Atlantic Union Bankshares Corporation (NASDAQ:AUB) Q4 2022 Earnings Call Transcript

Atlantic Union Bankshares Corporation (NASDAQ:AUB) Q4 2022 Earnings Call Transcript January 24, 2023

Operator: Good day and thank you for standing by. Welcome to the Atlantic Union Bankshares Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. Please be advised today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Bill Cimino, Senior Vice President, Investor Relations. Please go ahead.

Bill Cimino: Thank you, Michelle. And good morning, everyone. I have Atlantic Union Bankshares’ President and CEO, John Asbury, and Executive Vice President and CFO, Rob Gorman, with me today. We also have other members of the executive management with us for the question-and-answer period. Please note that today’s earnings release and the accompanying slide presentation we are going through on this webcast are available to download on our Investor website, investors.atlanticunionbank.com. During today’s call, we will comment on our financial performance using both GAAP metrics and non-GAAP financial measures. Important information about these non-GAAP financial measures, including reconciliations to comparable GAAP measures, is included in the appendix to our slide presentation and in our earnings release for the fourth quarter and fiscal year of 2022.

We will make forward-looking statements on today’s call, which are not statements of historical fact and are subject to risks and uncertainties. There can be no assurance that actual performance will not differ materially from any future expectations or results expressed or implied by these forward-looking statements. We undertake no obligation to publicly revise or update any forward-looking statements. Please refer to our earnings release issued today and our other SEC filings for further discussion of the company’s risk factors and other important information regarding our forward-looking statements, including factors that could cause actual results to differ from those expressed or implied in any forward-looking statement. And all comments made during today’s call are subject to that Safe Harbor statement.

At the end of the call, we will take questions from the research analyst community. Before I turn the call over to John Asbury, I wanted to remind everyone that Atlantic Union Bankshares common stock and depository shares, each representing 1/400th interest in the share of our preferred stock, are both now trading on the New York Stock Exchange. Our common stock symbol remains AUB, while our depository shares trade under AUB.PRA to conform with the NYSE nomenclature for preferred stock. I’ll now turn the call over to John.

John Asbury: Thank you, Bill. Good morning, everyone. And thank you for joining us today. Atlantic Union Bankshares delivered a strong quarter to close out 2022. Importantly, we hit our top tier financial targets during the fourth quarter as we said we would. We recorded low double-digit annualized loan growth, our net interest margin expanded meaningfully, asset quality remains strong, we kept expenses in line and generated significant positive operating leverage. As in prior quarters. I would like to begin by commenting on the macroeconomic environment and our primary operating footprint before I delve more deeply into details on our results. For perspective, traditionally, Virginia has been a stable economic area and not one prone to big swings in either direction.

The federal government acts as both a significant catalyst and shock absorber to the Commonwealth’s economic engine and the economic base here is diverse. Given how Virginia has fared in the past, we currently expect the effects of any potential recession to be somewhat muted as here, although we believe we are well positioned should economic conditions worsen from historical trends. Virginia’s last reported unemployment rate of 2.8% in November notched up slightly from 2.6% at the end of last quarter, but it remains below the national average of 3.6% during the same time period. This is relatively in line with where it was before the pandemic. As I like to do, I’ve been out meeting with our clients, the Virginia business community and our teams, and I can report that, anecdotally, we still do not believe dreary economic headlines nationally reflect what we see going on in our footprint.

Our markets appear to be healthy, and our lending pipelines, while down about 5% lower than the same time last year, are strong. We still don’t anticipate any near-term shift away from the positive trends of low unemployment and a benign credit environment, but we will continue to monitor conditions in our markets. While we do expect the Federal Reserve to further raise short term rates in the first half of 2023. Since we are fairly asset sensitive, additional short term rate hikes over the next few quarters should support our operating results and help to offset increases to cost of funds and the rising rate environment and accelerating deposit rate competition. As usual, we remain focused on generating positive operating leverage. That is, growing our revenue faster than our expenses.

Our numbers have been noisy for the past few years with pandemic-related loan loss provision swings, the revenue impact of the Paycheck Protection Program and various expense reduction items such as branch and facility rationalization. But if you drill down and adjust for those factors, which were not as material this quarter, you can see the strength of the core franchise over time. And to that point, pre-PPP adjusted revenue growth was approximately 11% year-over-year and was 7% on a linked-quarter basis from the third quarter of 2022. As a result of prior expense management actions, our adjusted operating non-interest expense run rate increased 4% year-over-year and was flat quarter-over-quarter. Company generated positive pre-PPP adjusted operating leverage of approximately 7% on a year-over-year basis and 7% quarter-over-quarter.

I’d also like to point out that, excluding PPP, pre-tax pre-provision adjusted operating earnings increased 23% year-over-year and 17% from the prior quarter. Now let me turn to some of the high points for the quarter and 2022. We posted annualized loan growth of approximately 15% point to point in the seasonally high fourth quarter. And for the full year, we recorded point to point loan growth of approximately 11% excluding PPP. This was our fifth consecutive quarter of high-single digit annualized lung growth or better, excluding PPP. We believe that we are well positioned to deliver 6% to 8% loan growth for 2023, given the strength of our current pipeline, our competitive positioning, the market dynamics and fundamentals in the markets that we serve.

We do recognize that the economic environment in our footprint could change as persistent inflation, higher interest rates and the threat of recession do loom, but currently we expect to remain in a moderate growth mode in 2023. C&I line utilization ticked up at the end of the quarter to 35%. And that’s still below our pre pandemic levels of over 40%, but better than at this time last year, which was approximately 28%. We believe we have further upside here as working capital needs continue to normalize among our clients over time. Our loan production in the fourth quarter of 2022 nearly equaled our record production in the fourth quarter of 2021. About 43% of production in the fourth quarter came from new-to-bank clients and 57% came from existing clients.

CRE payoffs continued to slow year-over-year and are well off the peaks we saw in the second through fourth quarters of 2021. As I’ve said for the last two quarters, rising term rates have suppressed both refinance activity into the long term institutional markets on commercial real estate and too good to refuse offers on commercial real estate properties. In the fourth quarter, we saw a notable acceleration in deposit rate competition. While deposits averaged up 3% quarter-over-quarter, we did experience runoff at the end of the year, largely in transaction accounts, impacting our point-to-point growth comparisons and more than offsetting the $418 million deposit increase we experienced in the third quarter. Nearly all of the third quarter increase was also in transaction accounts.

For the full year, point-to-point deposits declined 4.1%, and that was actually consistent with our original expectations for the year. There were a number of factors behind the late December transaction account runoff. These include a relatively small set of larger commercial clients and affluent consumer clients with excess liquidity, moving funds to higher yielding alternatives, normal seasonality outflows and some spending increases due to inflationary factors. At year-end, our loan-to-deposit ratio was 90.7%, which is at the lower bound of our targeted range of 90 to 95%. As of yesterday, the loan-to-deposit ratio was approximately 88%, with the improvement coming from deposit growth we posted month to date in January. Deposit rate competition intensified in the fourth quarter along with a rapid unprecedented rise in short term rates, and we have made further rate adjustments to seek to maintain competitiveness and defend the deposit base.

Since our deposit base overall is pretty granular and comprised of 57% transaction accounts, we do expect deposit betas throughout the remainder of the rising rate cycle to increase, but still be manageable. Our latest modeling shows that our net interest margin is likely now at or approaching an equilibrium point. By that, I mean we expect NIM to hold steady from here and further rate actions by the Fed will allow us to offset higher rates paid on funding with higher yields on our loan portfolio, half of which is variable rate. It’s difficult to forecast exactly what will happen, but we believe this is the most likely outcome. Rob will provide additional perspective on this during his comments. I do want to touch on a few new fee-based activities I mentioned last quarter.

We retooled our SBA 7(a) program in June and executed our first 7(a) loan sale during the fourth quarter. Additionally, loan syndications, originations were active and we are building a run rate with our foreign exchange program. The combination of these three new capabilities resulted in $1.3 million of fee-based net revenue for the quarter, and we expect them to generate around $6 million of net revenue over the course of 2023. Worth noting is that these new revenue streams should largely offset fee income declines from the various customer friendly NSF OD changes we made last year. Asset quality remains strong, with annualized net charge-offs of 2 basis points for the fourth quarter. For the full year. net charge-offs were also 2 basis points.

Credit losses will eventually normalize to historical norms, and one-offs can come at any time. But given the continued low unemployment rate and still solid fundamentals in our markets and client base, we have yet to see any sign of a systemic inflection point in our asset quality metrics. While economic uncertainty and the threat of recession could negatively impact our markets, the current economic situation and the footprint appears to remain sturdy and, as noted, we expect the impact of any macroeconomic slowdown to be somewhat tempered here in our home state of Virginia. Because we believe we’re in the late stages of a NIM expansion cycle, we also took additional expense actions during the quarter. Among other efficiency initiatives, we decided to consolidate five additional branches set for closure in March.

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Since the pandemic began, we have consolidated 27% of our branch network, yet still posted net positive consumer household growth for the year. In sum, 2022 was not only a good year for Atlantic Union, but also a good demonstration of the value and earnings power of the franchise we have all built. Looking back at my now six years at the company, we have been clear, consistent and intentional in our strategy. We’ve made great progress in successfully diversifying our product lines and capabilities, while building our core franchise, our culture and our brand. We’re far from done with these efforts. And in fact, we’ll never be done since we view our transformation as continuous and not an event. But we have come a long way, a very long way. And for that, I’d like to express my gratitude to our teammates, since they are the ones who make this all possible, delivering each and every day for our customers, shareholders and the communities we serve.

Looking ahead, I remain confident that we’re well positioned to manage our way through the challenges that lie before us. While the operating environment may be uncertain, what is certain is that Atlantic Union Bankshares remains a uniquely valuable franchise. It is dense, it is compact and great markets with a story unlike any other in our region. We’re scalable, and we’re growing our capabilities, operating in the right markets with the right team to deliver top tier financial performance, even in the most trying of times. I’ll now turn the call over to Chief Financial Officer, Rob Gorman, to cover the financial results for the quarter. Rob?

Robert Gorman: Well, thank you, John. And good morning, everyone. Thanks for joining us today. Now let’s turn to the company’s financial results for the fourth quarter. In the fourth quarter, reported net income available to common shareholders was $67.6 million and earnings per common share was $0.90. This was up approximately $12.5 million or $0.16 per common share from the third quarter’s reported net income available to common shareholders. Return on tangible common equity was 22.9% in the fourth quarter, up from 17.2% in the third quarter. Return on assets was 1.39% in the fourth quarter, up from the 1.15% reported in the prior quarter. And on an operating basis, the efficiency ratio was 50.6% in the fourth quarter, down from 54.1% in the third quarter.

Also during the fourth quarter, the company continued to generate positive operating leverage as total revenue grew approximately 7% and operating expenses were flat on a linked-quarter basis. Importantly, as John previously mentioned, we hit all of the top tier financial targets we set on a run rate basis in the fourth quarter. Turning to credit loss reserves, as of the end of the fourth quarter, the total allowance for credit losses was $124.4 million, which was an increase of approximately $5.4 million from the third quarter, primarily due to net loan growth during the quarter and increased uncertainty in the macroeconomic outlook. The total allowance for credit losses as a percentage of total loans remained at 86 basis points at the end of December.

The provision for credit losses of $6.3 million in the fourth quarter was relatively flat from the prior quarter’s $6.4 million provision for credit losses. Net charge-offs remain muted at $810,000 or 2 basis points annualized in the fourth quarter. And for the year, the net charge-off ratio came in at 2 basis points as well. Now turning to pre-tax pre-provision components of the income statement for the fourth quarter, tax equivalent net interest income was $168 million, which was up approximately $13.4 million or 8.7% from the third quarter, driven by higher interest income due to increases in loan yields on the company’s variable rate loans due to rising market interest rates and average loan growth, as well as increases in investment income primarily due to increased yields on taxable securities.

These increases were partially offset by higher interest expense due to higher cost of funds, primarily reflecting the impact of increases in short term interest rates on borrowings and deposits, increased use of short term funding and higher average deposits from the prior quarter. The fourth quarter’s tax equivalent net interest margin was 3.70%. That’s a net increase of 27 basis points from the previous quarter due to an increase of 66 basis points in the yield on earning assets, partially offset by a 39 basis point increase in our cost of funds. The increase in the fourth quarter’s earning asset yield was primarily due to the 70 basis point increase in the loan portfolio loan yield, which had a 62 basis points positive impact on the fourth quarter’s net interest margin.

In addition, higher investment securities yields in the fourth quarter drove a 3 basis point increase to the quarter’s net interest margin. The loan portfolio yield increased to 4.90% in the fourth quarter from 4.2% in the third quarter, primarily due to the impact of rising short term interest rates on variable rate loan yields. The 39 basis point increase in the fourth quarter’s cost of funds is due primarily to the 32 basis points increase in the cost of deposits, driven by increases in interest checking, money market and time deposit rates, as well as increased wholesale borrowing rates due to rising market interest rates. Non-interest income decreased $1.1 million to $24.5 million, primarily due to declines in equity method investment income, partially offset by increases in loan syndication, SBA 7(a) and foreign exchange revenues, each included within other operating income line item.

In addition, mortgage banking income decreased $1.01 million from the prior quarter due to lower mortgage origination volumes and gain on sale margins. And bank-owned life insurance declined $796,000, reflective of the impact of prior quarter’s mortality benefit received. These non-interest income category decreases were partially offset by increases in loan-related interest rate swap fees of $1.6 million due to an increase in average deal size amongst swaps executed in the quarter. Non-interest expense decreased $130,000 to $99.8 million for the fourth quarter versus $99.9 million in the prior quarter. Notable expense activity in the fourth quarter of 2022 included a gain related to the sale and leaseback of an office building, refunds of prior-period FDIC assessment expenses, costs related to the closure of five branches expected to close in the first quarter of 2023, as well as other restructuring expenses, the write-off of obsolete software during the quarter and increased variable incentive comp and profit sharing expenses, as well as professional services fee increases related to strategic projects incurred during the quarter.

Our effective tax rate for the fourth quarter declined to 14.3% from 17% in the third quarter due to changes in the proportion of tax exempt income to pre-tax income. In 2022, the full-year tax rate came in at 16.2%. In 2023, we expect the full-year effective tax rate to be in the 17% to 17.5% range. Now, turning to the balance sheet. Total assets were $20.5 billion at December 31, and that’s an increase of $511 million or approximately 10% annualized from September 30 levels. The increase was primarily due to loan growth during the quarter. At period end, loans held for investment net of deferred fees and costs were $14.4 billion, inclusive of $7.3 million remaining in PPP loans net of deferred fees, an increase of approximately $530 million or 15.1% annualized from the prior quarter.

If we exclude PPP loans, adjusted loans held for investments in the fourth quarter actually increased 15.3% annualized from September 30, driven by increases in commercial loan balances of $478 million or 16.2% linked quarter annualized, and consumer loan balance growth of $57.1 million or 10.2% annualized. Excluding the effects of PPP loans, adjusted loans held for investment in the fourth quarter increased $1.4 billion or 10.7% from the same period in the prior year. At the end of December, total deposits stood at $15.9 billion, and that’s a decrease of $615 million or approximately 14.7% annualized from the prior quarter, while average deposits were actually up $123.5 million or 3% annualized for the quarter. At December 31, the transaction-related deposit accounts comprised 57% of total deposit balances, which is down a bit, a basis point from third quarter levels.

And as John mentioned, the loan-to-deposit ratio is now at the lower bound of our targeted range of 90% to 95% at year-end. From a shareholder stewardship and capital management perspective, we remain committed to managing our capital resources prudently as the deployment of capital for the enhancement of long-term shareholder value remains one of our highest priorities. Regarding the company’s capital management strategy, capital ratio targets are set to seek to maintain the company’s designation as a well-capitalized financial institution and to ensure that capital levels are commensurate with the company’s risk profile, capital stress test projections and strategic plan growth objectives. At the end of the fourth quarter, Atlantic Union Bankshares and Atlantic Union Bank’s regulatory capital ratios were well above well capitalized levels.

The company’s tangible common equity and tangible assets capital ratio increased from the prior quarter, primarily due to the increase in the value of the available for sale securities portfolio as long term rates decreased somewhat during the fourth quarter. Again, we believe that the GAAP accounting versus regulatory accounting capital impacts of unrealized mark-to-market losses from rising interest rates in the available for sale securities portfolio will be recouped over time. Therefore, we also track tangible common equity ratio and tangible book value excluding this non-cash GAAP accounting requirement. During the fourth quarter, the company paid a common stock dividend of $0.30 per share, which was consistent with the prior quarter and also paid a quarterly dividend of $1.7188 each outstanding share of Series A preferred stock.

The company did not repurchase any shares during the quarter in order to preserve capital for organic loan growth and to position the company for any adverse developments arising from the current macroeconomic environment. following top tier financial targets and, as noted, achieved them during the quarter. Return on tangible common equity within a range of 18% to 20%, return on assets in the range of 1.3% to 1.5% and an efficiency ratio of 51% or lower. Regarding the efficiency ratio target, I’d again like to point out that it is difficult to compare our efficiency ratio to banks that don’t have significant operations in Virginia since Virginia banks do not pay state income taxes, but instead pay a franchise tax that flows through non-interest expenses and not income taxes.

The franchise tax quarterly non-interest expense run rate of approximately $4.5 million added approximately 2.4% to the company’s fourth quarter efficiency ratio. So setting the efficiency ratio target at 51% or lower is akin to a 49% or lower efficiency ratio target for peer banks not headquartered in Virginia. As a reminder, our top tier financial targets are dynamic and are set to be consistently in the top quartile among our proxy peer group regardless of the operating environment. As such, we reset these targets periodically to ensure they are reflective of the financial metrics required to achieve top tier financial performance versus peers in the prevailing economic environment. We do expect to achieve our financial targets for the full year based on the following key assumptions.

We expect to produce 6% to 8% loan growth in 2023. We expect the net interest margin to stabilize in the 3.7% to 3.75% range in 2023 as a result of the company’s asset sensitive position and the assumption that the Federal Reserve Bank will increase the Fed funds rate to 5% and maintain it at 5% throughout 2023. As a result of loan growth and a stable net interest margin, we expect net interest income to grow by 13% to 15% in 2023 from full-year 2022 levels. We also expect that the company will generate meaningful positive adjusted operating leverage in 2023 due to low teen revenue growth outpacing mid-single digit expense growth in 2023. On the credit front, while we have not seen any systemic credit quality issues to date, due to expectations for a mild recession to begin sometime in 2023, for modeling purposes, we are assuming an uptick in a net charge off ratio to 10 basis points in 2023 from 2 basis points in 2022.

I would reiterate that we do not see evidence of a return in the credit environment at this point, but one-offs are bound to pop up every now and then. The allowance for credit losses to loan balances is also projected remain within the range of 85 basis points to 90 basis points in 2023. In summary, Atlantic Union delivered strong financial results in the fourth quarter of 2022 as evidenced by hitting each of our top tier financial targets. As a result, we believe we are well positioned to generate sustainable, profitable growth and to build long term value for our shareholders in 2023 and beyond. And with that, I’ll turn it back over to Bill Cimino, who will open it up for questions from our analyst community. Bill?

Bill Cimino: Thanks, Rob. And, Michelle, we’re ready for our first caller please.

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Q&A Session

Operator: . And our first question comes from the line of Casey Whitman with Piper Sandler.

Casey Orr Whitman: I guess, first, bigger picture, John. Can you just remind us your views and sort of how you’re thinking about bank M&A for Atlantic Union this year?

John Asbury: I would say nothing has changed, Casey, for what you’ve heard for a while. We view that as a possible supplemental strategy. We believe we can accomplish what we intend to accomplish without that, which does not mean that we wouldn’t consider it. We would. But it will be a supplemental strategy. Big picture, the preferred approach, if we were to look at it, would be to do something €“ actually, let me backup. Clearly, it would have to make a strategic and financial sense and meet our acquisition parameters, et cetera, or we wouldn’t consider it. The ideal scenario would be something that is on the smaller side. And it would be more likely than not an infill within our existing markets where we can continue to increase density across Virginia, which would be the first choice and really drive brand power, extract cost, and use that for investment everywhere.

We love continuing to densify in Virginia. We think we have a long way to go. We’re not about to run out of room. We would consider contiguous markets. The most logical ones for us would be Maryland and North Carolina that becomes much fewer and further between. So again, a secondary strategy is not a primary strategy. It is a tough environment to do it. You have to think about the rate marks. And so, I think that one of the bigger constraints could potentially be just having to come to grips with whether it’s going to pencil out in terms of financial metrics. Anything to add to that, Rob?

Robert Gorman: Well, I think you’ve hit all the objectives that we would have from an M&A point of view. And we’ll see where we go from here. But it is a secondary strategy, as you note. A lot of organic opportunities that we want to work on

John Asbury: In this environment, a good core depository franchise becomes more attractive than ever. I would add that as well. It goes without saying you would have to have great confidence in asset quality and the due diligence. So that’s our thinking about it, Casey.

Casey Orr Whitman: Just looking at the loan production this quarter, Rob, can you give us a sense for where like the new loan yields are coming on, either during the quarter or where they’re coming on now?

John Asbury: During the quarter, as we said, we had really strong production this quarter. And if you look at the various originations, about 65% of the new production came on from a variable rate €“ actually, it’s a bit more than that, 75% when you include prime loans. Those are coming in in the 6.5% to 7% range in terms of yields. And then, the remainder is fixed. And those have been coming in, call it, the lower 5s, 5% to 5.50% on those. So, overall, it’s a bit above 6% when you blend it all together in terms of new yields coming on. Of course, the spreads over the indexes, as libraries increased and primes increased, those have remained fairly constant as rates have been rising, but those will be the yields that we’re seeing right now in terms of a new book.