USCB Financial Holdings, Inc. (NASDAQ:USCB) Q2 2024 Earnings Conference Call July 26, 2024 11:00 AM ET
Company Participants
Luis de la Aguilera - Chairman, President & CEO
Rob Anderson - CFO
Bill Turner - CCO
Conference Call Participants
Woody Lay - KBW
Michael Rose - Raymond James
Christopher Marinac - Janney
Operator
Good morning, and welcome to the USCB Financial Holdings, Inc. Second Quarter of 2024 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions]. After today's remarks, there will be an opportunity to ask questions. [Operator Instructions]. Please also note that this event is being recorded.
I would now like to turn the conference over to Luis de la Aguilera, Chairman, President, and CEO of USCB Financial Holdings. Please go ahead, sir.
Luis de la Aguilera
Good morning. With me today reviewing our Q2 highlights is CFO, Rob Anderson; and Chief Credit Officer, Bill Turner, who will provide an overview of the Bank's performance, the highlights of which commence on Slide 3.
This past Tuesday, July 23 marked the third anniversary since USCB launched a successful IPO and went public, a clear milestone for our bank. Despite strong headwinds, including a prolonged inverted yield curve, growing inflation, and an unprecedented rise in interest rates, our team has consistently executed a strategic plan with a sense of urgency, disciplined risk management practices, benign credit metrics, and the support of an associate base committed to superior customer service.
Over these three years, assets have grown 47% or $791 million, while loans and deposits increased 63%, or $724 million and 43% or $617 million, respectively. Our clear, actionable strategic plan and a motivated team of bankers have combined to deliver continued sustainable results.
Again this past quarter, the Bank has delivered on all our key performance indicators. Our focused efforts to rationalize and lower deposit costs, while growing them has led to strong NIM expansion in Q2. Diversified quality loan production with high coupons continues. Non-interest income has surged and record profits in the quarter has led to notable improvement in efficiency, profitability, and our earnings per share, all of which Rob will review in the detail in a moment.
The backdrop to our results is the strength of the Florida economy, which continues to demonstrate remarkable resilience and growth, significantly outperforming the national average in 2024. The following page is self-explanatory, directionally showing nine select historical trends since recapitalization. Profitable performance based on sound and conservative risk management is what our team is focused on consistently delivering.
So let's now turn our attention to our specific financial results and key performance indicators, which will be reviewed by our CFO, Rob Anderson.
Rob Anderson
Thank you, Luis, and good morning everyone.
Looking at Pages 5 and 6, I would characterize Q2 as a fantastic quarter for USCB. Net income was $0.31 per diluted share and the highest since going public and simplifying our capital structure. Return on average assets was 1.01%, up from 0.76% in Q1. Return on average equity was 12.63%, up from 9.61% in Q1. NIM was 2.94% and up 32 basis points from the prior quarter. The efficiency ratio was 56.33%, down from 63.41% in the prior quarter, and tangible book value per share grew to $10.24, up 13% annualized from the prior quarter.
Driving this record performance was threefold. First and most notably was the improvement in the net interest margin as average earning assets continue to reprice upwards and our overall funding costs saw a marked decrease.
Net interest income increased $2.2 million or 57.1% annualized compared to the prior quarter, and $3.1 million or 22.1% compared to the second quarter of 2023. This momentum will benefit forward earnings as we enter the second half of the year.
Next, non-interest income showed a marked uptick as our strategies mentioned over the past year continue to pay off. And last, credit metrics remain benign.
So with that overview, let's discuss deposits on the next page. First, we saw our average deposit balances continue to grow and most notably was the DDA growth. Average DDA deposits increased $35.6 million or 24.9% annualized compared to the second quarter of 2023, and comprised 29.3% of total average deposits for the second quarter.
Second, imbued by the DDA growth was the decrease in the -- our overall deposit costs. This was driven by the pricing actions we mentioned on our previous call. Specifically, we're able to price down our interest bearing deposits by 10 basis points through the quarter and we continue to evaluate all relationship pricing based on the breadth and tenor of that relationship. Going forward, we believe that we can hold the deposit book steady at these rates. The key for us will be to continue to grow the DDA book.
With that, let's take a look at our loan portfolio. Average loans increased $47 million or $10.6 million annualized compared to the prior quarter, and $259.2 million or 16.5% compared to the second quarter of 2023. Loan coupons increased 15 basis points compared to the prior quarter and 85 basis points compared to the second quarter of 2023. Driving this performance is really laid out on the next page.
First, for the past four quarters, we have originated $571 million of loans with a weighted average yield above 8%. That's over 30% of our total loan book. This is a critical component to the improvement in our net interest margin as we look to remix our balance sheet with assets at higher yields. Also, the majority of these loans are fixed rate with five to seven-year terms and have embedded floors and prepayment penalties. This will provide protection in a down rate scenario.
In terms of the pipeline, we have a steady pipeline with solid credits priced in a similar fashion. Additionally, and very noteworthy is the diversification we have achieved over the past four years. CRE loans, which is the predominant loan type opportunity in this market, now makes up 56% of our total loan composition, and that's down from 63% just four years ago.
Okay. Let's turn the page and look at the margin. Q2 showed a marked improvement in both net interest income and net interest margin. This is a direct result of a larger balance sheet, improved earning asset yields, and lower funding costs. We remain optimistic about maintaining the NIM around this level near-term, but we have several reasons to believe the NIM will improve over time. So let me mention them.
Deposits have already been adjusted to a higher rate environment, so we don't expect material jumps in our interest bearing deposit rates. In fact, this quarter we lowered them.
Next, if the Fed drops rates in September as the market fully expects, we have over $1 billion in money market accounts that can be immediately repriced. We have 175 million of CDs maturing in the second half of this year at a weighted average rate of 4.62% and currently all of our CD renewal rates are at or below this rate. New loan production has been above 8% for four straight quarters, and as shown on the loan slide, the yield on the loan book continues to grind higher. We fully expect this trend to continue.
Also, at the end of June, we executed the sale of $35.5 million of bonds at a net gain of $14,000. The bonds carried an average life of 2.4 years and the funds were reinvested into new loan volume effectively locking in an additional 275 basis points. And with this transaction, we also extended our asset duration, which will protect our balance sheet from an expected lower rates.
We expect $23.6 million of cash flows coming off the securities portfolio this year at a weighted average yield of 3.32%, which can be reinvested into higher earning assets. I would also note with interest rates drifting lower, there may be additional opportunities to sell securities to reinvest into higher yielding assets. And finally, with a strong liquidity position beginning in Q3, we can pass on non-relationship rate sensitive deposits.
Let's go to the next page. According to our ALM model, the Bank's balance sheet remains slightly asset sensitive. However, when compared to the previous quarter, our asset sensitivity has decreased. The reduction in asset sensitivity is the result of management efforts to better position the balance sheet for expected lower rates. As all of you are aware, these rate scenarios are run with parallel shocks across all tenors, which is highly unlikely, for transparency purposes, we show these scenarios as it is disclosed in our filings and a regulatory requirement.
For example, if rates drop 100 basis points across all tenors, which again is highly unlikely, the NIM will contract slightly according to our modeled assumptions. However, a more likely scenario would be for the Fed to reduce short-term rates and the longer-term rates being the five, seven and ten-year rates, do not move down in an equal fashion. In these scenarios, we model more favorably. So in short, we believe we are well poised to capitalize on a rates down scenario.
So with that, let me turn it over to Bill to discuss asset quality.
Bill Turner
Thank you, Rob.
Please turn to Page 12. As you can see from the first graph, the allowance for credit loss increased to $22.2 million. This was due to a $786,000 provision in the second quarter. The allowance for credit loss ratio increased 1 basis point to an adequate 1.19% of the portfolio. The provision was driven by the $48 million net increase in the loan portfolio and net losses remained near zero for the quarter.
The remaining graphs on Page 12 show that non-performing loans as at quarter end, which increased 1 basis point to 0.04% of the portfolio, and classified loans also increased 1 basis point the second quarter to 0.45% of the portfolio and less than 5% of capital. No losses are anticipated from these classified loans. The Bank continues to have no other real estate.
On Page 13, the first graph shows the loan portfolio mix at 6/30. The portfolio increased $48 million on a net basis in the second quarter to $1.9 billion. As you can see, the composition remains well diversified. Commercial real estate, both owner occupied and non-owner occupied represents 56% of the portfolio, or just over $1 billion, and is segmented between retail, multi-families, owner occupied, office, warehouse, hotel and construction.
The second graph is a breakout of the commercial real estate portfolios for non-owner occupied -- for owner occupied and non-owner occupied loans, which also demonstrates these portfolio's diversification. The table to the right of the graph shows the commercial real estate weighted average loan to values at less than 60% and debt service coverage ratio is adequate for each portfolio segment. The loan quality and payment performance is good for all segments and the Bank's pass-through percentage is less than 0.5% or 1%.
On Page 14, we discuss the office portfolio. Our portfolio at quarter end consists of 123 loans, totaling $179 million or less than 10% of total loans. Almost all properties are B and C with 94% located in Florida. The average loan amount is $1.5 million with an average loan to value of 56% and an average debt service coverage of 1.79.
The quality of the office portfolio is good with all loans paying as agreed and no past due loans are classified loans.
The first graph shows the owner occupied offices making up 32% of the office segment with 57% of these loans being occupied by professionals and medical businesses. The second graph is a non-owner occupied office loan comprising 68% of the office portfolio with 85% of their usage being multi-tenant and medical. We are especially vigilant of the upcoming loan repricing maturing schedule for all portfolio segments and monitor and model the loan repayment ability during annual reviews to respond proactively as needed. Overall, the quality and performance of the loan portfolio remains good.
Rob?
Rob Anderson
Okay. Thank you, Bill.
Outside of the net interest margin, our fee businesses were the other bright spot in the quarter. First, you'll notice the nice upward quarterly trend in service fees. We have been speaking for some time that we are gaining traction; differentiating ourselves from our competitors and becoming our clients go to bank for their operational wire needs.
We are gaining new correspondent banks, doing more business with current clients and modifying our approach to wire fees with clients across the Board. All of these strategies have yielded new business.
Additionally, we have seen several clients prefer interest rate swaps at this point in the cycle and was one of the main drivers for the overall increase in fees this quarter. We have a nice pipeline of interest rate swaps with clients in for Q3 and Q4, but these can be lumpy quarter-to-quarter and interest rate dependent.
We had a solid quarter for SBA loan sales and again have a nice pipeline for Q3 and Q4. Other non-interest income increased due to the BOLI restructuring we did back in Q3 of 2023 and steady increases in treasury management fees. While the fee lines can be lumpy quarter-to-quarter, we do expect future quarters to be above the previous run rate.
So with that, let's take a look at our expenses. Our total expense base was $11.6 million and up from the prior quarter. Salaries and benefits are predominantly up due to additional dollars set aside for sales and management incentives. As mentioned previously, all incentive programs are based on company performance, so when the company does well, our team shares in that success.
Other line items were fairly in line with prior quarter, so stepping back and looking at overall expense strength; we can point to the incentive accruals as the main driver for the increase. Last year the accruals were low because of company performance, in this quarter it has moved up with improved performance. This meant adding additional dollars to the accrual in Q2 and catching up the accrual from Q1.
Even with the increase in expenses the efficiency ratio was 56.3%, which benchmarks well compared to peers. And if you prefer looking at non-interest expense to average assets, the ratio was 1.88% and in line with prior quarters and again, benchmarks well to peers. Looking forward, we would expect future quarters to be around this dollar amount level.
So with that, let's go on to capital. USCB capital levels remain comfortably well above capital or above well capitalized guidelines. We paid $0.05 per share dividend in the quarter and the company repurchased 25,000 shares of common stock at a weighted average cost per share of $12.04 during the quarter. Since putting the repurchase programs in place back in January of 2023, we have repurchased 702,020 shares with an average weighted cost of $11.34 per share. As of June 30, 2024, 547,980 shares remain authorized for repurchase under the company's share repurchase programs.
So with that, let me turn it back to Luis for some closing comments.
Luis de la Aguilera
Thanks Rob.
The results of the second quarter are strong and on course with our budget expectations and strategic plan and sustainable as contrasted with the growth trajectory of the past three years. As we reported on our last earnings call, new production hires have been sourced, onboarded, and are well contributing to our loan deposit and fee generation efforts.
Our bankers promote a variety of non-CRE loan offerings, which have supported the continued diversification of a conservative quality well priced loan portfolio. Again, lenders have generated over $570 million in new loan production over the past four quarters with a weighted average coupon of 8% or higher. These loans have floors which will positively impact NIM expansion when rates adjust downward.
Our planned management of concentration risk has led to a loan portfolio, which has increased by 97% to $1.9 billion since June 2020, and which is now 44% non-CRE. We anticipate further diversification as we continue growing our loans.
Organic deposit growth is key to franchise value and all production units are focused on this goal. Average deposits increased $35.3 million, or 6.9% annualized compared to prior quarters and increased 11.3% compared to the second quarter of 2023.
Average DDA balances comprised 29.3% of total average deposits for the second quarter of 2024. Again, a variety of deposit aggregating business verticals, including association banking, correspondent banking, and our private client group are focused on developing local deposit rich submarkets, which include legal and medical professionals.
As we have seen, our efforts to rationalize deposit costs in a highly competitive market has delivered meaningful results as NIM increased to 2.94%, up 32 basis points from Q1. Another bright spot in our overall production efforts can be seen in the growth of non-interest income, which was $3.2 million for the three months ended June 30, 2024, an increase of $1.4 million, or 74%, compared to $1.8 million for the same period in 2023. The results posted this quarter are clearly strong, and as I said before, they are anchored in the strength and resiliency of the Florida economy. The state's positive economic outlook is bolstered by a GDP and private sector job growth that is nearly double the national rates.
Florida leads the nation with over $3 million in new businesses formed since 2019, with more than $266,000 already established in 2024. As a commercially focused bank, it is these small to medium enterprises that are our primary target market, which we work hard to cultivate, serve, and grow with.
With that said, I would like to open the floor for Q&A.
Question-and-Answer Session
Operator
We will now begin the question-and-answer session. [Operator Instructions].
And our first question today will come from Woody Lay with KBW. Please go ahead.
Woody Lay
Wanted to start on non-interest bearing trends on an average basis really encouraging. It looks like average levels were a little bit ahead of the end of period. Just any comment on the trends you saw during the quarter?
Rob Anderson
Yes. So we did a lot of the pricing action on our deposits at the end of the first quarter and into the first month of the second quarter. We did see some movement at the end of the quarter, but you typically can see some movement on the last two weeks of the quarter, whether it's companies doing window dressing. We feel strong about growing our deposit book, so there's a little bit ups and downs, but the average really drives the net interest income and the net interest margin. So I think we're going to be fine. We expect to fully continue to grow in the second quarter as well.
Woody Lay
Yes. And the margin expansion in the second quarter, I mean, was really great to see. Is there some more pull-through that we'll see in the third quarter, or was the margin, like, relatively stable throughout the second quarter?
Rob Anderson
It was relatively stable throughout the second quarter. Like I said, we did a lot of deposit pricing actions at the end of the first quarter and the first month of the second quarter, so March and April. So we saw kind of a 2.94%-ish margin for all three months basically. We expect that to be stable, maybe near-term, to start grinding forward, but certainly it was a nice to see, it was mainly on the deposit side that we were able to gain the traction.
Woody Lay
Yes, definitely. And then last, maybe just shifting over to the C&I segment, I mean, you saw pretty strong growth within that segment. Can you just talk about sort of how you developed that -- how you have developed the C&I segment and sort of your expectations going forward?
Luis de la Aguilera
Certainly. Over a number of years, we've developed a number of verticals to diversify away from the CRE concentration that this bank historically had before the recapitalization. We developed verticals on Association Lending, on Yacht Lending, on SBA Lending, which are probably the three main drivers. Also, we continue on the residential side.
So, as we focus, and South Florida, Miami specifically, is not a big C&I town, but we focused our people on those areas, and they've done a very good job in developing them. Each one of these verticals has a senior product specialist, which we brought in. They over time have not only helped create our marketing strategies, but also training our lenders.
So we've been able to leverage the existing sales team and not necessarily have to hire additional teams to be able to do the job. They are very proficient in what they do, and I believe that they're going to continue doing exactly what you've seen over the last three years.
Woody Lay
All right. That's all from me. Congrats on the great quarter.
Luis de la Aguilera
Thank you.
Rob Anderson
Thank you, Woody.
Operator
And our next question will come from Michael Rose with Raymond James. Please go ahead.
Michael Rose
Hey, good morning, guys. Thanks for taking my questions.
Luis de la Aguilera
Good morning.
Michael Rose
You know what -- good morning. What stuck out to me was the growth in swap fees. I think that's kind of contrary to what we've seen, and I think you mentioned, Luis, that the pipeline was solid as we think about it going forward. Can you just explain maybe why swap fees are strong? I mean, maybe your customers are just a little bit later to actually kind of locking in, but it seems like the activity at other banks has kind of slowed. Thanks.
Luis de la Aguilera
Our clients and our -- again, our sales force on the lending side are very adept and trained to offer this box to client to explain it to them. And there's a lot of people that when you take the time to explain the benefits of it, they see the value and they want to move in that direction. So when we have a loan of a special type and term and size, that conversation happens. So we take the time to educate our clients in it, and they're the ones who make the decision. So the decisions have been favorable and we have capitalized on them.
We not only look at our future growth in our loan portfolio by what we have in it as far as size, we also identify the swap deals that the clients have requested and the letters of intent that have been issued and the commitment letters that have been accepted. So when we track that, we feel very comfortable that the swap activity is going to continue into Q3 and Q4.
Michael Rose
Very helpful. And then maybe just as a follow-up to that, do you have a sense for kind of like, what percentage of your customer base is actually using swaps? I mean, just trying to size the opportunity that is already on the balance sheet. And then obviously, as you grow, I assume there'll be more opportunities, but just would love to have some color there. Thanks.
Luis de la Aguilera
I think that the opportunity is very significant. It's not a huge percentage. We probably started getting active in the swap market maybe three years ago. So I can get back to you with the exact number. But again, it's a growing number based on the production of the pipeline we have. And I think the key has been educating our folks. But I just was given the information here that it's about 3% of the portfolio right now.
Rob Anderson
Yes, I was going to say, Michael, I mean, you got a handful of clients that may seek the swap. I mean, if you think about why a client may want that right now, let's say you're doing a balance sheet rate, and that might be, let's call it 750. The swap rates plus a reasonable spread can be below that. And if they want a longer tenure, let's say 10 years, we may not want the fixed rate for the 10 years, and then we'll be getting a variable like SOFR plus spread, 200, 300 basis points, and the client gets the fixed rate.
So it come to them a little bit lower. But we are seeing a little bit more activity from clients asking for that. We have a pipeline, but those can be lumpy from quarter-to-quarter. This quarter was 650, the last quarter was 285. So -- but we are -- we all -- we are seeing the activity and we do have a pipeline for Q3 and Q4 is what I would say.
Michael Rose
Got it. Makes a lot of sense. Thanks for the color. Maybe just switching over to the balance sheet, obviously loan growth has been really strong. And I know you have a prior outlook of around 10%. You're tracking over that. Seems like maybe there's some, maybe nearer-term reticence, but just macro wise. But you guys are in really good economies. You have momentum. Any reason that that number wouldn't end the year higher than that and then just separately on deposits certainly appreciate the reduction rates. You'd kind of talked previously about also growing; I think deposits around 10%. Just wanted to get a sense for an update on both loans and deposits. Thanks.
Luis de la Aguilera
Yes, both loans and deposits. I think you're going to see a similar growth rate, I think in the future quarters as you saw this quarter. Right now, we'd like to fund kind of the loan growth with existing deposit growth relationship, low cost, cost deposits. As I mentioned, we're going to have some cash flows off the securities portfolio. We'll have some opportunistic maybe to look at selling a few more securities here and there to fund some stuff. But overall, I would say it's going to be in the low-double digits above.
Michael Rose
Very helpful. I'll step back. Thanks, guys.
Luis de la Aguilera
Thank you.
Operator
[Operator Instructions].
Our next question will come from Christopher Marinac with Janney. Please go ahead.
Christopher Marinac
Thanks. Good morning. I wanted to ask a little bit more about the cost of funds and the fact that you had a little bit of rollover this quarter. Do you see that continuing, and do you see any sort of new funding basis that can lower costs going forward?
Rob Anderson
Yes. Let me start. I would say, on it from a cost standpoint, even looking at the month of June and the three months in the quarter, we're probably going to be a little steady on our deposit cost. We did lose a little bit of funding at the end of the quarter, and that was kind of rate sensitive. When we did drop the rates, they stuck around for a little bit, but some of it moved. We anticipated that movement.
I think for us, growing our DDA growth and keeping the DDAs in there will be key, but the expectation is that we hold at kind of the current level on our deposit cost because we did do a pretty sizable push on the end of the first quarter in April to really reprice some deposits and looking through that. Now we're doing more of that. We do that every day. But I would expect the future quarters to be right around the current level, not up or down materially without any rate movements from the Fed.
Christopher Marinac
Great, Rob. That's helpful. And then just a quick credit follow-up, what do you see out there in terms of special mentioned criticized? Just want to go a little bit deeper than what you had in the presentation. Is there anything sort of pending on that front, either good or bad, on the inflows for credit?
Bill Turner
No. We monitor the portfolio very closely and react quickly to the problems as we see them. And there's nothing out there specifically that is of concern right now.
Christopher Marinac
Great. Thank you for all the disclosure this morning.
Luis de la Aguilera
Thank you, Chris.
Operator
And this concludes our question-and-answer session. I would like to now turn the conference back over to Luis de la Aguilera for any closing remarks.
Luis de la Aguilera
Well, thank you all very much. On behalf of the U.S. Century team, I would like to thank you all for your attendance and look forward to meeting again in our next earnings call.
Operator
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.