of mortgage servicing revenue, rights adjustments and gain on sale activity for the first three quarters of 2019 to the first three quarters of 2018 were up by approximately 22%.
With respect to asset quality, non-performing loans as a percentage of total loans improved by over 20% and non-performing assets as a percentage of total assets improved approximately 19% in the third quarter when compared to the second quarter. Charge-offs on a year-to-date basis are at 7 basis points, and our expectation for the full year is for charge-offs to be in line with what we experienced for the full year 2018, if not better. Overall, we expect asset quality to remain stable.
I would now like to turn the call over to Tim Esson, who will review our financial performance in greater detail.
Timothy W. Esson -- Executive Vice President and Chief Financial Officer
Thank you, Matt. Let me begin by reiterating Gary's opening comments that again, Q3 demonstrated very solid performance numbers. Our quarterly results at $0.218 per share on a fully diluted basis were 14.7% ahead of the same quarter last year and are consistent with our expectations.
Total loans grew $117.9 million, including loans held-for-sale, or 5.3% during the last 12 months and $35.3 million or 6.1% annualized compared to the previous quarter. Average quarterly customer deposits, which exclude brokered certificates of deposits increased $140.4 million or 7.2% from September 30, '18 and are flat compared to the linked quarter.
Net interest income totaled $21.6 million on an FTE basis for the quarter ended September 30, '19 compared to $21.7 million for the same period last year. Average earning assets grew $79.8 million during this time, but the benefit of this was offset by a 12-point decline in the net interest margin.
The net interest margin on an FTE basis was 3.21% for the third quarter of '19 compared to 3.33% in the third quarter of '18. Excluding the effects of purchase accounting adjustments, the net interest margin was 3.18% in the third quarter of '19 compared to 3.27% in the third quarter of '18. The 9 basis point decline in net interest margin, excluding purchase accounting, was due to the declining interest rates and the inverted yield curve.
The net interest margin on a linked-quarter basis declined 12 basis points from the 3.33% in the second quarter of '19 to 3.21% in the third quarter of '19. Excluding the effects, again, of purchase accounting adjustments, the net interest margin was 3.18% in the third quarter of '19 compared to 3.29% in the second quarter of '19. The dramatic fall in interest rates in the third quarter, along with continued treasury curve inversion continues to place pressure on margins. The Company expects stabilization in the margin in the range of 3.20% in the fourth quarter.
Non-interest income increased 14.1% or $869,000 to $7 million for the third quarter of '19 compared to $6.1 million for the same quarter last year. The primary reason for this increase in mortgage banking income are gain on sale of $1.1 million. This was offset by a decrease in the value of mortgage servicing rights of $331,000. The decrease in mortgage servicing rights valuation was due to the dramatic drop in long-term interest rates and the commensurate rise in mortgage prepayment speeds.
At the end of the third quarter, the company had $1.8 million [Phonetic] valuation allowance associated with its mortgage servicing rights. Steady or rising rates should allow the Company to recoup most of this $1.9 million allowance over the next 18 months or so. The increase in mortgage banking income was driven by increased margins and salable volumes when comparing the third quarter of '19 to the third quarter of '18.
Total non-interest expense was $15 million for the third quarter of '19 compared to $15.8 million during the third quarter of '18, a decrease of $763,000 or 4.8%. This decrease can primary be attributable to a decline in salaries and benefits, along with reduction in FDIC expense related to a credit adjustment on premiums. We continue to place emphasis on disciplined expense management to help in offsetting the rate environment that exists currently.
Our efficiency ratio has improved to 52.2% for the current quarter. One final comment regarding our effective tax rate, on an FTE basis for the quarter, the rate is 18.8%.
With that said, I would now like to turn the call back to Gary Small.
Gary M. Small -- President and Chief Executive Officer
Thanks, again, Tim. As we look toward year end, we see no material adjustment to our prior expectations communicated regarding loan growth. In commercial loan growth, we'd still -- we still expect to top 8% over the course of the year. Margin will continue to be under pressure, but with promo money market rates and some higher rate CD activity beginning to reprice substantially over the next two quarters, we should see some relief on that front. The residential mortgage business will continue to exceed prior year performance. And when adjusting for M&A expenses, and we'll have a few of those in the fourth quarter, we anticipate our expense run rate to continue to be at lower levels throughout year end.
Comments regarding our merger integration process with First Defiance, we are six weeks post announcement. Our full leadership team is in place. We have about 40 project teams working on the integration effort at this point and all is progressing as anticipated. I do want to be clear though that on behalf of both organizations, we remain 100% focused on our client needs and our opportunities and it's business as usual out in the field. And the strong third quarter results for each organization reflect this much.
So at this time, I would like to turn it over for questions.
Questions and Answers:
Operator
We'll now begin the question-and-answer session. [Operator Instructions] First question comes from Scott Siefers, Sandler O'Neill. Go ahead.
Scott Siefers -- Sandler O'Neill -- Analyst
Good morning, guys. Thanks for taking my question.
Gary M. Small -- President and Chief Executive Officer
Morning, Scott.
Scott Siefers -- Sandler O'Neill -- Analyst
Hey. Just wanted to ask on the expenses. Obviously, very good performance in the third quarter. And then it sounded, Gary, like from your prep remarks there at the end, is it possible that we'll be able to see additional declines from this quarter's, call it, $15 million run rate through the end of the year, did I catch that correctly?
Gary M. Small -- President and Chief Executive Officer
I think if we go back to earlier in the year, we were saying $16 million or a little under that was kind of a run rate. In this quarter just completed, we dropped to $15 million. Now we had a little FDIC bump that helped us along the way. But even without that, we would've been flat with prior year and well below that $16 million. So all things being equal, we'll still land somewhere between $15 million and $16 million, and I think we will be closer to Q3's number than past quarters.
Scott Siefers -- Sandler O'Neill -- Analyst
Okay. Perfect. All right. And then, can you add just a little additional commentary on the payoff expectations? It sounds like they'll stay elevated in the fourth quarter, but not to the same order of magnitude as we saw in the third quarter, so maybe just some additional comments there. And then to the extent you can expand upon your comments about your clients remaining sort of thoughtful or constructive on the overall outlook, just what kinds of things are they telling you as you sort of survey them in the field?
Matthew T. Garrity -- Executive Vice President of Commercial Lending & Credit
Sure, Scott. This is Matt. I would say with regards to payoff activity, we certainly saw a spike in the third quarter of planned payoff activity. And that included a couple of loans that we would've expected to payoff in the fourth quarter actually paying off in the third, along with the occasional property or two that might have been sold that wouldn't normally be in your planning.
And just to put some further color around third quarter, our payoffs in the third quarter would have been more than we experienced in the first and second quarter combined. And I think that's why we're pretty enthused about the level of commercial growth we were actually able to achieve in the third quarter.
With regards to the fourth quarter, again, with those payoffs pushing out or pushing up into the third quarter, we do expect the level of payoffs to abate slightly in Q4, and I would say somewhere in the neighborhood of 20% to 25% less than we experienced in Q3.
Regarding client perspective and clients -- where clients are today. As Gary mentioned, they've being cautious about large expansions, even acquisitions relative to valuations and things of that nature. Just an eye out in preserving liquidity and cash flow, which from a credit perspective you see in our numbers as well, it's been a really good credit environment for us.
Scott Siefers -- Sandler O'Neill -- Analyst
All right that's certainly...
Gary M. Small -- President and Chief Executive Officer
I would say just -- Scott, this is Gary. If you look at the full year and what we planned for the year relative to pay downs, there's always some lumpiness between the quarters. With a couple of exceptions where we really had clients who sold their business and we didn't see that one coming, we haven't been surprised by who is paying off. It's just the timings moved a little bit between quarters. So the original guidance we gave on commercial loan growth expectation from 12/31 to 12/31 is still holding up with our original discussion.
Scott Siefers -- Sandler O'Neill -- Analyst
Okay. Terrific. Thank you guys very much.
Gary M. Small -- President and Chief Executive Officer
Sure.
Operator
[Operator Instructions] This concludes the question-and-answer session. I'm sorry, we do have a question. Daniel Cardenas, Raymond James. Go ahead.
Gary M. Small -- President and Chief Executive Officer
Good morning, Dan.
Daniel Cardenas -- Raymond James -- Analyst
Maybe just a little bit clarity on the margin guidance that you gave in the 3.20% range. Are you baking in any additional rate cuts into that margin assumption?
Gary M. Small -- President and Chief Executive Officer
What we have, Dan, is we expect something at the end of this month, and we do have still a placeholder for December, although it doesn't really affect the margin numbers given the timing of that and we're kind of analyzing whether we feel committed to that December one or not, but that's the extent of it. But we have over $400 million in, I'll call it, promo money markets, meaning this time last year when we thought rates were getting ready to run up, as we all did, we were locking in some money, some 12-month lock-ins.
And so we're still paying out some pretty exorbitant rates on money markets right now, and they'll get a chance to reprice here in the fourth quarter and the first quarter of next year. And then the normal CD movement, but again, $400 million is not -- it's a big number in that movement. It would probably be 60 bps in today's rate environment on average downward.
Daniel Cardenas -- Raymond James -- Analyst
And maybe just a quick reminder. In terms of your variable rate, the portion of your loan portfolio that's variable rate, would be impacted by another rate cut?
Gary M. Small -- President and Chief Executive Officer
Well, we have $580 million or so that's either LIBOR or prime. And some of that LIBOR has already occurred. We got $275 million that's in the LIBOR spot. So again, it's more of a 2020 issue relative to what's moving LIBOR, got ahead of the curve on the October, so that's already priced in. And the December move wouldn't really have much of an impact on the margin, if it did occur.
Daniel Cardenas -- Raymond James -- Analyst
Okay. Fair enough. Right. And then, how should I think about your tax rate for Q4?
Gary M. Small -- President and Chief Executive Officer
Same range as what we're in right now, in that 18.8% range, with a normalized run rate. We may have some non-deductible expenses in the fourth quarter that would be M&A related, but on the normal flow if that rate [Indecipherable].
Daniel Cardenas -- Raymond James -- Analyst
Okay. Great. All right. Thanks, guys. I'll step back.
Gary M. Small -- President and Chief Executive Officer
Thanks, Dan.
Operator
This concludes our question-and-answer session. I'd like to turn the conference back over to Gary Small for any closing remarks.
Gary M. Small -- President and Chief Executive Officer
Again, I thank you all for joining us this morning. I would expect that we would likely release earnings again in January, but we probably will dispense with the call in January given the expected timing of our get together with First Defiance on 1/31. And for those of you that have been with us for a long time, it's been a pleasure and looking forward to seeing you all on the other side. Thank you.
Operator
[Operator Closing Remarks]
Duration: 22 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 of Commercial Lending & Credit
Scott Siefers -- Sandler O'Neill -- Analyst
Daniel Cardenas -- Raymond James -- Analyst
