Atlantic Union Bankshares Corporation

Good day, and thank you for standing by. And welcome to the Atlantic Union Bank Share second quarter 2023 earnings conference call. At this time, all participants are in listen-only mode. After the speaker's presentation, there'll be a question and answer session. To ask a question during the session, you'll need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your host for your host today's call, Bill Cimino. Please go ahead.

Bill Cimino Thank you, Justin, and good morning, everyone. I have Atlantic Union Bank shares president and CEO John Asbury and executive vice president and CFO Rob Gorman with me today. We also have American national chairman, president and CEO Jeff Haley on the call. Other members of our executive management team will be here for the question and answer period. Please note that today's releases and the accompanying slide presentation 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 on our earnings release for the second quarter of 2023. We'll make a number of 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 statement. Please refer to our earnings release, the press release announcing the proposed merger And the two slide presentations issued today, as well as 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'll take questions from the research analyst community. And now I'll turn the call over to John. Thank you, Bill, and good morning, everyone. Today we're excited to announce the planned merger of American National Bank, headquartered in Danville, Virginia, into Atlantic Union Bank. American National has $3.1 billion in assets and is a high-quality community bank with an exceptional 114-year history, a strong core deposit base, and outstanding asset quality. This is a company and leadership team we have long admired and know well, and the relationship between our two banks spans decades. We're eager to share our thoughts on this, and we will do so after Rob and I provide abbreviated comments on the strong Q2 results for Atlantic Union. Following that, American National Bank Chairman, President, and CEO Jeff Haley will join us for discussion of the merger. It was a solid quarter for AUB, making this an easier and hopefully shorter conversation, so let's begin. Last quarter, we spoke of the failures of nontraditional niche banks and how that shook confidence in the American banking system. Thankfully, we now see fewer so-called bank crisis headlines, and our clients, our markets, our company, and the economy as a whole are demonstrating resiliency. Broadly speaking, we saw our deposit base hold steady, better than expected loan growth, and admittedly a seasonally strong second quarter, good expense management, modest net interest margin compression, and impressive asset quality trends, all of this being a proof point that our franchise remains strong even in these uncertain times. We see the current environment as another confirmation of our long-term strategy of being a diversified, traditional, full-service bank that makes a positive difference in our markets with a strong brand and deep client relationships. We provide economically beneficial services and financing that help people and help businesses. It's a straightforward business model. It works, and it's proven the test of time over our 121-year history. This is why soundness, profitability, and growth in that order of priority remain our mantra and informs how we run this company. The remixing of non-interest-bearing deposits to interest-bearing deposits did continue over the quarter, though at a slower pace. Quarter-end non-interest-bearing deposits were 26% of total deposits. That's a decline of two percentage points linked quarter. Total deposits were steady and recovered from a seasonal dip, finishing down slightly at 1.1% linked quarter annualized, up 6% year-to-date, and up 1.8% year-over-year. Q3 customer deposit growth is off to a good start with a loan-to-deposit ratio of 90.6% as of yesterday. Fully taxable equivalent net interest margin declined five basis points to 3.45% from 3.50% linked quarter. While our cost of funds rose by 32 basis points, this was largely offset by increased earning asset yields of 27 basis points. By comparison, our Q2 fully taxable equivalent net interest margin of 3.45% was still up from 3.24% year over year. We do expect positive betas to remain under competitive pressure through the rising rate cycle, but remain manageable, as was the case in the second quarter. Helping us with NIM management is that approximately half our loan balances are variable rates, and that we liquidated some securities in the first quarter to reduce higher-cost wholesale borrowings. Now, let's dig into the macroeconomic conditions and then our quarterly results. Thankfully, inflation appears to be on an improving trend, though we expect the Fed is not yet done with its rate-tightening cycle. On a positive note, while for purposes of forecasting we continue to plan for a mild recession, it now seems the possibility of a soft landing has improved over the quarter. The macroeconomic environment remains sound in our footprint, and we do not expect this to change in the near term. Our markets appear to be healthy, and our lending pipelines, while down modestly from a year ago, remain good and are better than we would have expected. Virginia's last reported unemployment rate of 2.7% in June improved from 3.2% in March and, as usual, remains below the national average of 3.6% during the same time. We are not anticipating any materially negative near-term shift away from these low unemployment trends and overall benign credit environment, but as always, continue to closely monitor the health of our markets. We are focused on generating positive operating leverage, that is, growing our revenue faster than our expenses. Our results were noisy during the second quarter due to certain charges associated with the previously disclosed strategic cost savings initiatives we took during the quarter. which we expect will lower our expense-based run rate by an annualized $17 million. We expect that the lower expense benefit will begin to be realized in August. Setting aside these impacts, our adjusted operating non-interest expense run rate was down from the first quarter, reflecting seasonal trends. At the start of the year, we got it to mid-single-digit percentage adjusted operating non-interest expense grade for 2023, but after the strategic cost-saving initiatives that we took, We expect to be flat year-over-year for 2023. Rob will speak to the outlook in his section. Here are a few financial highlights for the second quarter, which Rob will detail later. On a year-over-year basis, we generated positive operating leverage of approximately 1%, as adjusted revenue growth was up 5%, while adjusted operating non-interest expenses increased 4%. I'd also like to point out that pre-tax, pre-provision adjusted operating earnings increased 8% year-over-year. We posted annualized loan growth of approximately 13% point-to-point in what is traditionally our second strongest quarter, led by growth in CNI. Year-to-date loan growth was 8%. Lending production was up across CNI and CRE in the quarter. Construction lending production slowed from Q1 and was the lowest in over two years, and that's part by design on our part and part by developers choosing to delay or, in some cases, pause projects. Our pipelines are holding up pretty well and are modestly down from a year ago and remain healthy and balanced. At this time, we expect full-year loan growth to be in the mid-single digits during 2023. While our pipeline levels continue to imply that we may do better, despite the strength in Q2, we continue to suspect opportunities will take longer to pull through, especially if rates continue to rise. Further, the wind-down of our indirect auto lending took effect beginning in June, and we currently project the run-off will generate about $200 million of liquidity annually for the next three years, and that will seek to recycle into our relationship lending. Additionally, we're expecting some larger payoffs in what is normally a seasonally slow Q3, leading us to believe that the pace of loan growth will come down materially from what we saw last quarter. We do see opportunities in this environment to continue to acquire new clients in addition to serving existing client needs. While the economic outlook in our footprint and borrower demand could change, for now we expect to remain in a moderate loan growth mode in 2023. Credit was a good story as we recorded annualized net charge-offs at four basis points for the second quarter, down from 13 basis points in the first quarter. As a reminder, the majority of first quarter charge-offs is attributed to a memory care facility loan originated by our predecessor, Xena Bank. Last quarter, we moved this to help for sell with the expectation of selling the note, but we're pleased to see the client re-engage on its resolution, make a sizable loan curtailment, so we moved it back to loans held for investment. We have yet to see any sign of a systemic inflection point on our asset quality metrics, which remain benign. While we continue to expect a normalization in asset quality at some point, following a long run of minimal net charge-offs, we remain confident in and are pleased with our asset quality. In sum, We thought this was a solid quarter for Atlantic Union Bank. The banking system showed its resiliency, and we did too. We remain competent in our positioning for the remainder of the year and our ability to navigate challenges, both expected and unexpected. As usual, with uncertainty comes opportunity, and we do see opportunity. Atlantic Union is a diversified, traditional, full-service bank with a strong brand and deep client relationships in stable and attractive markets. We remain on solid footing, and we are resilient. I'll now turn the call over to Rob to cover the financial results for the quarter. Rob?

Thank you, John, and good morning, everyone. Thanks for joining us today. Please note that for the most part, my commentary will focus on Atlantic Union's second quarter financial results on a non-GAAP adjusted operating basis, which excludes the $3.9 million in pre-tax costs recorded in the second quarter for the strategic cost-saving initiatives. as well as pre-tax loss on the sale of securities of $13.4 million and the pre-tax $5 million legal reserve, each of which was recorded in the first quarter. In the second quarter, reported net income available to common shareholders was $52.3 million, and earnings per share for common share were $0.70. Adjusted operating earnings available to common shareholders was $55.4 million, or $0.74 per common share for the second quarter, which was an increase of 8.2 million, or 17.3% from the first quarter, and up $4.1 million, or 8% from the second quarter of 2022. The adjusted operating return on tangible common equity was 17% in the second quarter, which was up from 15.2% in the prior quarter. The adjusted operating return on assets was 1.16% in the second quarter, which was up 16 basis points from the first quarter. On an adjusted operating basis, the efficiency ratio came in at 55% in the second quarter, down slightly from 56% in the prior quarter. Turning to credit loss reserves, as of the end of the second quarter, the total allowance for credit losses was $136 million, which was an increase of approximately $4.5 million from the first quarter, primarily due to loan growth in the second quarter and the impact of continued uncertainty in the economic outlook. The total allowance for credit losses as a percentage of total loans remained steady at 90 basis points at the end of June. The provision for credit losses of $6.1 million in the second quarter was down from the prior quarter's $11.9 million provision for credit losses, primarily driven by lower charge-offs. That charge-off decreased to 1.6 million or four basis points annualized in the second quarter and from 4.6 million or 13 basis points annualized in the first quarter. The year-to-date net charge-off ratio was eight basis points on an annualized basis. Now turning to the pre-tax, pre-provision components of the income statement for the second quarter, tax equivalent net interest income was $155.8 million, which was down approximately $1.5 million, or 1% from the first quarter, turned by higher deposit costs due to increases in market interest rates, as well as changes in the deposit mix as depositors continued to migrate to higher-costing, interest-bearing deposit accounts. These decreases were partially offset by an increase in loan yields on the company's variable rate loan portfolio due to increases in short-term interest rates during the quarter, as well as by the impact of average loan growth. Second quarter's tax equivalent net interest margin was 3.45%, a net decrease of five basis points from the previous quarter due to an increase of 27 basis points in the yield on earning assets, which was more than offset by a 32 basis point increase in our cost of funds. The increase in the second quarter's earning asset yield was primarily due to the 27 basis points increase in the loan portfolio loan yields, which had a 22 basis points positive impact on the second quarter's net interest margin. And the positive impact of changes in the earning asset mix between quarters added five basis points to the second quarter's net interest margin. The loan portfolio yield increased to 5.62% in the second quarter from 5.35% in the first quarter, primarily due to the impact of increases in short-term market interest rates on variable rate loan yields. The 32 basis point increase in the second quarter's cost of funds to 1.74 percent was primarily due to the 33 basis point increase in the cost of deposits to 1.61 percent, which had a 29 basis point negative impact on the second quarter's net interest margin. The deposit cost increase was driven by changes in the deposit mix as depositors migrated to higher-costing interest-bearing deposit accounts during the quarter, increased levels of higher-cost broker deposits, as well as by increases in interest-bearing deposit rates driven by rising market interest rates. Non-interest income increased $14.6 million to $24.2 million for the second quarter, primarily due to the $13.4 million pre-tax loss on the sale of securities recorded in the prior quarter. Adjusted operating non-interest income, which excludes gain and loss on sales of securities, increased $1.2 million in the second quarter, primarily due to an increase of approximately $900,000 in loan-related interest rates swapped fee income from the prior quarter due to higher transaction volumes, an increase in loan syndication revenue of approximately $259,000, as well as increases of several non-interest income categories, including certain service charges, debit interchange fees, and fiduciary and asset management fee income. These non-interest income increases were partially offset by a $405,000 decline in mortgage banking income due to a decline in our gain-on-sale margins during the quarter. Non-interest expense decreased $2.6 million to $105.7 million for the second quarter from $108.3 million in the prior quarter. Adjusted operating non-interest expense, which excludes amortization amortization expense related to intangible assets in the first and second quarters, expenses incurred associated with the strategic cost savings initiatives in the second quarter, and a legal reserve associated with an ongoing regulatory matter recorded in the prior quarter. Non-adjusted expenses declined by $1.5 million to $99.5 million in the second quarter. The quarterly decline in adjusted operating non-interest expenses was primarily driven by OREO-related gains recognized in the current quarter of $879,000, as well as reduced branch closing costs of $466,000 as compared to the prior quarter. In addition, salaries and benefits expenses were reduced by $1.4 million due to seasonal decreases in payroll-related taxes and 401 contribution expenses. These expense declines were partially offset by increases of $1 million in professional services expense related to LIBOR transition and other strategic projects, $466,000 in marketing and advertising expense, and $424,000 in technology and data processing expense increases. At period end, loans held for investment added deferred fees and costs were $15.1 billion, an increase of approximately $483 million, or 13%, on an annualized basis for the prior quarter, driven by increases in commercial loan balances of $454 million, or 14.8% linked quarter annualized, and consumer loan balance growth of $28.5 million, or 4.9% annualized. At the end of June, total deposits stood at $16.4 billion, a decrease of $44 million, or approximately 1% annualized from the prior quarter. due to the impact of customer behavior in response to inflation and higher market interest rates, resulting in a decline in demand deposit balances, partially offset by an increase in interest-bearing checking balances, customer time deposits, and broker deposits. At the end of the second quarter, Atlantic Union Bank shares and Atlantic Union Bank's regulatory capital ratios were well above well-capitalized levels. In addition, on a pro forma basis, we remained well-capitalized as of the end of the second quarter if you include the negative impact of ALCI and health and maturity securities unrealized losses in the calculation of the regulatory capital ratios. For the most part, we are sticking with the full-year 2023 financial outlook referenced in our first quarter's earnings call. We expect to generate loan growth in the mid-single-digit growth range. We continue to project that the full-year, fully taxable equivalent net interest margin will fall in the range between 3.35% and 3.45%, driven by the updated assumption that the Federal Reserve Bank will increase the Fed funds rate to 5.5% tomorrow and maintain it at that level throughout 2023. In addition, we continue to project that our through-the-cycle deposit betas will approximate 40%, which will be more than offset by the projected through-the-cycle loan yield beta of approximately 50%. As a result of loan growth and our fully taxable equivalent net interest margin projection. We continue to expect fully taxable equivalent net interest income to increase by mid single digits in 2023 for full year 2022 levels. We also expect that the company will generate positive adjusted operating leverage in 2023 due to the expected mid single digit adjusted operating revenue growth outpacing expected relatively flat adjusted operating non-interest expense growth in 2023. from full-year 2022 levels as a result of the strategic cost-saving measures we took earlier in the quarter. In summary, Atlantic Union delivered strong financial results in the second quarter despite the challenging banking environment we find ourselves in. As a result, we believe we are well-positioned to continue to generate sustainable, profitable growth and to build long-term value for our shareholders in 2023 and beyond. We're now excited to turn it attention to providing details of our merger announcement with American National Bank. For this discussion, John and I will be joined by American Nationals Chairman and CEO, Jeff Haley.