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Edited Transcript of UCFC earnings conference call or presentation 24-Jul-19 2:00pm GMT

Q2 2019 United Community Financial Corp Earnings Call

Youngstown Aug 6, 2019 (Thomson StreetEvents) -- Edited Transcript of United Community Financial Corp earnings conference call or presentation Wednesday, July 24, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Gary M. Small

United Community Financial Corp. - President, CEO & Director

* Matthew T. Garrity

United Community Financial Corp. - Executive VP of Commercial Lending & Credit Administration and Director of Home Savings Bank

* Timothy W. Esson

United Community Financial Corp. - CFO

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Conference Call Participants

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* Adela Dashian

Keefe, Bruyette, & Woods, Inc., Research Division - Assistant Analyst

* Robert Scott Siefers

Sandler O'Neill + Partners, L.P., Research Division - Principal of Equity Research

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Presentation

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Operator [1]

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Good morning, and welcome to the United Community Financial Corp. Second Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded. I would now like to turn the conference over to Tim Esson, CFO. Please go ahead.

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Timothy W. Esson, United Community Financial Corp. - CFO [2]

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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.

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Gary M. Small, United Community Financial Corp. - President, CEO & Director [3]

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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 the 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 and residential portfolio was 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 reenergized our indirect lending effort after about a 6-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. Noninterest-bearing deposit growth was just shy of 8% over that period and business deposits are 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 is up 5.8% Q2 to Q2. Margin for the quarter is down 3 basis points from last year's same period and down 5 basis points on a linked-quarter basis. Of the 5 basis point linked-quarter reduction, lower purchase accounting accretion accounts for 2 bps of the reduction. We lost a bp 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 6 to 8 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 of some of those promotional rates. We were moving over 40 basis points versus where we were when we were trying to attract money.

We have sufficient liquidity and funding sources to support our balance sheet growth, and that's going to allow us a more moderate deposit pricing positioning in the marketplace through year-end. Credit quality indicators remained very positive. For the quarter, we were at a net recovery position and the slight increase in nonperforming loans that appeared as of 6/30 has already subsided due to paydowns 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 noninterest income perspective, the residential mortgage 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 worse 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 markdown 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 -- residential mortgage production activity and expect excellent results in the residential mortgage business for the remainder of the year.

On the expense front, we returned to a more normalized level for our organization of just under $60 million for the quarter, as we had expected.

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

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Matthew T. Garrity, United Community Financial Corp. - Executive VP of Commercial Lending & Credit Administration and Director of Home Savings Bank [4]

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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 activity in our commercial business and non-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 continue 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 salable originations. This improvement provided an offset to the 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, we're 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.

Nonperforming 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 will review our financial performance in greater detail.

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Timothy W. Esson, United Community Financial Corp. - CFO [5]

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Thanks, Matt. Let me begin by reiterating Gary's opening comment that Q2 again demonstrated very solid performance numbers. And as far as income concern, it was a record performance.

We saw a 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 were 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 $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 increase aggregated 7.7%. Increases in money market, business and noninterest-bearing accounts have all contributed to this increase. We have experienced significant deposit growth in the first half of '19, but we'd 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 compare 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 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, noninterest 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 2 quarters, further complementing this for increases in brokerage and mortgage servicing fees along with trading and security gains.

These gains were partially offset with a fairly significant mortgage servicing rights valuation adjustment of approximately $995,000 during the quarter. This adjustment can be credited to a drop in long-term interest rates and the commensurate rise in mortgage prepayments fees.

Noninterest 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 noninterest expense over the last year's level.

The efficiency ratio is at 55.4%. As we indicated on our last call, we expect this number to decrease to the mid-50s level for the quarter, which aligned 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.

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Gary M. Small, United Community Financial Corp. - President, CEO & Director [6]

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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 point 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 in 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, a 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. We'll have stronger fee income primarily driven by the residential mortgage business, and expenses are right on target. Expect net income to come in as we'd planned for the year, which is slightly higher than the current consensus estimates. We've had a more robust share repurchase plan over the first 6 months than we originally planned, and that's adding to the trajectory of EPS.

I can affirm that our expectations of 12% to 15% EPS improvement on a full year basis versus the same period last year or the 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.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question will come from Scott Siefers of Sandler O'Neill.

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Robert Scott Siefers, Sandler O'Neill + Partners, L.P., Research Division - Principal of Equity Research [2]

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Just wanted 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 paydown activity being elevated, unfortunately kind of an industry issue. But it sounds like it is a little bit of a greater headwind than we might have anticipated. I guess just, Gary, any thoughts on -- any update and insight or any relief that you might see? Or how do you think about that dynamic as well?

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Gary M. Small, United Community Financial Corp. - President, CEO & Director [3]

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Good question, Scott. I'm going to turn it over to Matt to give us the particulars.

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Matthew T. Garrity, United Community Financial Corp. - Executive VP of Commercial Lending & Credit Administration and Director of Home Savings Bank [4]

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Sure, Scott. 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, were people were just selling their businesses, which were great gains for them, great returns. But not something that we necessarily would be able to budget and have planned. So when we look at our outlook for the year, that really represents that decline from original guidance. And to your first question about the 6%, that's for the full -- that will be full year growth. The 6% to 8% loan growth guidance that we gave you is full year guidance, not trajectory.

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Robert Scott Siefers, Sandler O'Neill + Partners, L.P., Research Division - Principal of Equity Research [5]

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Okay. Perfect. 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 with -- 2Q was a really big number so there's sort of a lot of error between what you did in the 2Q and what the typical quarter is. Just curious as to your thoughts there.

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Gary M. Small, United Community Financial Corp. - President, CEO & Director [6]

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Yes, it was -- 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 re-up with the Board this quarter. 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 it's actually will be the same, less or more. But as part of our capital managing strategy and with the balance sheet being a little bit more crimp by 2% or so than we had originally planned, we're just that much more over capitalized and we'll act accordingly.

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Operator [7]

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The next question will come from Michael Perito of KBW.

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Adela Dashian, Keefe, Bruyette, & Woods, Inc., Research Division - Assistant Analyst [8]

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This is actually Adela Dashian on for Mike Perito. My first question is -- I have a question about the mortgage banking business. You mentioned in the release that margin should be stronger. But do you think this pipeline consisting of recent activity really starts to decrease?

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Matthew T. Garrity, United Community Financial Corp. - Executive VP of Commercial Lending & Credit Administration and Director of Home Savings Bank [9]

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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 a nice improvement with respect to what makes up refinance activity in our pipeline. So that's a growing piece of our business right now.

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Gary M. Small, United Community Financial Corp. - President, CEO & Director [10]

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And 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, and then we only have modest growth expectations there. Really, the only thing that goes on is what needed to facilitate the bigger business of originating sale, and that margin on our sell and sold business has been climbing all year.

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Matthew T. Garrity, United Community Financial Corp. - Executive VP of Commercial Lending & Credit Administration and Director of Home Savings Bank [11]

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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. It's helped 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 salable business in our book.

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Adela Dashian, Keefe, Bruyette, & Woods, Inc., Research Division - Assistant Analyst [12]

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Okay. Great. And then could you also give us a more color on how the insurance investment fee income initiatives are coming along? Like what are some reasons to hold great expectations there?

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Gary M. Small, United Community Financial Corp. - President, CEO & Director [13]

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I'd say just on the insurance side, we'll have a year that's better than last year. We had better profit sharing, and so forth. We continue to see sort of a mixed story in 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 forward is continued acquisition opportunities to grow that business beyond the -- and gain some scale, and that's probably our fastest path to more meaningful results.

But the business, it does pretty well, we're very happy with our margin on the line of business and the investments we've made. On the investment side, we're having a good year. We've moved some dollars between, say, trust and investment, 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 transaction 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.

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Operator [14]

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

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Gary M. Small, United Community Financial Corp. - President, CEO & Director [15]

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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 provision discussion managing their expenses and probably doing a little bit better on the fee income side.

We do view a couple basis point movement downward on absolute growth as an episodic issue that's 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 thoughts 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 would be back on the table again once we get up to this year. And thank you for joining us and I look forward to next quarter.

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Operator [16]

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Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines. Have a great day.