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Intrinsic Value is all-important and is the only logical way to evaluate the relative attractiveness of investments and businesses.
Good day and thank you for standing by. Welcome to the Atlantic Union Bankshares third quarter 2021 earnings conference call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question and answer session. To ask a question during that session, please dial one on your telephone. Please be advised that today’s conference is being recorded and if you require any assistance during the call, please press star, zero.
I would now like to hand the conference over to your speaker today, Mr. Bill Cimino. Mr. Cimino, you have the floor.
Thank you Chris, and good morning everyone. I’m with 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 our executive management team with us for the question and answer period.
Please note that during today’s earnings release and through the accompanying slide presentation we are going through today on the webcast are both available to download on our investor website at 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 our earnings release for the third quarter of 2021.
Before I turn the call over to John, I would like to remind everyone that on today’s call, we will be making forward-looking statements which are not statements of historical facts and are subject to risks and uncertainties. There can be no assurance that actual performance will not differ materially from any future 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 for the third quarter 2021 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.
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.
Now I'll turn the call over to John Asbury.
Thank you Bill, and thanks to all for joining us today.
Reflecting on the big picture over the third quarter, we were pleased to see reason for optimism in the outlook for COVID-19, declining unemployment, and the most benign credit environment I’ve witnessed in my 34-year career. On the other hand, supply chain disruptions continue unabated, pressures on wages and the ability of our business clients to fill open positions remained a challenge, and we don’t expect any improvement in the short term rate environment for perhaps another year.
Having said that, our business clients are holding up well and most report strong demand for their services but are challenged in filling orders due to the scarcity of needed inventory, supplies and equipment. The good news is this is a supply problem, it’s not a demand problem, and despite challenges should improve in the coming quarters. While the economic outlook may have been muted somewhat by these factors, it’s still a positive outlook and we remain decidedly in an optimistic camp. All of this has pros and cons for us, with the pros being the absence of credit problems and what appears to be a coiling spring for loan growth, and the cons being surplus liquidity, elevated loan pay downs, and wage pressures.
The decline in loan balances we experienced over the quarter was more than we expected. It was in fact a record level of payoffs as stabilized commercial real estate was sold or financed into the long term institutional markets and surplus liquidity was used by clients to pay down bank debt. We are encouraged by the outlook for loan growth, though, as new loan production was the highest we’ve seen in any quarter year-to-date and new construction loans set a record high. However, initial fundings were not enough to offset payoffs and closings should have been higher still were it not for the project delays we’ve been seeing all year long. We do believe we are set up for a solid finish in Q4 with quarterly loan growth looking good month to date, and I’ll elaborate more on that momentarily.
I typically begin and end my comments on these calls with familiar statements, and I do that intentionally to demonstrate consistency in our strategy and how we run the business, so I’ll do that again now. Our mantra of soundness, profitability and growth, in that order of priority, serves us well and continues to inform how we run the company. A sound bank is and will remain our single highest priority. A prudent and conservative credit culture served the company well during the Great Recession and it’s serving us well in the current environment, as evidenced by our credit quality which remains pristine.
Our second priority is profitability, and we did incur added expense to maintain competitiveness in the current labor environment, particularly for our retail branch network. We also had some one-time expenses related to both hiring and severance. We continue to balance investment and the business for the long term while remaining mindful of the continuing challenges of the low rate environment, though expense control will be of supreme importance for as far as the eye can see. It’s very clear wage pressures are real and we’ll mitigate this through additional expense actions.
With the noise of PPP and provision released subsiding, we now have enough line of sight to 2022 to reestablish our top tier financial targets, as we said we’d do. Rob will walk you through the details on that during his section.
As for growth, we remain optimistic in our economic outlook and we believe we have a long runway ahead of us to grow both organically and through takeaway from our larger competitors that dominate market share in our home state of Virginia, supplemented by our operations in Maryland, North Carolina, and our specialized lending capabilities in government contract finance and equipment finance. We are focused on and believe we’re benefiting from the disruption occurring at two of our largest competitors.
As mentioned, elevated commercial real estate payoffs and commercial and industrial line pay downs were the headline for loan balances in Q3. Loans excluding the impact of PPP averaged down 0.6% over the course of the quarter, and that’s approximately 1.3% point-to-point due to CRE payoffs having been the highest we’ve experienced as stabilized properties were sold or refinanced into the long term, non-recourse institutional markets, and C&I borrowers continued to pay down bank debt with surplus liquidity. C&I line utilization ticked down 3 percentage points to 25% and should be about bottomed out. As mentioned, while production was strong, initial fundings were not enough to overcome outsized pay downs last quarter.
October has been busy to date and we have recaptured more than half of the reported third quarter loan balance decline in our commercial loan portfolio excluding PPP. Bookings should continue to be active in this seasonally strong Q4, and we expect to close out the year with good loan growth.
We’re also encouraged that construction lending activity has been rising for some time and construction loans outstanding grew over the quarter, the first time we’ve seen that for a while. Construction loan new commitments dropped significantly in the first half of 2020 with the onset of COVID and were missing two quarters of normalized funding ramp-up from them. Construction lending rebounded beginning in 3Q20, has been running strong since then, and set a record level in 3Q21.
Borrowers first need to burn through their equity as projects proceed before making draw downs on their financing, and while this has been a very strong headwind throughout 2021, it does set up a nice tailwind in 2022 for loan growth. Traditionally we can offset CRE pay downs with construction fundings but have not been able to do so this year due to the combination of new construction loans having been suppressed much of last year and historically high payoffs. As I mentioned before, that headwind is now abating as construction loans are funding up and growing.
Based on what we see at this time, we’re expecting more normalized loan growth in the fourth quarter and in 2022 as our pipeline strength, expanded lending capabilities, new hires, market dynamics, and economic outlook support that opportunity. We do believe we’re on a growth footing.
PPP1 forgiveness during the third quarter was steady. Approximately 3,000 clients from both round one and round two received forgiveness totaling approximately $392 million during the quarter, bringing the total amount forgiven to date to approximately $1.7 billion. Our current PPP balances are $482 million. Overall, the PPP loan forgiveness process is running smoothly and this should largely wrap up over the next few quarters.
Turning to credit, the headline here remains the absence of credit problems. As we continue to climb out of the systemic downturn, our credit losses have been minimal so far. Impressively, for the second consecutive quarter, charge-offs netted to zero basis points. Realistically, though, at some point credit losses will normalize, but given all the liquidity that remains in the system, declining unemployment and the strengthening economy, we see no sign of a systemic inflection point and all of that feels distant to us.
To that point, the economic outlook remains positive and we’re optimistic. Here in our home state of Virginia, September unemployment came in at 3.8%, down from 4.3% in June, and that was one percentage point better than the national average of 4.8%. While that’s all good news, the employment challenge in our markets is not the unemployment rate, it’s the ability of businesses to fill their open jobs. Rob will talk you through the provision for credit losses and our CECL modeling, but by all indications and metrics, credit appears to have never been better.
The past year challenged us in new and unexpected ways, bringing out our best to meet the unprecedented needs of our customers and teammates, and as I said before, we’ve come out on the other side as a stronger and more capable organization. Also as I’ve said before, we’ve learned to work differently and our customers have learned to bank differently. We’ve seen usage in our digital channels increase substantially; for example, year-to-date approximately 17% of new checking accounts originated online, 28% of savings accounts originated online, and 9% of consumer loans originated online. We expect to further drive these numbers up as we continue to refine our digital offerings and capabilities.
Digital log-ins are up 23% since this time last year, with 76% of those log-ins coming from a mobile device. Mobile check deposit utilization continues to grow and now accounts for 19% of our deposit transactions, and Zelle users are up 71% year-over-year with more than 49,000 users and transaction dollar amounts are up 176%. We continue to work on new projects and improve the omnichannel customer experience with quarterly releases and upgrades to our product offerings.
During the third quarter of the year amid significant accomplishments and major undertakings, we’re having completed the transition to a universal banker model in our branch network. This is a big structural change and that enabled us to update our pay scales to remain competitive while also making branch staffing more efficient and productive. While this did increase our salary expense run rate in Q3, it’s a good example of an investment, one that makes us more productive, efficient and scalable over the long run.
We added a new commercial team to our Maryland operations and we finalized plans in our equipment finance division to launch a new specialty vehicle financing team in the fourth quarter that further expands our growing specialty financing strategies.
Looking ahead, our goal remains to achieve and maintain top tier financial performance regardless of the operating environment, as evidenced by our newly reestablished financial targets. We will continue to work on ways to make the company more efficient and scalable while improving and automating processes and the customer experience. We should see operating leverage results coming from this.
I remain convinced we are emerging from the pandemic stronger, better and more efficient from before, and that will give us opportunities both organic and possibly through M&A. We are leveraging our learnings and ingraining our new found capabilities, agility, and innovation into the company’s culture so that we’re flexible and adaptable in the current lower for longer rate environment and forthcoming post-pandemic next normal, while also delivering a differentiated customer experience. I also remain confident in what the future holds for us and the potential we have to deliver long term, sustainable performance for our customers, communities, teammates and shareholders.
Of course, I’ll close with my customary reminder, that Atlantic Union Bankshares remains a uniquely valuable franchise, dense and compact, in great markets with a strong unlike any other in our region. We’re scalable with the right capabilities, the right markets, and the right team to deliver high performance even in the most trying of times.
I’ll now turn the call over to Rob to cover the financial results for the quarter.
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 third quarter.
In the third quarter, reported net income available to common shareholders was $71.6 million and earnings per common share was $0.94, down approximately $10.8 million or $0.11 per common share from the second quarter. The non-GAAP pre-tax, pre-provision earnings were $72.1 million, which was down from $77 million in the prior quarter.
For third quarter, return on equity was 10.9%. The non-GAAP return on tangible common equity was 18.8%. The return on assets came in at 1.47%, and the operating efficiency ratio was 53.91%.
Turning to credit loss reserves, as of the end of the third quarter, the total allowance for credit losses was $109 million, comprised of the allowance for loan and lease losses of $102 million and the reserve for unfunded commitments of $7.5 million. In the third quarter, the total allowance for credit losses declined by $19 million primarily due to lower expected losses than previously estimated as a result of economic improvements in our footprint, benign credit quality metrics to date, risk rating upgrades during the quarter, and an improved macroeconomic outlook over the forecast period. The total allowance for credit losses as a percentage of total loans was 83 basis points at the end of September, which was down from 94 basis points in the prior quarter. Excluding SBA guaranteed PPP loans, the total allowance for credit losses as a percentage of adjusted loans decreased 14 basis points to 86 basis points from the prior quarter.
As a reminder, our day one CECL reserve came in at 75 basis points.
The $19 million decline for the company’s total allowance for credit losses took into consideration the COVID-19 pandemic impact on credit losses both through the two year reasonable and supportable macroeconomic forecast utilizing the company’s quantitative CECL model and through management’s qualitative adjustments. Beyond the two year reasonable and supportable forecast period, the CECL quantitative model estimates expected credit losses using a reversion to the mean of the company’s historical loss rates on a straight line basis over two years.
In estimating expected credit losses within the loan portfolio at quarter end, the company utilized Moody’s September baseline macroeconomic forecast for the two year reasonable and supportable forecast period. Moody’s September baseline economic forecast for Virginia, which covers the majority of our footprint, has improved from the June baseline forecast and now assumes that the Virginia unemployment rate will average 2.7% over the two-year forecast period, which is down from the 3.2% two year average state unemployment rate assumed in the June baseline forecast. On a national level, the September baseline forecast now assumes GDP will increase by 6% in 2021 and 4.3% in 2022.
In addition to quantitative modeling, the company has also made qualitative adjustments for certain industries viewed as being highly impacted by COVID-19. Additional economic scenarios were considered as part of the qualitative framework in order to capture the economic uncertainty and concerns related to the path of the virus, vaccination distribution efforts, and the potential for other more unfavorable economic developments.
The negative provision for credit losses of $18.8 million in the third quarter was lower than the prior quarter’s negative provision for credit losses of $27.4 million and represents a decline of $25.4 million from the $6.6 million positive provision for credit losses recorded in the third quarter of 2020. The decline in the provision for credit losses as compared to the same quarter in 2020 was driven by the benign credit impacts since the pandemic began, the significant recovery in the economy since last year, as well as the improvement in the economic forecasts utilized in estimating the allowance for credit losses as of September 30.
In the third quarter, net charge-offs were de minimis at $113,000, or less than one basis point, compared to $69,000 in the prior quarter and $1.4 million or 4 basis points in the third quarter of last year.
Now turning to the pre-tax, pre-provision components of the income statement for the third quarter, tax equivalent net interest income was $140.7 million, which was down $3 million from the second quarter primarily driven by the decline of PPP loan fee accretion interest income from $11.5 million in the second quarter to $9.4 million in the current quarter. Net accretion of purchase accounting adjustments of $4 million added 9 basis points to the net interest margin in the third quarter, which was in line with the 9 basis point impact in the second quarter.
The third quarter’s tax equivalent net interest margin was 3.12%, which is a decline of 11 basis points from the previous quarter as earning asset yields declined by 15 basis points from the second quarter due to the impact of the low interest rate environment on core loan and investment security yields and the increase in low yielding cash balances due to excess liquidity, which was partially offset by a 4 basis point decline in the cost of funds from the second quarter. The loan portfolio yield decreased to 3.7% from 3.76% in the second quarter, primarily driven by the impact of core loan yield compression of 10 basis points due to pay downs of higher yielding loans and lower loan yields on loan renewals and new production. The core loan yield compression was partially offset by the increase in the yield on average PPP loans, which was 6.45% in third quarter, up from 4.91% in the prior quarter.
In addition, earning asset yields declined by approximately 7 basis points from the prior quarter due to elevated levels of excess liquidity held in low yielding cash equivalents and an additional 2 basis point decline due to lower investment securities portfolio and yields resulting from the reinvestment of portfolio cash flows and the deployment of excess liquidity into the investment securities portfolio at lower market rates.
The quarterly decrease in the cost of funds to 19 basis points from 23 basis points was primarily driven by a 4 basis point decline in the cost of deposits to 14 basis points in the third quarter. Interest-bearing deposit costs declined by 5 basis points to 20 basis points in the third quarter primarily due to the maturity and re-pricing of high cost time deposits in the quarter.
Non-interest income increased $1.5 million to $30 million in the third quarter, up from $28.5 million in the prior quarter primarily driven by the recapture of $1.1 million worth of unrealized SBIC fund investment losses recorded in the prior quarter in other operating income. In addition, deposit and other service charges increased $591,000, mortgage banking income increased $199,000, and asset management fees were higher by $210,000. These quarterly increases were partially offset by declines in other non-interest income categories, including a decline of approximately $500,000 in bank owned life insurance income due to life insurance proceeds received in the prior quarter.
Non-interest expense increased $3.3 million to $95.3 million from $92 million in the prior quarter. The increase in non-interest expense was primarily driven by increases in salaries and benefits of $2.8 million driven by higher salary costs of approximately $1 million as a result of banking pay structure changes and other market-driven salary adjustments made during the third quarter of 2021. In addition, increased performance-based variable incentive comp and profit sharing expenses increased $655,000, and employee-related recruiting, severance and other cost increases of approximately $900,000.
In addition, other expenses increased by $1.6 million for the quarter primarily due to OREO and related credit expenses increasing by $1 million, reflecting the impact of gains on the sale of closed branches which were recorded as a reduction in other expenses in the prior quarter. Non-interest expense increases were partially offset by declines in professional services fees of $616,000. Non-interest expense for the third quarter of 2021 also included approximately $200,000 in expenses related to PPP loan forgiveness processing compared to approximately $250,000 in expenses in the second quarter.
The effective tax rate for the third quarter decreased to 18% from 18.3% in the second quarter. For the full year of 2021, we still expect the effective tax rate to be in the 17% to 18% range.
Turning to the balance sheet, period end total assets stood at $19.9 billion at September 30, which was a decrease of approximately $54 million from June 30 as declining loan balances due to PPP loan forgiveness were partially offset by increases in cash and cash equivalent balances due to excess liquidity, and by net growth in the investment securities portfolio. At period end, loans held for investment were $13.1 billion, which is inclusive of $467 million in PPP loans, a decrease of $558 million from the prior quarter primarily driven by $392 million in PPP loans that were forgiven during the quarter and declines in commercial loan balances ex-PPP of approximately $165 million.
Loan balances excluding PPP loans in the third quarter decreased by $166 million or 5.1% annualized, driven by declines in commercial loan balances of $165 million or 6% annualized as a result of historic levels of pay down activity outpacing loan production levels across the portfolio. Consumer loan balances were flat to second quarter levels, driven by a 13.9% annualized growth rate in indirect auto balances offset by the strategic run-off of third party consumer loan balances.
At the end of September, total deposits stood at $16.6 billion, a slight decline of $37 million or approximately 0.9% annualized from the prior quarter driven by a decline of $113 million in high cost time deposits. At September 30, low cost transaction accounts comprised 56% of total deposit balances, which was up from 54% in the second quarter.
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. At the end of the third quarter, Atlantic Union Bankshares and Atlantic Union Bank’s capital ratios were well above regulatory well capitalized levels.
During the third quarter of 2021, the company paid a common stock dividend of $0.28 per share, which was consistent with the prior quarter, and also paid a quarterly dividend of $171.88 on each outstanding share of Series A preferred stock.
The company repurchased 2.3 million shares for $82.7 million in the third quarter, which fully utilized its $125 million share repurchase authorization from May 4, 2021. In total, the company repurchased 3.4 million shares under the repurchase program since May.
We continue to operate in a challenging operating environment and the impact on revenue growth caused by the lingering effects of the pandemic and the intractable lower for longer interest rate environment are now expected to persist into 2022. However, with the financial impact of the PPP loan program winding down and the pandemic-driven volatility related to expected credit losses and credit loss reserve levels subsiding, we are now in a position to reestablish our top tier financial metric targets to the following: return on tangible common equity within a range of 13% to 15%, a return on assets in the range of 1.1 to 1.3%, and an efficiency ratio of 53% or lower.
Our financial performance targets are dynamic and are set to be consistently in the top quartile among our peer group, regardless of the operating environment, and at this time we believe this new targets are reflective of the financial metrics with regard to achieve top tier financial performance in the current economic environment.
In summary, Atlantic Union delivered solid financial results in the third quarter and is well positioned to generate sustainable, profitable growth and to build long term value for our shareholders.
With that, I’ll turn it over to Bill to open it up for questions from our analyst community.
Thank you Rob.
Chris, we’re ready for our first caller, please.
[Operator instructions]
Our first question comes from Casey Whitman from Piper Sandler. Your line is open.
Hi Casey, good morning.
Hi, good morning. Maybe we could start with expenses, because there was a lot of movement this quarter. Rob, can you walk us through what you kind of consider the run rate for expenses over the next quarter or two from that, I think, $95 million that you guys had this quarter?
Yes Casey, as we noted in our prepared remarks, we’ve actually increased during the quarter the run rate for the company, and our view is as we go forward here, we’re going to be in the $95 million to $96 million range as a result of the pull forward, if you will, in terms of increased salaries related to both the universal banking operating model we went to this quarter, as well as some market salary adjustments that were made in the quarter. We do expect that that will continue as we go forward in the fourth quarter and into 2021.
In addition, we’re also looking, as noted--as John noted, we’ve lifted out a couple of teams, one in Maryland, and we’re also launching a specialty vehicle financing unit, and that’s going to increase our run rate a bit, so again we’re looking at a $95 million to $96 million run rate going forward.
As we look forward, though, we are looking at all aspects of managing our expenses and we’re currently going through our budget process for 2022, and our target for growth from that run rate is 1 to 2%. We feel like we’ve got a lot of opportunity to mitigate any additional expense growth going forward, and that’s the current outlook as we speak. We’ll obviously update that in the fourth quarter earnings call.
Yes, I just want to underscore that point. Wage inflation is real. We are investing in the business as we should, but we have to mitigate that, and so there’s a reason why we’ve published our go-forward financial targets, and Rob is right - we will manage to the lower net overall expense growth target.
Okay, and those financial targets that you put out there, does that assume some help from rates or not?
It doesn’t--well, it does expect some help in rates to get to the higher end of the ranges that we put out there. We feel pretty good about ROTCE and return on assets at the lower end of the range in 2022, but expect that that should improve throughout the year next year.
In terms of our projections in terms of rates, we aren’t expecting much of a material increase in the short term rates until late next year in the fourth quarter, where we think the Fed will start moving at a quarter point a quarter, starting in the fourth quarter of next year, but copping out around 1% into 2023, so not a lot of help in terms of the rate environment but to get to the higher end of those targets, we’d be looking for some help. But again, we don’t expect that help from the margin and net interest income component until 2023 and beyond that period.
Okay, helpful. I’ll let someone else jump on. Thank you.
Thanks Casey. Chris, we’re ready for our next caller please.
Thank you. Next we have Catherine Mealor from KBW. Your line is open.
Good morning Catherine.
Thanks, good morning. I just wanted to get an update on your outlook for growth. I think, John, you mentioned that you think fourth quarter will look better than--or you’ll see better growth in the fourth quarter, so what do you think is a good target? Do you think kind of mid single digit is the range that you could get to as you move into 2022?
Then I guess as we look towards that--question one is just on growth, and then question two is just how do you think about other revenue levers that you can pull as we move into next year to try to get us closer to that 53% efficiency target? It feels like a long way from where we are today if we pull out PPP, so just any path or thinking on the revenue side, I think would be helpful to help us get to that number. Thanks.
Yes, thanks Catherine. Exactly what happens in Q4 on the loan growth side is mostly going to be a function of just the level of payoffs that we see. We hope that we are bouncing around bottom on line utilization, but I will point out if you look at--production is strong. This was the best production quarter of the year. Construction lending new production is the highest we’ve ever seen, and that’s really important, so what’s happening now is the pump is primed. As I mentioned, we’re missing two vintages of normalized quarters - that’s Q1 and Q2 of ’20 - of construction lending funding up. It didn’t go to zero, but it was down. That’s kind of through the system now, and so we can see the schedules of construction loans funding up and that plays an important role in offsetting the payoffs, so we see that, we see loans booking.
C&I balances quarter-over-quarter excluding PPP actually weren’t down that much - it was $18 million point to point, and so what that’s showing you is that even though line utilization came down, we’re landing new clients and we’re booking new fundings, so as we look at the pipeline, we feel pretty good about Q4. Exactly what the number will be point to point is kind of hard to say. Could it be in the normalized low--pardon me, upper single digit growth rate? Possibly - 5%, 6%, 7% point to point, something like that, we think based on what we’re seeing right now, and then as we get into next year, we think we should be in position to where we ought to be able to accomplish what we would call normalized organic growth, which for us normalized organic growth traditionally means high single digit. I wouldn’t look for 9%, I would look at the lower end of that band, so we think that’s possible, and so obviously that’s a big driver in terms of revenue.
As we look at other forms of fee income, the spot business, which is really our largest capital markets item, has been slow this year because we just haven’t seen a whole lot of fundings, and typically you’ll see that oftentimes as loans roll out of the construction bucket into permanent mortgage for developers who choose to keep them, so sometimes they’ll swap for three to five years, that sort of thing, and we see some of this in the commercial business as well.
We’re adding new capabilities. We now have a syndications effort where we can originate larger deals, and we have a head of syndications and we are beginning to book syndication gains that help on the margin. We have a new foreign exchange program with a new head of foreign exchange that came out of one of the larger banks, that’s comfortable--pardon me, that’s familiar with these markets, and that’s going to be an incremental revenue add. And of course, we continue to look to other businesses such as wealth management, treasury management, etc., and we’re seeing more activity going on. We’re seeing a rise in terms of the consumer base. We grew net households in the consumer bank about 3% - that’s actually pretty good. If you look at industry averages, based on our data it’s less than 1%, so we feel like we’ve got a bigger book of business. Spending is up, so we’re seeing more debit cards.
I guess what I would say to you, Catherine, is it’s not going to be one thing other than additional revenue from loan growth, but it’s going to be a series of things and we have some other initiatives that we’re working on as well. But at the end of the day, we have to take action to help offset some of the additional salary and benefit costs that we are incurring as a result of this environment - that’s just the reality. We can’t simply absorb that. We’ll have more to say about that as we come back to you with Q4 earnings.
Do you have anything you’d add--?
I’ll just add to that, the efficiency ratio target of 53 or less is probably the most challenging of the metrics in the top tier ranges we’ve set. It’s going to be difficult to achieve that in 2022, but as we go and get some help from the rate increases going into ’23, we think we’ve got a path to get there. Our working assumption for next year is ex-PPP to see 5% to 6% growth in net interest income and 8% to 10% in non-interest income, some of which was, as John mentioned, more swap activity, more FX activity, and it’s just general increases in deposit service charges and things like that.
Great, very helpful. Thank you so much.
Thanks Catherine. Chris, we’re ready for our next caller, please.
Thank you sir. Next we have David Bishop of Seaport Research. Your line is open.
Good morning David.
Yes, good morning gentlemen. The slide on the [indiscernible] was pretty informative here in terms of the different channels in terms of opening some of the deposit accounts here and with the targets here. Are those near term targets, long term targets? Do you think the checking channel, can that get to even higher levels, and can that inform even further winnowing of the branch system over time?
David, you broke up a little bit. I think your question is that when we show the new account digital activity, the current percentages versus targets, are they near term or longer term? I would say that those are very near term. We do have industry data that benchmarks, call it what you want to call it, midsized bank, super community banks. We’re not allowed to cite specifics, but I can tell you we’re over-indexing and we feel very good about the ability to continue to drive up usage, and we have some new offerings coming on that we can talk about as well, including for consumer lending.
Maria Tedesco is here, President, anything to add? Our view is that the targets that we’ve laid out on that slide are short term, and we think we can move from there.
Absolutely, yes. We completely agree. I’m not sure I have anything to add.
Okay. By the way, that does have implications for branch staffing, branch network, etc., as we see more digital adoption.
Got it, and then maybe a little bit of color in terms of the details for the Maryland team and the new specialty finance group. Maybe just talk about expectations for those two groups.
Certainly. David Ring, Head of Commercial Banking is here. Dave, do you want to take that, what’s going on in Maryland as well as what’s going on in equipment finance?
Sure. We continue to invest in our growth markets, one of which is Maryland, and we’ve brought over a team that will cover Montgomery County, which is a county we did not cover prior to hiring--bringing the team in. We feel like while number one, they’ve already produced even though they’ve just started three weeks ago, we’ve already booked $9 million of fundings from that team, so we expect them to be very active. It’s a three-person team, so our typical production per banker is something in the range of $20 million to $25 million, to give you an expectation there, and they’ve hit the ground running, so we’re very happy with that.
And that’s a C&I focus.
Yes, it’s all C&I. On the flipside, we have also hired two folks to cover real estate in Maryland. Right now, they’ve just started.
Then on equipment finance, it’s been very successful. We’re now one of the top 100 largest equipment finance companies, whether bank or non-bank, by Monitor Magazine. Now, the specialty finance unit is a vertical which will cover shuttle buses that are under contract, coaches under contract, and school buses and smaller ticket items. Our average ticket right now is around $6 million per deal with about a note size of $1.8 million. In this business, it will look like high volume, lower ticket, so a more granular portfolio, so the average ticket will be between $250,000 and $350,000 per.
So we continue to look for opportunities to extend the capabilities of the equipment finance team, and that helps us both in our footprint and they can also operate out of footprint as well, so that’s been a big success for us. We built that from scratch, and that’s a good example of the type of organic growth opportunities that we’re interested in. They also are looking at a really good pipeline.
By almost any measure if you read the data, the outlook for capital equipment investment is very strong. The issue is simply getting the equipment off assembly lines, off ships to the extent that it’s imported, and getting it in place. Supply chain disruption is an issue, but we feel good about the outlook for equipment finance in ’22.
Got it, then just one final question. Obviously the support down in Norfolk is probably a key distribution hub. I know up in Baltimore, they’re clearing some of that port traffic in containerships pretty quickly. Just curious how any sort of backlogs or supply chain issues or distribution issues that are impacting Norfolk, or are they maybe benefiting from more supply ships [indiscernible]?
Yes David, as you’re probably recalling, I’m on the board of the Port of Virginia, so I love having this point of insight. The Port of Virginia is the fifth largest container port by volume in the United States, the third largest on the east coast. There are no backlogs, it’s actually one of the most modern ports in the industry based on the investment that’s been made so the good news is they’re able to process pretty much in real time. You’re not seeing the number of ships lined up off the shore that you’re seeing at other major ports on the east and the west coast.
The limiting factor right now is really the ability to haul containers and whatever the cargo is once they come off the ship. That’s the problem, so from time to time the railroads are placing embargoes which means that they won’t allow the rail cars to be laden and put on the track, because they don’t have space - that’s a problem, because it’s too congested and it’s very difficult if you don’t have contract freight haulers, truck lines lined up. It’s hard to find capacity for someone to come get the cargo.
But it’s a terrific operation. They continue to book record month after record month. Part of what’s happening now is we’re getting more first port of call ship lines coming in, so more ships are coming here as their first stop and they’re doing that because they don’t have to go wait in line somewhere else, and so that’s good for us. It has lots of implications for logistics.
The biggest problem we have to be able to take advantage of that here in Virginia is the lack of warehousing to put the cargo, and it also has implications--we actually don’t want the cargo to be warehoused and shot off on the railroad or truck line somewhere else. You look for more value-added manufacturing, so we’re very bullish on logistic and we’re very bullish on the port and its implications.
It’s also the hub for the offshore wind. We have what should be the largest wind energy field going on in federal waters, certainly off the east coast, and that’s a big project underway, so this bodes well for the greater [indiscernible] in Virginia.
Great, appreciate the color.
Thanks David. Chris, we’re ready for our next caller, please.
Yes sir. Next we have Brody Preston of Stephens Inc. Your line is open.
Hi Brody, good morning.
Hey, good morning everyone, hope you’re doing well.
I just wanted to circle back on the financial targets. John, I know it’s going to be a lot of different things that maybe get you there, but when I kind of look at this quarter, you’re at a 1.28 ex-PPP, PP&R ROA, and ’18 and ’19, you all provisioned 12 BPs on average assets, so when I put all that together, I get to an ending tax-affected ROA in the 1% range. It seems like getting to the 1.1 to 1.2, because I know you’re kind of skewed towards the lower end without much help from rates, is going to be reliant on growth, and so I guess when you look at the forward projections, do you think 7% ex-PPP loan growth is enough to get you to that 1.10 to 1.20 ROA, or is there going to be other things that need to happen in between that gets you there?
Yes, I think upper single digits will allow us to get there in that range from a loan growth perspective. The real drivers of that are really keeping expense growth down while improving the growth in the revenue stream ex-PPP.
One of the things, as I mentioned, was we are looking for about 8% to 10% growth in non-interest income, which will be helpful towards those targets, as well as the 5% to 6% ex-PPP growth in what I’ll core net interest income. You take those factors all together, we should be seeing, again ex-PPP, we should be seeing about, call it 8% to 10% growth in our pre-tax, pre-provision numbers, which should get us, as I mentioned, to that lower end of the ranges on return on tangible common equity and ROA.
Also as I mentioned, it won’t get us to that 53 or less efficiency ratio, but that’s where we’re going to have to rely on some margin expansion due to increased rates going forward plus continued growth in the loan book.
Understood, understood. Then I think John had mentioned, Rob, in his prepared remarks that there were some one-time costs this quarter. Do you happen to have what those were?
Yes, if you look at a couple things, probably in the $800,000 range or so, we had some severance costs which we wouldn’t expect to be continued. We had some sign-on bonuses, although we expect that we’ll incur some of those this quarter as well. My estimate is about $800,000 in that 95-plus.
Yes, those wouldn’t be normal run rate items.
Right, okay.
The whole issue is we have increased the run rate due to these salary adjustments that were made in the quarter [indiscernible].
Understood. On the CRE payoffs, I just wanted to ask, is it customer refis or are customers selling their properties, and then are there any specific geographies within the footprint where the payoffs are more concentrated than others?
It’s pretty broad-based. The larger books of business are going to be places like here in the Greater Richmond Area and larger traditional markets, like Fredericksburg would be an example. It’s really across the key markets.
Brody, a couple of things are going on here. More than half of it is going to be sale of property. Now, this is not that uncommon, so if you’re a developer, you construct it, we finance your construction, the property goes out of construction into we would categorize it as non-owner occupied, and then it stabilizes - it leases up, it gets a track record. If it’s a merchant developer, meaning their principle intention is to build, which creates value, and sell, that’s been going on at a very accelerated pace. There are several reasons for that.
If you look at the low cap rates, there’s a good argument that commercial real estate values could be as good as it gets in the short term. There is some anecdotal evidence that there’s a foot race going on, trying to get ahead of a potential rise in capital gains tax, the potential elimination of 10-31 exchanges. Now, based on what we heard the president say recently, maybe people should be a little less concerned about that - I don’t know, but we’re clearly seeing these properties sold, then if you intend to hold them, and some do, if you’re going to hold it for the long term, what you should do is you should go to an institutional, non-recourse fixed rate term lender, like an insurance company. Multi-family is kind of ground zero for this - you can see it based on the drop in multi-family balances, because there’s so many places you can go to get non-recourse fixed rate term financing, 20-year amortization more and that in term, and that’s not something we do. We do see banks out in the market competing with institutional lenders booking very long term fixed rate loans. We generally are not going to do that.
Dave Ring, do you want to comment on what you’re seeing?
Yes, we just have set up a business where we can act as intermediary for those permanent placements outside to the investor community.
So part of our capital markets effort is we can actually place fixed rate, non-recourse term debt for institutional lenders and capture some of the value chain, if we will. We can, for example, do a construction loan and have our own take-out in place, so we may as well take advantage of that because that’s the normal course. So Brody, that’s what we see going on. It’s at a record level. It’s been elevated for a while, and I guess on a positive note, it’s demonstrating that we’re financing high quality projects with high values, and there’s a lot of demand for them.
But the good news is that the construction pipeline and the commercial real estate pipeline looks terrific. We did have a record quarter of new bookings, and I can’t emphasize enough the comment I made about what I call the missing the vintages of new construction loans, that they were suppressed in Q1 and Q2, and so we didn’t have them kind of refilling. Think of it as [indiscernible] draining out of the commercial real estate bathtub faster than we were refilling it, and so now the faucet is on and it has been for a while, so that actually will create a tailwind and hopefully help mitigate this.
[Indiscernible] questions everyone, I appreciate it.
Thanks Brody. Chris, we’re ready for our next caller, please.
Thank you. Our next question comes from Laurie Hunsicker of Compass Point. Your line is open.
Hi Laurie, good morning.
Hey thanks, good morning. Rob, I’m hoping you can help us think about core margin a little bit here - you know, PPP fees, obviously 21 basis points accretion, 9 basis points in for your release going to potentially 3 basis points next quarter. If you can just remind us what is unamortized fees remaining in PPP, and then just netting that, you’re getting to a 2.80 number, how we should be thinking about that and how you’re thinking about that, I guess with respect to your targets. Any help you could give there would be great, thanks.
Yes Laurie, in terms of what’s remaining from a PPP deferred fee level, it’s about $15 million, and we do expect that a material amount should come in this quarter as we have about $450 million or so outstanding loans that could be in the process of being forgiven over the next two quarters, is what we estimate. Probably the bulk of that hopefully will be in this quarter and some will bleed into the first quarter.
In terms of the core margin, as you probably calculated, this quarter if you take out PPP and you actually take out accretion, we were about 2.89, which was down about 11 basis points from the prior quarter, again a lot of that being driven by the lower yields that we’re seeing on the loan side due to the lower interest rate environment and pay downs of what we’d consider higher yielding loans out of the portfolio, and securities yields coming down a bit due to considerable reinvestment at the low market rates that we’re seeing.
It’s kind of twofold. One is we’re pricing about $40 million to $50 million in mortgage-backed cash flows coming through that we’re reinvesting, and then we’ve also added to the securities portfolio due to the excess liquidity and increased that $200 million or $300 million in the quarter. I expect that we’ll kind of stay in that relative position. We’re about 19% of total assets now, and we could get up closer to 20% before it’s all said and done. We do have $600 million of excess liquidity that we want to put to work, both in the loan book and then probably some of that going into the investment securities book.
All that said, is we’re expecting the core margin kind of to bottom out around this level and start to see some, hopefully, increasing throughout next year, although not a lot until we start to see some of the interest rate movements as the Fed starts to move late next year and into the next year, ’23. But we’re kind of in this up a couple, 2 to 5 basis points as we go into next year, is the way we’re thinking about it, primarily because we’re reinvesting that excess liquidity into higher yielding assets.
I hope that helps.
Very, very helpful, thanks. Then just a follow-up question on credit, so I guess both for you and maybe Dave. Just looking, your overall reserves to loans, 77 basis points if you exclude PPP, 80 basis points, how do you think about holding that line? How do you think about where the right level in terms of reserves to loans should be?
Yes, you kind of broke up there.
How do you think about the appropriate reserve under CECL today? How low is it going to go?
Oh, sorry. Yes, so you’re right, Laurie - of course we’ve been releasing reserves, really since the end of last year and each quarter this year. The way we’re looking at that is CECL, day one CECL is about 75 basis points, and if you look at just the allowance for loan losses, it was about 71 basis points. Included in that, our working assumption is that we think we’ll be kind of stabilizing in that area; however, it could actually go a little bit lower, but it all depends on continued economic forecasts looking good and the credit metrics continue to be good.
But there is a case to be made that it could go lower than that, because if you look at our day one CECL allowance, that included almost $300 million of third party consumer loans that are in runoff mode. Those are down to about $87 million as we look at the end of this quarter, and $24 million of our original CECL allowance reserve was related to that portfolio - it was pretty heavily reserved for. If you look at it from the commercial and the other categories of loans, we were more in the 60 basis point range, blended to about 75, but it was about 60 if you take out PPP or third party consumer.
That’s come down nicely, that will continue to come down, so there’s a possibility we could drop a little bit below that day one CECL, although we’re not calling for that at this point.
Okay, great. Then just really quickly, do you have an update on deferrals? I know they were somewhat de minimis, but do you have a dollar number there?
It’s de minimis. Deferrals are just not a factor at this point.
Okay, and then John, last question - can you help us think how you’re approaching M&A? Are you still actively looking, have things changed from last quarter? Just any thoughts, your currency is strong, how you’re thinking about that.
Sure, thanks Laurie. Not a lot new to add here. I always preface any comment with the same statement, so I’ll do it again for the record - you know, this is--we view ourselves principally as an organic strategy that can be supplemented or complemented by M&A. We are interested. We do think it can be helpful. The goal here, which we try hard to achieve, you want to actually [indiscernible] and that puts you in a good position, so sure, we’d be interested. Nothing has changed there.
Anything that we would consider would have to make strategic and financial sense or we wouldn’t consider it. We think about the continuum from larger to smaller, and we’re sort of--we have this running debate at the company about how small is too small, how large is too large, but we feel like it’s all about optionality, Laurie. From our standpoint, I don’t like the term opportunistic - I wince whenever I hear the term opportunistic M&A, because that sounds like something just came along or somebody did a process or an auction, and that’s not our style. We need to make sure that there’s good strategic alignment, good cultural fit, and I would just reiterate, as we’ve said before, if and when we did something, I don’t think we would surprise anyone in terms of why we did what we did, because it would have to check all of those boxes.
[Indiscernible] we’re disciplined. I see this as a 2022 opportunity perhaps, and I’ve been here five years now and there are conversations I’ve been engaged in for five years in some cases, so there’s always some degree of conversation going on out there. That’s really the best answer I can give you, but I can assure you anything we do would make financial and strategic sense, and it would be something where we had supreme confidence in our ability to execute it well or we simply wouldn’t do it, because it does too much damage otherwise.
Great, thank you.
Thanks Laurie, and Chris, we’re ready for our last caller, please.
Yes sir. Lastly, we have William Wallace of Raymond James. Your line is open.
Hi Wally.
Hey John, thanks for taking my question. I have a couple. On the expense side, you’ve highlighted some--I think you classified it as market adjustment at the branch level due to wage inflation pressures, and I’m just curious, were you losing people, were you worried about losing people, struggling to recruit? Just kind of--you know, some indication of why now rather during the normal COLA time.
Yes, all of the above. This issue is especially pronounced in terms of wage inflation, the entry level roles and sort of the lower tiers of the pay scale, and so we were having challenges, and remember we’re talking--you know, there’s still a pandemic out there, and we’re talking about frontline, client-facing roles, and that added to the challenge. But the reality is that wages have gone up, period, for these types of roles. We were having some challenges in terms of attrition, nothing crazy but it was definitely higher than we wanted to see. We were having challenges filling open jobs, and you can see headcount went up and some of that was simply the fact that as we made this change, we began to be able to more successfully recruit, we’ve seen attrition go down.
There’s another--I think this is one of the better things that we’ve done in the sense that it wasn’t simply let’s raise wages and the branch. This was really strategy, and I compliment Shawn O’Brien, Head of Consumer Banking with the fundamental strategy, which is let’s change these roles around, so instead of having traditional tellers, we now have universal bankers. These are higher value-added roles, they’re trained when the branch is not busy, they’re able to come off the teller line and assist customers with advisory services, sales activity, etc., and they can go back to the teller line when we need help there. It’s just a higher value-added role. There’s nothing new about the universal banker model, but it was a change for us so we had to bite the bullet, we did the right thing, and I think that positions us more competitively.
Shawn, do you have anything you want to add to that in terms of what we did and why?
Yes, I think that was a good summary, John. The only thing I’d add is obviously the universal banker role allows us to run these branches with less staff, so that is helpful as, post-COVID, we are running with smaller staff. It has helped us with attrition, as you mentioned - we’ve seen that drop considerably. We are able to start bringing talent in again, we were struggling with that early in the year.
Then last, we are seeing a significant increase in sales, as you’ve talked about. We are seeing significant growth in customers, we are seeing our highest months ever as far as checking sales, and we’re even seeing a return to consumer lending growth, which is the first time in a long while, so very positive trajectory for us in the branch network.
Good timing, too, because some of you recognize Project Sundown, which is a focused effort on the Truist merger, and then I guess we should also throw in that other big competitor that’s experiencing challenges. We are seeing outperformance as branch closures are happening now.
Maria, do you want to comment on--?
Sure. I’m glad you mentioned Project Sundown, because it really wasn’t--it started out as sort of the Truist target, but we widened it because there were several opportunities in our market where there’s consolidation happening with other banks and mergers. The program really is designed to acquire consumer and business market share from these competitors, given the disruption that we’ve seen in the market, so we’ve had several programs that are targeted specifically when there’s branch closings or lots of disruption that we’re hearing on the ground, so we have targeted these programs. Last March, we knew there was specifically 33 branch closings in our market, that campaign that included media, digital advertising, feet on the street, really guerilla warfare kind of marketing, we saw about a 28% increase in new checking accounts in that month, and then again this fall we’ve seen the same thing happening. We go in and out of the market depending on what’s happening at that time.
Next year, we do have some new market intelligence that there’s about 40 Truist branches, which is the largest branch closing, so we are going to expect to institute the exact same program at that time and we expect very strong results as well.
So you can see why we took the bull by the horns in terms of the consumer bank. We’re getting good results from that team, which we appreciate.
Okay, appreciate all that color. One last question - on the C&I line utilization, you said, I believe, 25% and you hope you’ve troughed. I wonder if you’ve gone back in time and just looked at how utilization rates have rebounded in times when they’ve troughed, and maybe based on historical data, how quick could rates--could utilization rebound, and to what magnitude?
Well, those are all great questions. Dave, I’m going to ask you to chime in here in a minute since we are getting a little longer in the tooth in our careers. The first thing that comes to my mind is what we saw in the financial crisis in the Great Recession, when we saw utilization plunge as companies began to hoard cash and sales dropped off, etc. Wally, the complexion of our organization has changed as we’ve grown, added new capabilities, so it’s kind of hard to say--if you asked me, what would you expect normal utilization to look like at Atlantic Union Bank, a couple years ago I would have said 42%, low 40s is about what we would expect. It’s hard to know what’s normal from here, but I can tell you it’s not 25%. I have never seen anything that low.
David Ring, do you have any perspective on what to think?
Just to add onto what you said, if it just goes up 10 percentage points to 35, we’d add another close to $250 million of outstandings, and so any sort of investment in the businesses will really help us.
The other thing is companies are also not investing in owner-occupied properties, they’re just doing maintenance of what they have, so we normally see a lot of owner-occupied property financing and we’re actually seeing a decrease in that here.
And that’s just normal amortization, mostly. Those are term loans that pay back every month, and to your point, we’ve seen a reduction in that.
Right, so those operating companies borrowing on lines or real estate just getting back to some level or normal will help us in getting that.
Now, here’s where supply chain disruption comes in, in my opinion. You could talk to any business client, and we talk to a lot, they’re going to tell you they’re having trouble meeting their orders, that they could sell more stuff if they had more inventory, more equipment, more people. This is my point I made in my opening comments - this is a supply problem, and I think it’s going to be with us for a while but I think it’s going to be on an improving trend.
So what does that mean for us? What it means is it means increasing line utilization as they begin to build working capital and we finance classic timing differences and that sort of thing. I think that there’s reason--there’s good reason to be hopeful that we’ll see some improvement in line utilization, we think. We’ll continue to fight excess liquidity, but businesses seem pretty confident, and we keep adding new clients as well, which is good.
Then another point, I hate to keep coming back to construction lending, but it’s such an important part of the headwind that we faced. What was construction loans outstanding a year ago? $1.2 billion, which is pretty normal for us. What is it right now? $877 million, so there’s another delta. Because of the ramp that’s going on in that construction loan pipe, we should have the ability to drive that up. To Dave’s point, it won’t take too much increase in utilization to pick up, so these are things that give us some reason for optimism, but we don’t want to be overly optimistic because there’s going to be a lot of liquidity sloshing around for a while.
But you know, these businesses are actually doing pretty well.
So to put words in your mouth, is it fair to say that you would classify your 7%-ish type loan growth target as conservative?
I wouldn’t say that. At this point, there’s such--it’s so difficult to forecast anything, Wally, I would just say realistic - how’s that? We think we have a reasonable line of sight to making that happen. Anything could happen. Could it be better? It’s possible. We’ll continue to update you quarter by quarter.
Okay, fair enough. Thank you very much for the time. Take care.
Thanks Wally, and thanks everyone for joining us today. We appreciate your time. We ran a little bit over, but the webcast will be available on our website at investors.atlanticunionbank.com. Have a good day, and we’ll talk to you next quarter. Goodbye.
This concludes today’s conference call. Thank you all for participating. You may now disconnect and have a pleasant day.