United Community Banks (UCBI) Still Following A Tested Formula

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It may seem like damning with faint praise, but there’s nothing all that unusual about the business strategy that United Community Banks (UCBI) is following. A smaller bank still focused principally on commercial real estate lending, UCBI has used serial acquisitions of small banks to build its operations, and the company remains focused on attractive fast-growing markets in the Southeast.

It’s been a while since I’ve written about United Community, but over the past five years, the company has more or less tracked the small bank sector. United Community operates in increasingly competitive markets, but the bank prioritizes high-touch customer service at a time when many larger banks are trying to shift more commercial lending to a digital-enabled “DIY” model. What’s more, there’s still room for the company to expand beyond CRE lending, with asset-backed lending, equipment finance, healthcare, and SBA lending all offering opportunities.

United Community doesn’t jump off the page as being dramatically cheaper than other growth banks, but I do still believe that a lot of growth banks are trading with some worthwhile upside. Between attractive underlying markets, opportunities to expand the lending franchise, and more M&A in the future, I believe that UCBI could generate long-term earnings growth in the double digits, making the current 11.5x multiple on 2023 earnings (similar to banks with more modest growth expectations) worth a further look.

A Somewhat Lackluster End To 2021

United Community’s fourth quarter wasn’t awful, but it wasn’t a strong end to the year, as higher expenses led to a modest miss at the pre-provision line as well as a small miss at the core EPS line.

Revenue declined 8% year over year and 5% qoq, coming in about 2% better than expected. Net interest income declined 5% yoy and 2% qoq, beating modestly, as net interest margin declined another 31bp (missing by over 30bp), but earning asset growth significantly exceeded expectations, growing 8% sequentially.

It’s well worth mentioning that bank M&A typically complicates the modeling process, and the process of running PPP loans through adds another twist. “Core” net interest margin was down less than 10bp, and there really wasn’t anything structurally wrong with the results.

Fee income declined 12% qoq, with a significant decline in the mortgage business (down 21%), but overall results were still better than expected. Expenses rose 4% qoq, coming in a little better than expected. Pre-provision profits declined 14% and accounted for about half of the $0.03 “core” EPS miss, but again given the recent acquisitions, I would be careful about reading too much into that double-digit decline in PPOP.

Loan Demand Ramping Up As Management Looks To Leverage Recent Deals

To this point in the recovery, commercial and industrial (or C&I) lending has been outpacing CRE lending, with strength in areas like asset-backed lending standing out. While UCBI’s 2% organic sequential loan growth was a little lackluster compared to what many of the larger regional banks have done (banks with larger C&I lending businesses), UCBI has done relatively well for a CRE-led business (management includes owner-occupied CRE in C&I, but I do not).

The better news is that business conditions are improving. With the exception of South Carolina (which accounts for a little less than 20% of UCBI’s loan book), real estate markets across the Southeast are very healthy now, and the bank is looking at improving loan demand and higher rates in 2022. Double-digit loan growth is likely a stretch, but I believe high single-digit loan growth is attainable even with run-off from recent deals. I also see opportunities for UCBI to grow its asset-backed lending business and take advantage of dislocations in healthcare markets like senior care where many banks have pulled back or pulled out of the market.

Rates will also help. Management believes that net interest margin has bottomed, and while UCBI isn’t exceptionally asset-sensitive, it does still have positive leverage to higher rates and a lot of excess liquidity that can be deployed more profitably into lending.

More Deals A “When, Not If”

Management is going to take its time integrating the recent Aquesta and Reliant acquisitions, but I would argue that management is always open for business when it comes to strategic M&A if the price is right. I expect that whole bank deals are the preferred option, but I think management would consider a specialty lending deal if the right opportunity came to them.

As far as target markets, I would expect UCBI to want to increase its presence in North Carolina, as the bank is relatively under-exposed to both the Triangle (Raleigh, Durham, Cary, Chapel Hill) and Triad (Greensboro, Winston-Salem, High Point) regions, both of which are demographically attractive in terms of population growth and median incomes. I also wouldn’t be surprised if UCBI considered deals in Virginia and/or looked to “backfill” other parts of its existing multi-state footprint. Longer term, I believe markets in the Florida panhandle and Alabama could also make sense.

Growth by acquisition is frowned upon by a lot of investors, and it’s inarguably true that overpaying, buying the wrong assets, and/or screwing up the integration can all waste investor capital and destroy value. Banking is a little different, though, given the consistent opportunity to leverage back-office cost reductions, and I believe UCBI has shown it can successfully integrate deals. I think it’s also worth noting that UCBI’s tangible book value per share has grown at an annualized rate of 11% over the last decade.

The Outlook

Modeling acquisitive banks is always more challenging than banks more focused on organic growth. If you exclude potential value-creating deals, you often underestimate the current value of the franchise. If you try to estimate future deal values and accretion, it’s easy to get sucked into a “choose your own outcome” process where you set a target and work backwards.

I believe that if UCBI were to not do another deal, it could still reasonably generate high single-digit core earnings growth on the strength of the underlying growth in its markets and its opportunities to take business from less attentive large banks and less capable community banks. Add in some level of M&A and I think double-digit earnings growth is credible.

The Bottom Line

Because of the uncertainties of modeling an acquisitive bank, I use my normal go-to valuation approach (long-term core earnings/excess returns) more as a backstop and reality check than a primary valuation tool. While I have my issues with the P/E approach, it can be useful in cases like this. Currently, UCBI is trading at a pretty average-looking 11.5x multiple of my ’23 EPS estimate, and I think a well-run bank with a mid-teens ROTCE and double-digit growth potential should trade more in the 13x-14x range, giving me a $40.50-$44 near-term fair value target.

UCBI’s model won’t work for all investors, and it’s certainly true that UCBI could face more competition in its Southeast markets and more difficulty profitably growing loans than I currently forecast. With an improving macro backdrop and a proven management team, though, I think this is a name for more aggressive investors to consider.

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