Univest Financial Corporation (UVSP) Q1 2020 Earnings Report, Transcript and Summary

Good morning, and welcome to the Univest Financial Corp. First Quarter 2020 Earnings Conference Call. [Operator Instructions]. Please note the event is being recorded.Now I'd like to turn the conference over to CEO, Mr. Jeff Schweitzer. Please go ahead.

Thank you, Nick, and good morning, and thank you to all of our listeners for joining us. Joining me on the call this morning is Mike Keim, President of Univest Bank and Trust; and Brian Richardson, our Chief Financial Officer.Before we begin, I'd like to start by saying I hope everyone listening is staying safe and you and your families are healthy. I also need to remind everyone of the forward-looking statements disclaimer. Please be advised that during the course of this conference call, management may make forward-looking statements that express management's intentions, beliefs or expectations within the meaning of the federal securities laws.Univest's actual results may differ materially from these contemplated -- from those contemplated by these forward-looking statements. I will refer you to the forward-looking cautionary statements in our earnings release and in our SEC filings. Hopefully, everyone had a chance to review our earnings release from yesterday. If not, it could be found on our website at univest.net under the Investor Relations tab.We reported net income of $838,000 during the fourth quarter -- first quarter, sorry, or $0.03 per share. Earnings for the quarter were significantly impacted by $20.3 million or $0.55 per share of expense related to COVID-19, which was the result of economic assumptions within our CECL model.Before we get into further discussions on earnings, I would like to briefly discuss our response to the COVID-19 pandemic. Let me first say that our approach to this pandemic has been to focus, first and foremost, on the safety of our employees and customers and the decisions we have made as their safety is our highest priority.We are following the current guidance and recommendations from the government and regulatory agencies to protect the health and safety of our employees, customers and communities. We were the first financial institution in our market to institute drive-through only banking at our financial service centers, and 95% of our non-branch personnel are working remotely, at least part time with the vast majority working remotely full time.As the situation continues to evolve and the financial impact remains unknown, we continue to provide the service that Univest customers expect. We implemented new operating procedures at all of our financial centers and have reminded customers of the digital solutions available to them. We are offering assistance to our business and consumer customers who have been negatively impacted by the pandemic in the form of deferrals and waived fees.As noted in our earnings release, we have modified or are in the process of modifying over 1,100 loans with principal or principal and interest deferrals with an aggregate principal balance of $540 million. Additionally, we are one of the first banks in the market taking applications and approving loans through the SBA's $349 billion Paycheck Protection Program. We received over 2,850 applications for funding through this program. And before the initial funding was fully utilized, we got 1,051 applications approved by the SBA for $415.7 million. Interestingly, we have not seen notable usage of lines of credit as total line usage is consistent with where it was in January and February.Excluding the provision and expense we recorded in the first quarter related to COVID-19, we were pleased with our financial results for the first quarter. Prior to the stay-at-home orders going into effect in our markets, we had generated solid loan growth and ended the quarter with $62 million of loan growth or 5.7% annualized and deposits grew $47.2 million or 4.3% annualized for the quarter. Another bright spot for the quarter was the growth in mortgage banking revenue, which increased 468.1% or $2.3 million compared to the first quarter in the prior year as refinances picked up due to the low interest rate environment.Additionally, we took aggressive action with respect to deposit pricing during the quarter, reacting to the Federal Reserve's interest rate cuts. Brian will discuss our margin further in his comments. However, as everyone knows, the world changed in March, which calls into question many things for the duration of the year. We still do not know when stay-at-home orders will be relaxed in our markets or when businesses will be allowed to reopen. As a result, we are resending our original guidance for 2020 and will not be giving guidance for the remainder of the year at this time, as the impact of the pandemic on our local business communities and the timing of the return to more normal operations for local businesses is unknown.Before I throw it over to Brian, I just want to thank the members of the Univest family. I could not be more impressed or proud of the way our employees have handled the current environment. Their attitude, compassion, flexibility and willingness to jump in wherever needed over the past 6 weeks says a lot about them as individuals and about the culture at Univest. I thank them for all their amazing efforts and service to our customers, communities and each other.I will now turn it over to Brian for some additional discussion on our results.

Thank you, Jeff, and I would also like to thank everyone for joining us today. I hope each of you, your families and your friends are safe during this challenging time. As Jeff mentioned, we reported earnings of $0.03 per share for the quarter, which was impacted by $0.55 of COVID-19 related credit costs.We adopted CECL effective January 1, 2020. In conjunction with this adoption, our reserve for loan and lease losses -- loans and leases increased by $12.9 million, our reserve for investments increased by $300,000 and our reserve for unfunded commitments increased by $1.1 million. This was a total increase in reserves of $14.3 million, which resulted in an after-tax retained earnings adjustment of $11.3 million.Total CECL related charges for the quarter were $21.8 million. This included expense of $20.3 million or $0.55 per share related to COVID-19 and the resulting impact on economic forecasts used within our model. Excluding the COVID-19 impact, our CECL credit cost for the quarter would have been $1.5 million. Through the adoption of CECL in the first quarter provisioning, our reserves for credit losses and unfunded commitments have increased by $35.7 million or 100% since December 31, 2019. As of March 31, our allowance for credit losses is 1.53% of total loans and leases.I would now like to touch on 2 items related to the earnings release. First, despite the Federal Reserve's emergency rate cuts in early March, net interest margin, excluding purchase accounting and excess liquidity, increased 1 basis point compared to the fourth quarter of 2019. This was the result of certain liabilities repricing faster than a portion of our LIBOR-based variable rate loans. However, this was a short-term benefit, and we expect continued pressure on NIM and NII as our variable loans continue to reprice in the second quarter.During the quarter, we opportunistically sold $58 million of lower-yielding investments at a gain of $652,000 and extinguished a $35 million borrowing with a onetime cost of $656,000. Subsequently, we were able to purchase replacement investments with a slightly higher yield, which were partially funded with a 4-year borrowing at a rate approximately 125 basis points less than the extinguished borrowing.Second, our mortgage banking business had a very strong quarter. Net gain on mortgage banking activities totaled $2.7 million, which represented an increase of $2.3 million when compared to the first quarter of 2019. This was driven by strong refi activity, which accounted for approximately 60% of the origination volume for the quarter.On previous calls, we had expressed our intention to redeem approximately $50 million of sub debt on March 30, 2020, when it hit its 5-year anniversary. Based on the current economic conditions, we elected not to redeem the sub debt. We now have the ability to redeem it on a quarterly basis, and we'll evaluate those options as economic conditions normalize.Lastly, as Jeff mentioned, due to COVID-19 uncertainty and the related impact on -- from stay-at-home orders and social distancing directives could have on our customers and our businesses, we are resending the 2020 guidance that I provided on last quarter's call.While we are operating in uncertain times, our strong capital and liquidity positions us well to navigate this challenging environment. That is it for my prepared remarks. We'll be happy to answer any questions.Operator, would you please begin the question-and-answer session.

[Operator Instructions]. First question comes from Michael Perito of KBW.

Glad to hear everyone is doing reasonably well under the circumstances. I wanted to start on the credit side of the house. It seems like a lot of your local peers that adopted CECL are using kind of the baseline Moody's forecast to drive some of your GDP and unemployment assumptions. I guess, is that similar to what you guys utilize? And can you maybe lay out in a bit more detail what some of the underlying macro assumptions that you're using to drive kind of the reserve level that you put up in the first quarter?

Sure, Mike, this is Brian. We use various economic factors across our loan segments, including unemployment, housing price index, GDP, retail sales, et cetera. We do use Moody's. And for purposes of the March 31 calculation, we use Moody's baseline forecast from March 27.

Okay. So I mean it's reasonable. Obviously, what you guys did in the first quarter, I think it's fair to classify as kind of conservative and proactive. But having said that, obviously, there's still a lot of unknowns out there, right. So I mean, as you see it now four weeks later after that March 27 consensus that you used, I mean, there's probably room for a little bit more provision in the second quarter. I know it's hard to see even that far, so I'm not going to really ask to go beyond that. But is that a fair kind of sentiment you think at this point, given what you know?

I mean, our practice is to use the most recent forecast as of the balance sheet date. That said, we don't really focus on forecast that come out subsequent to the quarter. And as it relates to the second quarter, what real matter is where the forecast ends at the end of June. And it's certainly too early to tell exactly where those will land.

Okay. All right. That make sense. But as you guys look at the, I guess, how do you balance the reserve today against kind of stimulus and deferrals and things of that nature? I mean, it seems like it's a little bit of a tight role. I mean, you guys have an idea of how many clients are deferring. And my guess is those lines could get a risk of coming on the other side not quite as strong, but there's a lot of stimulus going around. How did you guys kind of factor that in when trying to decide kind of ultimate loss rates and the reserve level?

Well, at the early part of the cycle where we are here, I mean, using the baseline forecast, we presume includes a little bit of contemplation of that as we can go to a more determining on price forecast. That said, a 90-day deferral or a 180-day type deferral, it will shift cash flows, but under a life of loan loss perspective, there isn't an overwhelmingly large assumption of what that will do over the life of loans baked in currently.

Okay. Couple of more things I want to hit quickly. On the margin, I apologize if I missed it, but I was listening to your comments. I was just wondering if you had an idea of what the impact from the debt extinguishment would be on the second quarter NIM? And do you think it's enough to kind of hold NIM down only a few basis points? Or do you think with the full quarter's impact of all those thoughts, there'll be a decent amount of pressure on the margin in the second quarter?

There's a lot of moving parts when you look at NIM and NII in the second and even in the third quarter. Obviously, PPP...

I should clarify, yes. Sorry, Brian, excluding PPP. I know obviously, PPP could end up at the end because that's going to bring a lot of...

Lot of volatility to -- pricing of LIBOR loans is also going to bring inherently some volatility. There's a slight benefit that will come from the extinguishment of debt. But conversely, by holding on to the sub debt, there's an expense that goes along with that. So I would think kind of just assuming that there will be downward pressure going forward due to LIBOR loans resetting. Just as a reminder, during the first quarter, 1-month LIBOR averaged 141 basis points. As of yesterday, it was at 57 basis points. So there will be pressure resulting from that.

Yes. Okay. And then just lastly for me, and I'll step back. Jeff, just on capital. What are you guys thinking at this point? Obviously, the first quarter was a little onerous from a capital perspective. You had CECL in there and you had the big provision in there, and growth was still pretty robust. I imagine the capital levels will be a little bit [Technical Difficulty] higher going forward when you take some of those onetime items out and the balance sheet growth probably a bit slower in the second quarter. But can you comment maybe just on how you feel capital levels are today? And just general thoughts around the dividend and whether you're comfortable kind of keeping that at this point with the uncertainty?

Sure, Mike. We feel good about where our capital is. We obviously stress our capital levels and feel good about where we are from a capital and liquidity perspective, given all the uncertainties that everybody is aware of, going forward, we're comfortable that we have a good solid capital position and where we are, we aren't going to be doing any buybacks, consistent with pretty much everybody else in the industry. And at this point, the dividend is obviously something that Board looks at on a quarterly basis. But given our capital levels and where we are, we feel comfortable from a dividend perspective, at least for the near-term as we go forward.

Next question comes from Frank Schiraldi of Piper Sandler.

I just wondered if, Brian, maybe you could talk a little bit about your concentrations in some of the more sensitive areas like energy, restaurant, hotel, as a percentage of the total loan book and then to the extent you have the amount of each that is in deferral currently?

Sure, Frank. So from a hospitality, if we look at hotels, motels and the like, we're around $170 million is our exposure there from an outstanding perspective. Food service and the like, we're around $60 million. So that kind of gives you a sense on that side. On the CRE retail side, outstandings are roughly $250 million. So that's really the higher right now, everything is -- can be deemed higher risk when we have these stay-at-home and shutdown orders. But the ones I know that are commonly talked about kind of tend to be in retail and hospitality type space, and that's the exposures that we have in the current book right now. On the energy side, we don't have significant exposures at all.

Okay. And do all of those areas have elevated deferrals at this point, I would imagine?

Yes. I mean, on the hospitality side, around 60% is our deferral rate. So 60% of our book has some level of deferrals. And then on the remaining CRE retail, we're in that 10% to 15% range.

And food service that you mentioned, do you have that?

Yes. That's a net 10% to 15% -- sorry, no, that's included in my 60% for total aggregate hospitality between hotels and food service.

Got you. Okay. And just following up on that, another sector. Just curious how you guys are feeling about the ag book in this environment? Any color you can offer there?

Frank, it's Mike. Generally speaking, our ag book continues to perform and, quite frankly, continues to grow because we largely serve the Stanley type farms that are well diversified. And there continues to be a need for their products, be it eggs, be it poultry, be it milk, et cetera. And even though milk is at a declining level because the schools are being closed and some other factors, there's the alternative uses for milk that it can be used, such as cheese, ice cream, et cetera. So we continue to feel good about what we're doing on the ag side.

Okay. Great. And then just finally, just thinking about Phase 2 of PPP. It sounded like you guys had plenty in the hotter that when the government ran out of the 350. So I would imagine, do you think there's plenty of good opportunity there? How large do you see that opportunity for Univest?

Right now, Frank, we continue to get as many loans approved or as approved at this point. We believe that we'll have about 900 ready to go, when Congress formally allocates the money, when the House acts later today. And we have a large team ready to hit go and work through the FDA process. So that 900 equates to somewhere in the neighborhood of $85 million of additional funding, which will bring us very close to 2,000 loans and $500 million.

[Operator Instructions]. This concludes our question-and-answer session. I'd like to turn the conference over to Mr. Jeff Schweitzer for any closing remarks. Please go ahead.

Thank you, Nick, and thank you, everyone, for joining us today. These are obviously very uncertain times and challenging times. And most of all, I just hope that everybody listening is staying safe, social distancing and taking care of yourself and your families and everybody is healthy. We look forward to talking to everybody again at the end of the second quarter. And hopefully, we have a little more clarity on what's going on in the world. But until then, as I said, stay safe and appreciate you participating today. Have a great day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.