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People's Utah Bancorp (NASDAQ:PUB)
Q3 2019 Earnings Call
Oct 24, 2019, 12:00 p.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good afternoon and welcome to People's Utah Bancorp third quarter earnings conference 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 that the event is being recorded.

I'd like now to turn the conference over to Mark Olson, Executive Vice President and Chief Financial Officer. Please go ahead.

Mark K. Olson -- Executive Vice President and Chief Financial Officer

Good morning. Thank you for joining us today to review our third quarter 2019 financial results. Joining me this morning on the call is Len Williams, President and Chief Executive Officer for People's Utah Bancorp. Our comments today will refer to the financial results included in our earnings announcement released last night. To obtain a copy of our earnings release, please visit our website at www.peoplesutah.com.

Our earnings release contains forward-looking statements. All statements other than statements of historical fact are forward-looking statements. Such statements involve inherent risks and uncertainties, many of which are difficult to predict and beyond the control of the company. We caution readers that a number of important factors could cause actual results to differ materially from those expressed in or implied or projected by such forward-looking statements. These forward-looking statements are intended to be covered by the safe harbor for forward-looking statements provided by the Private Securities Litigation Reform Act of 1995. Forward-looking statements speak only as of the date they are made, and we assume no duty to update such statements.

I'll now turn the call over to Len Williams, Len?

Len E. Williams -- President and Chief Executive Officer

Thank you, Mark. Good morning and thank you for joining us on the call today. People's Utah Bancorp achieved another quarter of strong financial performance even as we continue to position, strengthen and fortify our balance sheet. We realized the return on assets of 1.9% and a return on equity of 13.8% for the third quarter after building our average equity to average assets from 12.8% a year ago to 13.7% for the third quarter 2019, while increasing our allowance for loan losses from 1.4% a year ago to 1.8% at the end of the quarter.

Our total assets grew 10.5% from a year ago. This was primarily the result of strong low-cost core deposit growth. Total deposits grew $230 million or 12.3% year-over-year as our retail branches and commercial treasury management team focused on raising commercial deposits from existing clients as well as the acquisition of new client relationships. We recently signed a contract for new treasury management platform that we believe will help us continue to grow our commercial deposit base and improve our fee income. We anticipate rolling this new platform out at the beginning of 2020.

Our cost of interest bearing deposits increased 14 basis points to 0.70% for the third quarter 2019, compared to 0.56% for the same period a year ago. Our total cost of deposits increased only 9 basis points or 0.45% for the third quarter of 2019, compared with 0.36% for the same period a year earlier. We continue to experience significant competition for deposits. As a result, we anticipate that the downward deposit betas will be lower than in previous interest rate reduction cycles. Loans held for investment were relatively flat for the first nine months of this year, decreasing $3.8 million or 0.2% to $1.68 billion at September 30, 2019 compared with September -- December 31, 2018, and decreased $43.2 million or 2.5% compared with September 30, 2018.

The decline is primarily the result of reduction in the acquisition, development and construction loan portfolio of $38.7 million or 11.9% from December 31, 2018 to September 30, 2019 and $96.4 million or 25.2% from a year ago, as we have managed loan concentration levels and have become more selective with the type and size of construction projects that we're willing to finance giving our perspective on a potential slowing economy.

We've reduced our acquisition, development, construction portfolio to total capital concentration from a high of 149% at the end of the first quarter 2018 to 90% at the end of the third quarter 2019. We continue to focus on diversifying our loan portfolio. In particular, we are focused on growing our C&I book. Currently, we operate two commercial banking centers that are located in Salt Lake County and we're in the process of building out a commercial banking team to open in Utah County this quarter. We are continuing our efforts to automate and digitize our commercial loan origination process through the implementation of an online commercial lending application and have begun the building, testing and uploading phases of nCino which is an industry leader in the commercial banking loan operating systems space. The goal of this project is to ensure that we continue to provide our historical high touch and unparalleled responsiveness to our clients and to be able to offer the same client service as we continue to grow in size and complexity and expand our geographical footprint. We expect to have the first phase of this project completed this quarter.

On the retail banking front, we mentioned on our last call, our plan to open a new business oriented branch in the fast-growing Pleasant Grove area, where a number of technology firms have recently built new corporate offices. The branch has been open and we have experienced positive results as we work to build additional business relationships in the area. We have completed the demolition of our Alpine branch and have made significant progress on rebuilding the branch. We expect to complete the rebuild sometime in the fourth quarter of 2019. The Alpine branch is one of our oldest branches with over $120 million in deposits.

As I mentioned on our last couple of conference calls, we have decided to simplify our branding strategy to a single unified name for our bank. A new logo and a more contemporary look. We have identified the new name, logo and overall style. We are currently communicating the new brand with our existing clients through one-on-one discussions and other forms of communication. We plan to make a public announcement on November 12th, 2019 regarding our new branding strategy. We expect this new branding strategy will provide us with the opportunity to increase market penetration as potential clients better understand our size, scale and product offering as a unified Bank.

Ultimately, we anticipate these efforts will result in greater growth in our loan and deposit portfolios and higher overall revenues. While the economy in Utah continues to be strong, we believe that there are beginning to be signs of a general economic slowdown including flattening of the treasury yield curve and the Federal Reserve lowering interest rates by 25 basis points, twice so far this year.

We believe it's prudent for us to be prepared for an economic slowdown so that we can take advantage of market conditions to expand our market share either organically or through acquisitions. We continue to actively evaluate potential acquisition opportunities, both in Utah and in states contiguous to Utah, particularly along the I-15 corridor.

I'm also pleased to announce that the Board of Directors declared a quarterly dividend payment of $0.13 per common share, the dividend will be payable on November 12th, 2019 to shareholders of record on November 4th, 2019.

I will now turn the call back over to Mark to discuss our financial performance. Mark?

Mark K. Olson -- Executive Vice President and Chief Financial Officer

Thank you, Len. Net income was $11.1 million or $0.59 per diluted common share for the third quarter of 2019, compared to $11 million or $0.58 per diluted common share for the second quarter of 2019 and $10.5 million or $0.55 per diluted common share for the third quarter a year ago. For the third quarter 2019 net interest income grew 3.7% or $1 million to $28.2 million compared with $27.2 million for the same period a year earlier. The increase is primarily the result of average interest-earning assets growing 8.3% or $170 million, while yields on interest-earning assets declined 18 basis points to 5.44% for the same comparable period. Lower yields on interest-earning assets was primarily the result of a $207 million or 62.5% increase in the average amount of lower yielding cash and investment securities held by us stemming from average core deposits, increasing $172 million or 9.4% for the same respective period.

Yield on total loans increased 16 basis points to 6.49% for the third quarter 2019 compared with the same period a year ago, while average loans declined $35.5 million or 2.1% for the same comparable period. The percent of loans to total interest earning assets decreased to 75.7% for the third quarter of 2019, compared with 83.7% for the third quarter of 2018. Acquisition accounting adjustments, including the accretion of loan discounts and amortization of core deposit intangibles added 10 basis points to the net interest margin for the third quarter of 2019.

For the third quarter of 2019 provision for loan losses were $2.1 million compared with $1.9 million for the same period a year earlier. The increase in provision for loan losses in the third quarter is due primarily to a $1 million increase in specific reserves satisfied with the remainder, the result of increased general reserves. We recorded annualized net recoveries of 0.08% for the third quarter of 2019, compared with net charge-offs of 0.21% for the same period a year earlier. For the nine months ended September 30 2019 annualized net charge-offs were 0.05% compared with 0.03% for the same period a year ago.

Non-performing assets were $4.3 million or 0.17% of total assets at September 30 2019, compared with $8.8 million or 0.40% a year earlier. The percentage of allowance to loans held for investment increased to 1.82% at the end of September compared with 1.36% a year earlier. In addition to our allowance for loan losses, we have $6.4 million in both non-accretable and accretable credit discounts remaining on our acquired loan portfolio. The allowance for loan losses plus credit discounts to loans held for investment was 2.2% at September 30, 2019. We believe that it is prudent for us to continue to build our overall allowance for credit losses, given that we believe we are nearing the end of an overall economic cycle. For the third quarter of 2019, non-interest income increased $0.7 million or 17.7% to $4.5 million compared to $3.8 million for the same period a year ago. The increase was primarily the result of mortgage banking income, increasing due to higher loan sales in the third quarter of 2019 compared to the same period a year earlier, as we experienced an increase in refinance volumes as overall interest rates declined.

For the third quarter of 2019, non-interest expense was $16.1 million compared with $15.3 million for the same period a year earlier and is primarily the result of $0.5 million in higher salary and employee benefits, $0.5 million in higher marketing and advertising expense related to the rebranding of the company. We expect higher marketing and advertising expenses as we roll out our new brand strategy, both in the fourth quarter 2019 and into 2020. Higher costs were offset by lower FDIC premiums as we applied the small Bank FDIC assessment credits to our overall premium assessment. We expect to benefit from these assessment credits for an additional two quarters.

Our efficiency ratio was 49.2% for the third quarter of 2019, compared to 49.3% for the same period a year ago. Non-interest expense to average assets was 2.7% for the third quarter of 2019, compared with 2.8% for the same period a year earlier. For the third quarter of 2019, income tax expense was $3.4 million compared with $3.3 million for the same period a year ago. The effective tax rate was 22.2% compared with 23.9% for the same respective period. In June 2016, the financial accounting standard Board or FASB, issued an accounting standard update or ASU related to the measurement of credit losses on financial instruments.

The ASU significantly changes the accounting for credit loss measurement on loans and debt securities. Loans and held-to-maturity debt securities, the ASU requires a current expected credit loss or CECL measurement to establish the allowance for credit loss or ACL for the remaining estimated life of the financial assets, including off balance sheet credit exposures, using historical experience, current conditions and reasonable and supportable forecast.

The ASU eliminates the existing guidance for purchase credit impaired or PCI loans, but requires an allowance for purchase financial assets with more than an insignificant deterioration since origination, otherwise known as purchase credit deteriorated or PCD assets. This ASU is effective beginning after December 15, 2019. On October 16, 2019, the FASB voted to delay the adoption of this ASU by two years to January 2023 for private companies, not-for-profit companies and certain small public companies that meet the definition of a smaller reporting company or SRC as defined by the Securities and Exchange Commission. To meet the requirements of an SRC, an entity must be an issuer and have public float of less than $250 million or public float of less than $700 million in annual revenues of less than $100 million.

As of June 30 2019, our public float was $466 million and our annual revenues for 2018 were $130 million. Therefore, we do not meet the requirements of an SRC and will be required to adopt ASU effective January 1, 2020. The implementation process includes the evaluation of technical accounting topics, developing, validating and implementing models and methodologies used to calculate CECL, updating ACL documentation, validating the internal controls and overall operational readiness for the adoption of this ASU. We are currently reviewing new models and processes in parallel with the existing model and processes under current accounting guidance in advance of the January 1, 2020 effective date.

These parallel runs will focus on technical functionality of the CECL calculation, operational execution at the end -- of the end-to-end processes as well as disclosure requirements. We've established a project team and a steering committee to provide cross-functional governance over and make key decisions related to the project plan and the parallel runs. We expect to use the weighted average remaining maturity or WARM approach adjusted for prepayments to calculate CECL. As described in the FASB staff questions and answers, we intend to use the qualitative approach to adjust historical loss information for current conditions and for reasonable and supportable forecast and then immediately revert to historical credit losses.

As noted in the ASU, an entity can or shall the consider the need to adjust historical information to reflect the extent to which management expects current conditions and forecast to differ from the conditions that existed for the period over which historical information will be evaluated. The adjustments to historical loss information may be qualitative in nature and should reflect changes related to relevant data. We are currently in the process of evaluating the impact of the ASU on our earnings, financial position and regulatory capital amounts and ratios. We expect our ACL to increase upon adoption because the ACL will be required to cover the full remaining expected life of the portfolio, rather than the incurred loss model under current US GAAP.

In addition, a portion of the increase will be due to PCI loans that will be reclassified as PCD loans with the credit related non-accretable discount increasing both the ACL and loan balances, but not retained earnings. However, accretable discounts held on non-PCD loans are not allowed to be moved to ACL as part of the adoption. As a result, we will be required to set addition -- set aside additional ACL for non-PCD loans through retained earnings upon adoption. As a result, we will continue to hold accretable discounts that will be recorded into interest income over the remaining life of non-PCD loans as well as a similar amount in our ACL. We expect greater volatility in our earnings, and those of other banks after adoption due to the nature and time horizon used to evaluate CECL. In addition, we expect the potential negative impact of credit availability and reduced loan terms to borrower as the ACU is adopted by financial institutions.

Lastly, we expect a lack of comparability with financial performance to many of our peers as we adopt this ASU due to the delayed adoption for public companies similar in size to us, but that meet the requirements of an SRC. The ultimate effect of CECL on our ACL will depend on the size and composition of the loan portfolio. The loan portfolio's credit quality and economic conditions at the time of adoption, as well as any refinements to the model methodologies and other key assumptions used. At adoption we will have a cumulative effect adjustment to retained earnings for the change in the ACL, which we expect to negatively impact our regulatory capital amounts and ratios. Bank credit for agencies have provided regulatory accounting relief for an initial capital decrease from the adoption of this ASU by allowing a phased adoption over three years on a straight-line basis, which we expect to utilize.

I will now turn the call back over to Len.

Len E. Williams -- President and Chief Executive Officer

Thank you, Mark. We are pleased with the strong financial performance and positioning we achieved in the third quarter of 2019 and year-to-date. In particularly, we're pleased with the momentum we've experienced in our treasury, cash management, commercial program and the resulting growth in deposits. We continue to focus on taking advantage of the strong economic prospects in the markets we serve. We're passion and enthusiastic about our prospects to expand our commercial and industrial lending to small and medium-sized businesses through our branches in commercial banking center.

Also, we continue to actively pursue potential acquisition opportunities throughout the Intermountain West, which we believe is crucial component to our business strategy and shareholder value creation model going forward. Thank you for joining us today. At this point. I would now like to open the lines for questions.

Questions and Answers:

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions] First question comes from Jeff Rulis, D.A. Davidson. Go ahead.

Jeffrey Allen Rulis -- D.A. Davidson -- Analyst

Thanks.

Len E. Williams -- President and Chief Executive Officer

Good morning, Jeff.

Jeffrey Allen Rulis -- D.A. Davidson -- Analyst

Good morning.

Mark K. Olson -- Executive Vice President and Chief Financial Officer

Hi Jeff.

Jeffrey Allen Rulis -- D.A. Davidson -- Analyst

Len, I was hoping to kind of range bound the economic slowdown that you've sort of references for several quarters. And I want to -- well, I think certainly prudent at this point in the cycle, just wanted to check in and see that level of caution. I suppose, I think you're speaking more of a downshift than a reverse and knowing the Utah economy is in a great relative shape. Just wanted to kind of sharpen what I think is your view of how the economic landscape is progressing?

Len E. Williams -- President and Chief Executive Officer

Yeah, Jeff, probably the easiest way for me to explain it is going from almost unbelievably well to very good. You know, I mean that's an odd slowdown, but we have seen inventories in residential new construction lengthen. We're seeing a little bit more availability to where there has been such excess demand and no supply. We're starting to see a little bit of supply. And we have, as we've stated, had a pretty high concentration in the real estate arena that we've backed down and we're starting to see some extensions and things carried out a hair longer. So, it's typical stuff you see in a normal economy that we haven't seen for a while and that's what we're talking about.

Jeffrey Allen Rulis -- D.A. Davidson -- Analyst

Got it. Okay. And I guess given sort of that backdrop and you spoke on the M&A approach, I guess given that cautious stance, does that slow that effort in some in lieu of sort of buying someone else's problems, do you get the sense that the Bank's health or targets that you're looking at or have you aged or changed your interest given your view of the landscape?

Len E. Williams -- President and Chief Executive Officer

You know I think a lot of this last year, year-and-a-half has been positioning for us to be opportunistic in any climate. And we feel we fortify the balance sheet. We've identified our credits well enough to where even in a downturn we don't feel we're going to be 100% internally focused like sometimes happens. So we want to be able to play offense and acquire and grow market share even if things reverse, let alone slow down. So that's the intent. We feel we're pretty well there at this point.

Jeffrey Allen Rulis -- D.A. Davidson -- Analyst

You get the sense, there is more inbound, I mean, when do you see the turn in the economy, some of the smaller players may look out to reach to a partner and say, wow, this is a tough road ahead. I guess, are you getting any sense that there is more people coming to the table and say, all right, I'm willing to be a little more reasonable with my valuation given there. Do you think that that's impacting the targets as well and their reasoning?

Len E. Williams -- President and Chief Executive Officer

Yeah, we're not seeing reasonable valuations yet. Jeff. We're -- we've conversations out there, there are plenty of people talking, but this has been a pretty long upswing and most privately held community banks have done quite well through the cycle. I think we're going to actually have to wait until either this interest rate cycle or a business slow down impacts earnings. At that point I think we'll have some opportunities.

Jeffrey Allen Rulis -- D.A. Davidson -- Analyst

Got you. Okay. And then maybe one last one maybe for Mark as well. I'm just looking at that reserve build, you guys are on a pretty steady clip upward, all while you're diminishing the construction land development. I guess is the reserve build above 2% in the future, is that reasonable to think you'd climb to that or it's not really a number that you're actively watching. It's just the underlying risk in the portfolio? Thanks.

Mark K. Olson -- Executive Vice President and Chief Financial Officer

Yeah. No, I don't think we'd get to 2% under current accounting guidance, that's certainly under CECL. There'll be an increase in reserves and that would increase that number overall. So, yeah, I do believe we'll go over 2% potentially after the adoption of CECL.

Jeffrey Allen Rulis -- D.A. Davidson -- Analyst

Okay. I'll step back. Thank you.

Len E. Williams -- President and Chief Executive Officer

Thank you.

Operator

Our next question comes from Andrew Liesch, Sandler O'Neill. Go ahead.

Andrew Brian Liesch -- Sandler O'Neill & Partners LP -- Analyst

Good morning guys.

Len E. Williams -- President and Chief Executive Officer

Hi Andrew.

Andrew Brian Liesch -- Sandler O'Neill & Partners LP -- Analyst

You continue to have really good deposit growth without much in the way of grown loan portfolio and I understand why. But what -- how should we looking at this liquidity here. Cash is increasing without necessarily a big increase in the securities book. Are you looking to apply this in a securities. What's the thought with the deposits that have come on over the last few months.

Len E. Williams -- President and Chief Executive Officer

Yeah, we've purchased some securities. I mean, not a great time to be buying securities, quite honestly. Particularly, if you're going out longer in duration, that you just don't get paid for the risk. So we continue to watch that and to the extent that we can see good pricing on certain securities we are buying. We would obviously like to invest the cash in lending and anticipate that we'll have opportunities to grow the loan book a little bit more and put that to use.

Andrew Brian Liesch -- Sandler O'Neill & Partners LP -- Analyst

So how should we be looking at the size of the securities portfolio relative to the overall asset base and instead [Phonetic] the best time to be buying securities in this rate environment. But what's -- I mean is there a certain percentage that you'd like to keep it up?

Mark K. Olson -- Executive Vice President and Chief Financial Officer

Yeah, we would like to keep it at around $300 million to $350 million, that's where we'd be careful.

Andrew Brian Liesch -- Sandler O'Neill & Partners LP -- Analyst

Okay, got you. And then just with fewer loan growth opportunities, given some of the caution and the liquidity coming on, I mean is it unreasonable to think that we're still going to see the margin come in. Maybe still be able to grow net interest income, but margin be under pressure?

Len E. Williams -- President and Chief Executive Officer

You're right on, Andrew. We do feel we're going to be able to grow the net interest income, but we are impacted by these rate reductions in a pretty big way. We've got our short duration of our portfolio. That said, we talked about earlier about our concentration and bringing the loans, the capital down. We're now under a number where we're comfortable actually rebuilding some of that back up with the right clients and the pipelines we think will allow us to do some of that. So we'll probably see some longer-term larger real estate deals go on here in the next quarter to two quarters.

Andrew Brian Liesch -- Sandler O'Neill & Partners LP -- Analyst

Great. That's good to hear. You've covered all my other questions, I'll step back.

Len E. Williams -- President and Chief Executive Officer

Thank you.

Mark K. Olson -- Executive Vice President and Chief Financial Officer

Thanks, Andrew.

Operator

[Operator Instructions] Our next question comes from Don Worthington, Raymond James, go ahead.

Donald Allen Worthington -- Raymond James Financial Inc. -- Analyst

Thank you, good morning guys.

Len E. Williams -- President and Chief Executive Officer

Hi Don.

Donald Allen Worthington -- Raymond James Financial Inc. -- Analyst

Mark, you talked about the FDIC credit going another quarter or two. Is it at the same rate in this quarter or would it be a diminishing credit?

Mark K. Olson -- Executive Vice President and Chief Financial Officer

It would be about the same effect as we have right now for the next couple of quarters. I mean it's not a huge dollar amount, but we do get the benefit. So --

Donald Allen Worthington -- Raymond James Financial Inc. -- Analyst

Every little bit helps. Right. Yeah.

Mark K. Olson -- Executive Vice President and Chief Financial Officer

Exactly.

Donald Allen Worthington -- Raymond James Financial Inc. -- Analyst

And then mortgage banking revenue that was strong. Do you expect that to continue, particularly if rates declined further?

Mark K. Olson -- Executive Vice President and Chief Financial Officer

We do, we've actually hired a new gentleman to run our mortgage division. And we're increasing the size of it as far as producers as we speak. So, we are looking at non-interest income growth, both in the mortgage area if rates continue to decline, and then also by some of the strategies we have regarding treasury management, fee income.

Donald Allen Worthington -- Raymond James Financial Inc. -- Analyst

Okay, great. Thank you.

Mark K. Olson -- Executive Vice President and Chief Financial Officer

Thank you.

Len E. Williams -- President and Chief Executive Officer

Thanks Don.

Operator

This concludes our question-and-answer session. I'd like to turn the conference back over to Len Williams for any closing remarks.

Len E. Williams -- President and Chief Executive Officer

Great. Thank you all for joining us and your interest in the company. We appreciate you're being with us and look forward to these as we -- in the coming quarter. So thank you all and have a wonderful Thursday.

Operator

Conference is now concluded. Thank you for attending today's presentation. You may now disconnect.

Duration: 30 minutes

Call participants:

Mark K. Olson -- Executive Vice President and Chief Financial Officer

Len E. Williams -- President and Chief Executive Officer

Jeffrey Allen Rulis -- D.A. Davidson -- Analyst

Andrew Brian Liesch -- Sandler O'Neill & Partners LP -- Analyst

Donald Allen Worthington -- Raymond James Financial Inc. -- Analyst

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