Atlantic Union Bankshares Corp (AUB) 2017 Q3 法說會逐字稿

Good morning. My name is Denise, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Union Bankshares Trust Third Quarter Earnings Conference Call. (Operator Instructions)

Bill Cimino, Director of Corporate Communications, you may begin your conference.

Thank you, Denise, and good morning, everyone. I have 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 today's earnings release is available to download on our investor website, investors.bankatunion.com.

During the call today, we will comment on our financial performance using both GAAP metrics and non-GAAP operating metrics. Operating metrics exclude the after-tax merger-related expenses for the pending Xenith acquisition. Important information about these non-GAAP operating metrics, including our reconciliation to comparable GAAP measures, is included in our earnings release for the third quarter of 2017.

Before I turn the call over to John, I would like to remind everyone that on today's call, we will make forward-looking statements, 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 results expressed or implied by these forward-looking statements. Please refer to our earnings release for the third quarter of 2017 and our other SEC filings for a further discussion of the company's risk factors, important information regarding our forward-looking statements, including factors that could cause actual results to differ and the pending Xenith acquisition. At the end of the call, we will take questions from the research analyst community.

I'll now turn the call over to John Asbury.

Thank you, Bill, and thanks to everyone for joining us today. Union delivered another solid quarter of loan and deposit growth on an annualized basis and improvements to our profitability metrics on an operating basis, particularly the efficiency ratio.

Before I dig into the quarter, I'd like to provide an update on the Xenith acquisition. As a reminder, we announced the acquisition on May 22 and noted how I checked off every one of our 4 strategic priorities of diversification, core deposit funding, efficiency and crossing the $10 billion asset threshold. The planning work to ensure successful merger integration is on track, the teams continue to work well together, and the process is moving along smoothly. Union and Xenith are holding our respective shareholder meetings next week to approve this transaction. We have filed all required applications with the regulators, and we have received all required regulatory approvals. We expect to complete the transaction in very early January 2018.

I continue to meet with commercial clients, prospective commercial clients, state and local government officials and centers of influence to tell our story, and I'm delighted with the support that we're receiving. The most enthusiastic commentary relates to Virginia, once again, having a statewide regional bank, something we've not had in the commonwealth in nearly 20 years. We're not alone in believing that the combined franchise is uniquely valuable to our teammates, customers, shareholders and the communities that we serve.

With our differentiated competitive positioning and expanded capabilities, we are intensifying our efforts to go head-to-head with the out-of-state-based superregional and national banks that dominate banking market share in Virginia. As I love to tell our clients and prospective clients, at Union, no one calls us from Charlotte, Atlanta, Winston-Salem, San Francisco or anywhere else for that matter, to tell us what we can and can't do. We decide, and any client has opportunity to meet the decision-makers.

Through the merger, we're excited to gain footholds in North Carolina and Maryland. I'm finding from my visits there is that our story is intriguing to those markets, too, as there are no similar regional banks based in North Carolina, Maryland or Washington, D.C. Over time, I expect contiguous states to be important contributors to our growth story as the franchise expands.

Turning back to the earnings report. Rob will provide more financial details on the quarter, so I'll just speak about some key achievements. Year-to-date, Union has achieved improvements of 7.2% in operating net income and 7.8% in operating earnings per share from 2016. Union also saw outstanding period-end balance sheet growth, 12.2% in loan growth, 10% in deposit growth from September 30, 2016.

Looking at our profitability metrics. Operating return on assets improved by 1 basis point from the second quarter. Our operating return on tangible common equity was up 22 basis points from the prior quarter. And the company's operating efficiency ratio dropped 163 basis points from the second quarter.

We saw improvements in credit quality in the third quarter even as net charge-offs increased. And that was primarily due to 2 credits that we discussed since the first quarter. Those are working their way through. Nonperforming assets are down, both in nonaccruals and OREO. I do want to note that $6.4 million of the increase in the 30- to 59-day past dues were from loans being renewed at quarter-end and do not reflect credit concerns.

The economy and our footprint remains steady. The leading indicators of credit quality within Union are benign. I continue to believe that problem asset levels at Union and across the industry remain below long-term trend lines, but we still have no early indications of a downturn in portfolio-level credit quality at this time.

Turning to the bigger picture. As I mentioned above and have stated for the last 2 calls, there are 4 areas that we're focused on in 2017. Those are diversification, core deposit funding, efficiency and preparing to cross the $10 billion asset threshold. I'll give you a quick update on each.

First, diversification. Having now joined Union 1 year ago, I remain confident in our ability to further diversify our loan portfolio and our income streams. Certainly, the Xenith acquisition and changes to the executive ranks that I'll reference later are key accelerants to the executing on the opportunities that lie before us.

On the fee-based revenue initiative. Assets under management have grown $2.5 billion as of -- pardon me, have grown to $2.5 billion as of September 30. I believe the wealth team is making good progress towards their objectives and has made some high-profile hires. We continue to actively explore opportunities to acquire registered investment advisers and believe that will be the fastest path to meaningfully increasing our fee income stream, but not the only path.

On the loan portfolio diversification initiative. While loan growth slowed seasonally as expected from the second quarter, we continued to see broad-based growth across most markets and most categories. I do feel comfortable with our loan growth momentum, and our pipeline looks strong heading into the fourth quarter and beyond. While outstandings for our commercial and industrial loan type decreased slightly during the quarter, this was due to a reduction in revolving credit utilization. We've actually grown our C&I loan balances 9% on a year-over-year basis. Our C&I commitments grew by 22% annualized linked quarter, and that bodes well for future balance growth. Owner-occupied real estate outstandings grew by 7% annualized for the quarter, and that represents a key commercial banking product type.

We continue to believe there's significant upside in C&I as more small-, medium-sized and lower middle-market companies become aware of our expanded capabilities and new relationships are developed. This will ultimately fuel growth in C&I and owner-occupied real estate loan categories, core deposits and treasury management fee income. I predict this will eventually be the largest driver of future growth for Union as the effort matures past Xenith acquisition.

Core deposit funding. We want to grow our core deposit base to manage our loan-to-deposit ratio to our targeted 95% level over time. We are intensely focused on improving our retail banking depository offerings, increasing our deposit-intensive small and midsize business relationships and enhancing our treasury management capabilities where we believe we can offer a superior treasury solution and with a better and in-person support. Deposit growth narrowly trailed our loan growth rate during the third quarter, with deposits increasing a respectable 6.9% annualized compared to 7.5% loan growth annualized for the quarter. The growth was driven by demand deposits, money markets and time deposits.

We grew core households by a 3% annualized rate of increase in the quarter, building upon our already strong retail deposit base. As a reminder, 50% of our deposit base comes from transactional accounts, an unusually good deposit profile. I will reiterate we have a great opportunity to build our deposit base with deposit-intensive commercial businesses. This has not traditionally been a primary focus at Union, but it certainly is now.

Third point is efficiency. We are making headway on the efficiency ratio organically at Union. In the third quarter, the operating efficiency ratio declined 226 basis points from the prior year on a consolidated FTE basis. Further efficiency improvement remains a significant opportunity for the company, and we'll move down meaningfully as efficiencies are captured post-merger. Xenith aside, numerous opportunities for efficiency improvement at Union were identified through our recently completed third-party peer benchmarking work and are being executed on a path independent from the integration work. We benchmarked against both our premerger peer group and our post-merger peer group.

And the fourth area of focus is preparing to cross $10 billion. I have a simple update on this one: we're ready. We're ready to cross the $10 billion asset threshold with the Xenith merger. This has been a multiyear process, and I feel very confident in the work the team has put in since 2014.

And last, I want to take a minute to talk about 2 critically important leadership changes that occurred late in the quarter. John Stallings joined Union Bank & Trust as President in late September. He comes to us from SunTrust where he was the Virginia commercial banking leader. John has an uncommon background of leading both retail banking and commercial banking lending teams across a large footprint. John knows our markets well, including Central and Eastern North Carolina, I would note, has a great passion for the client experience and has been a well-respected competitor. He's one of the higher-profile banking executives in Virginia and is the immediate past Chairman of the Virginia Bankers Association, meaning he's well known among the smaller bank community. As President of Union, he will lead all lines of business, marketing and digital strategy. As my #2 at the bank, he'll handle day-to-day business, enabling me to focus on bigger-picture items and the strategic direction for Union.

We also added David Ring as our Commercial Banking executive in late September. Dave is a career-track commercial banker, has a great reputation for building teams and processes at banks on a growth curve similar to ours. Dave and I knew each other from the industry. He ran all commercial teams for Wachovia, from Virginia to Massachusetts, prior to their being acquired by Wells Fargo. That means he's familiar with the Virginia market. Immediately prior to joining Union, Dave was leading middle-market commercial banking, specialized industries and business banking for Huntington Bank. David is a deeply skilled commercial banking leader and the right leader for our commercial teams as we make our transition to a small regional bank from a large community bank.

These additions to the executive leadership team are proof points, proof points as to the attractiveness of the Union Bank platform with key talent and proof points as to the purposeful strategy underway to accelerate our development. We'll accomplish more, faster with John and Dave on the team.

To summarize, Union had a good third quarter and year-to-date performance, with solid growth in loans, deposits, operating earnings per share and operating net income. And we made further progress on our 4 focus areas, signaling for improvement. We made strategic changes in the executive ranks. The Xenith integration planning is going well. The acquisition has been approved and is on track to close in early January. I should say it has been approved by our regulatory authorities. I remain highly confident in what the future holds for Union and the potential we have to deliver long-term, sustainable performance for our customers, communities, teammates and shareholders.

I'll now turn the call over to Rob to cover the financial results for the quarter. Rob?

Well, thank you, John, and good morning, everyone. Thanks for joining us today. I'd now like to take a few minutes to provide you with some details of our financial results for the quarter.

On an operating basis, which excludes $661,000 in after-tax expenses related to the pending Xenith acquisition, consolidated earnings for the third quarter were $21.3 million or $0.49 per share. That's up 6.5% versus the second quarter on an earnings per share basis.

From a segment perspective, third quarter operating net income for the community bank segment was $21 million or $0.48 per share, while the mortgage segment added $347,000 to earnings or $0.01 per share in the quarter.

Now turning to the major components of the income statement. Tax-equivalent net interest income was $73.8 million. That's up $2.2 million from the second quarter and up $4.4 million from the prior year's third quarter, and that primarily was driven by increased levels of earning asset balances. The current quarter's tax-equivalent net interest margin was 3.59%. That's a decline of 3 basis points from the previous quarter and down 17 basis points from the prior year. As a reminder, the year-over-year decline in net interest margin relates to the 10 basis point margin impact of our $150 million subordinated debt that was issued last December.

Accretion of purchase accounting adjustments for loans and borrowings added 9 basis points to the net interest margin in the third quarter. That's up 1 basis point from the second quarter. The net interest margin decline was due to the 4 basis point increase in our cost of funds, which was partially offset by a 1 basis point increase in earning asset yields. The quarterly 4 basis point increase in the cost of funds to 66 basis points was driven by higher deposit costs, which increased 5 basis points from the second quarter to 42 basis points. The quarter-to-quarter increase was primarily due to the changes in deposit mix and increases in business interest checking, relationship money market and CD special rate promotions as a result of increasing short-term market interest rates as well as strategies to increase deposit balances.

The quarterly net increase in earning asset yields was primarily driven by higher loan portfolio yields, excluding loans and hedge accounting impacts, which improved by 5 basis points due to the impact of increased short-term interest rates on variable-rate loan yields. This increase was partially offset by seasonally lower loan fees of 3 basis points and a 1 basis point decline due to fair value hedge accounting ineffectiveness resulting from the flatter yield curve experienced in the quarter. Excluding the noted impacts of the quarterly loan fee volatility and hedge accounting ineffectiveness, the third quarter's net interest margin would have been 3 basis points higher and in line with the second quarter's reported net interest margin of 3.62%.

The provision for loan losses for the third quarter of 2017 was $3.1 million. That's an increase of $750,000 compared to the previous quarter and an increase of $653,000 from the prior year same quarter. The increase in the provision for loan losses was primarily driven by loan balance growth and increased levels of charge-offs experienced in the quarter.

For the third quarter of 2017, net charge-offs were $4.1 million or 25 basis points on an annualized basis. That compares to $2.5 million or 15 basis points for the prior quarter and $929,000 or 6 basis points for the same quarter last year. As John noted, of the net charge-offs in the third quarter of 2017, more than half related to 2 impaired credits that were previously identified in prior quarters.

On a year-to-date basis, net charge-offs were $7.4 million or 15 basis points on an annualized basis compared to $4.7 million or 11 basis points for the same period in 2016.

Turning to noninterest income. Third quarter noninterest income declined by about -- approximately $520,000 to $17.5 million from the prior quarter as a result of lower loan-related swap fees of $615,000, which was driven by lower back-to-back swap activity in the quarter and lower mortgage banking revenue of $488,000. These declines were partially offset by increases in customer-related fee income and higher insurance-related income.

The mortgage banking income declined to $2.3 million in the third quarter from $2.8 million in the prior quarter. And that was driven by lower mortgage loan originations during the third quarter, which declined by $9.2 million to $127.3 million in the current quarter.

On the expense basis. Excluding Xenith merger-related costs of $732,000 recorded in the third quarter, operating noninterest expense declined $422,000 to $56.8 million in the third quarter from $57.2 million in the second quarter. Salaries and benefit expenses declined by $792,000 primarily related to declines in incentive compensation, payroll taxes and group insurance costs. In addition, marketing costs declined by $335,000 from the prior quarter. These quarterly expense reductions were partially offset by increases in OREO expenses of $797,000, primarily due to higher valuation adjustments recorded in the quarter of $569,000 and $140,000 in increased losses on the sale of OREO properties compared to the prior quarter. In addition, third quarter expenses included approximately $65,000 in branch closing costs related to 2 in-store branch closures, which were consolidated into a new location in August.

Looking at the balance sheet. Total assets stood at $9 billion even at September 30, an increase of $771 million from September 30 of the prior year. The increase in assets was driven primarily by net loan growth.

At quarter end, loans held for investment were $6.9 billion, an increase of $127 million or 7.5% annualized from the prior quarter. Loans held for investment increased $750 million or 12.2% from the prior year's levels, while quarterly average loans increased $789 million or 13.1% from the prior year. The quarterly loan growth was broad-based across commercial and consumer loan categories, with the exception of seasonally lower C&I loan balances, as John mentioned earlier in the call. Looking forward, we continue to expect lower double-digit loan growth for the full year of 2017.

At September 30, total deposits were $6.9 billion, an increase of $117 million or 6.9% annualized from June 30 levels, driven by increases in demand deposits, money market accounts and time deposit balances. Deposit balances were up $623 million or 10% from September 30, 2016 levels.

Looking at credit quality. Nonperforming assets decreased $5.2 million to $28.9 million during the quarter, comprised of $20.1 million of non-accruing loans and $8.8 million in OREO balances, which includes $2.3 million of former bank locations. Of note, approximately $3.4 million in OREO properties were under a sales contract at the end of the quarter, with $900,000 related to OREO that was -- the contracts that were closed in the first week of October.

The allowance for loan losses decreased by $1.1 million to $37.2 million at September 30, primarily due to the continued decline in the historical loss rates, reductions in specific reserves on impaired loans that were charged off during the quarter and the benign credit quality environment. The allowance as a percentage of the total loan portfolio was 54 basis points at quarter end, down slightly from June 30 levels.

So in conclusion to our prepared remarks, Union's third quarter financial results demonstrated continued progress toward our strategic growth objectives as we generated solid loan and deposit growth again this quarter and the company's operating profitability metrics improved. The Xenith integration planning is going well, and we are confident that we will achieve the strategic and financial benefits of the combination once the acquisition closes in early January. As always, we remain focused on leveraging the Union franchise to generate sustainable, profitable growth and remain committed to achieving top-tier financial performance and building long-term value for our shareholders.

And with that, I'll turn it back over to Bill Cimino who will open it up to questions from our analyst community.

Thank you, Rob. And Denise, we are ready to start taking calls now.

(Operator Instructions) Your first question comes from Catherine Mealor with KBW.

I wanted to start with the margin. Rob, can you just give us an outlook on where you see the margin going for the back half of the year? And particularly in a quarter where we're not going to have the full impact of a recent rate hike presumably, how do you expect deposit costs to trend?

Yes. So I would expect that we will see deposit costs stabilizing in the fourth quarter. We had -- as I mentioned, we had some movement in deposit rates during the third quarter, primarily in our business checking account, and also the impact of relationship money market rates and CD promotions that we had. We expect those will stabilize during the fourth quarter. So I wouldn't expect to see material increases in our total deposit costs for the quarter. On an overall margin basis, we are looking at -- we expect that there will be continued flat curve environment. So we'll probably be flattish, maybe advise down to 1 bp or so in the fourth quarter. As we go into 2018, of course, Xenith will have a fairly strong impact on us. We expect, from a core margin basis, that the combination with Xenith will add a couple of basis points to our legacy Union outlook. So on a core basis, call it 3.50% to 3.50% -- a couple of basis points on that. And then accretion, we would expect that, including our accretion income and accretion that we expect from Xenith, we're probably in the 3.65%, 3.66% range, not to put a fine point on that but in the 3.60% range -- 3.60s range.

And does that 3.50% to 3.52% range on a core basis include the assumption for rate hikes next year?

Yes. Yes. So on that point, we do expect that the Federal move in December really won't help us too much in -- won't have much of an effect obviously in the fourth quarter, but in the first quarter. And then we are projecting another Fed move late in 2018. So we're not expecting a lot of help during the year, although it would be helpful if they did move more aggressively during 2018.

Yes. But you do still assume a flattish yield curve. So if the curve steepens more, then there's upside to that, okay.

Yes. Yes. We don't see any -- we don't see really much steepening. Like, basically flat through next year is the way we're looking at it. But it clearly would help us.

Okay. All right. That's very helpful.

Yes, the steepening would be helpful, right. Sorry. Go ahead.

And then one more on the margin. Your loan yields ex accretion were fairly flat this quarter. Can you give any incremental commentary on pricing you're seeing on new production?

Yes. If you look at our loan portfolio yields, we're at about 4.44%. We've been putting on new loans on average about in the 4.35% range over the last several months, so we hope to not see much pressure on -- compressing on the loan yields going forward, but not quite there yet. I will say that loan yields were up if you subtract out the impacts of the hedge ineffectiveness, and we do have some volatility related to loan fees quarter-to-quarter. You saw a 5-plus increase in the loan yields during the quarter.

So, Catherine, I think that's an important point. If you look at -- if you sort of deconstruct what happened in the margin, you'll see that lower quarter-over-quarter loan fees had a material impact. Q3 is traditionally a seasonally lower origination period, and there are certain fees that we take into income during the period. So we kind of see that. And then the hedge ineffectiveness was 1 basis point. So it's fair to say that we were largely matching increase in rate paid on deposits with increase in loan yield.

Yes, I think that's right. We had about a 5 basis point increase in cost of deposits. And ex those factors, we were about 5 basis points on loan yield increase.

Your next question comes from Austin Nicholas with Stephens.

It was good to see the core expenses come down quarter-over-quarter. Any color on where we should expect those to go over the next couple of quarters maybe on a legacy Union basis? Anything left to build on the $10 billion mark? I know there's around $5 million, I think, in the run rate already for some of the ERM systems. But yes, any color just on the operating expenses would be helpful.

Yes. In terms of looking forward to the fourth quarter, I think you can see, just on an operating basis, excluding any merger-related costs, we'll probably be flattish to the current quarter. And then going into the new year on a legacy basis, pretty much in line with where we are in the fourth quarter, adding any inflation adjustments, merit decreases and that sort of thing, in the 2.5% to 3% range, is -- probably is a good outlook for us. Of course, that's on a legacy basis. With the Xenith acquisition as you know, we are projecting to take out 40% of their run rate expenses basically in 2018. We expect that the full run rate, we should be seeing that in late third quarter, probably fourth quarter of 2018. And again, if we look forward, from an efficiency point of view, we expect to be in the mid-50s range once we can extract those costs with the Xenith acquisition.

And Austin, we would reaffirm, based on everything we know so far, we have high confidence in our ability to achieve the cost savings target that we publicly communicated.

Got it. That's very helpful. And then maybe just on the loan growth, any trends there you're seeing in any of your markets? Were there any paydowns this quarter that slowed loan growth at all or any expectations that you have for those over the next couple of quarters?

Yes. I'll start with paydowns. We did see some paydowns on the C&I revolving credit side. That's why we have this contrast of commitments, growing quarter-over-quarter annualized 22%, yet actual C&I balances declined slightly. Now remember, by definition, C&I means a commercial loan not secured by real estate. And so whenever you hear me talk about the commercial banking effort, from a lending perspective, that includes 2 pieces. That includes C&I loans, commercial loans not secured by real estate, plus owner-occupied real estate. Owner-occupied real estate is not constrained by concentration limits, and that is simply a commercial loan secured by real property. Source of repayment is cash flow from the business. And that actually grew 7%. So the declines that we saw in the C&I outstandings are entirely accounted for based on just paydowns. And that's something, as we continue to grow, as we continue to mature and become more of a commercial bank, you're going to see this. You're going to see more volatility in terms of C&I outstandings because those are mostly revolving credit. And so they kind of go up and down, but they should go up over time. We're up 9% year-over-year, for example, in terms of C&I balances. Didn't have any, I would say, any sort of significant out-of-the-normal course paydowns elsewhere in terms of the commercial nonowner-occupied real estate portfolio. By its normal course, you will always have situations where properties mature, stabilize and are either sold by a merchant developer or are refinanced into the institutional nonrecourse long-term markets. So we always have an element of that. That's healthy. You want that, and then you overcome that, of course, with new originations. But I would say that the summer months traditionally are slower months for the commercial banking effort, for the obvious reason: people go on vacation. And so things slow down. Traditionally, Q4 should be one of the strongest quarters of the year. And again, the complexion of Union is changing as we expand the commercial banking effort and are able to deal with larger companies. But I'm feeling pretty good. Geographically, it's the usual suspects in terms of it always skews toward our larger markets: Richmond, Fredericksburg, Charlottesville and -- Hampton Roads has actually been doing pretty well. The Charlotte office has done well, and the smallest markets tend to be slower, not surprisingly. What I'm probably most excited about, I'm probably most excited about the traction that we're rapidly gaining now on the C&I front. Even ahead of the Xenith acquisition, we are talking to companies, and we are developing relationships and landing new relationships with companies that I don't think would have banked with us a year ago. And I'll let Xenith speak for what they're seeing on their side, but we're excited about that. We think we have a great story. We think we have a differentiated story. And so as I look at the pipelines for C&I quoted loans and owner-occupied real estate, I'm looking at things that are multiples of where we were early in the year. I don't want to get too far ahead of that conversation because there's a lot to be done here, but I'm feeling pretty good. And I think that on the nonowner-occupied real estate side, it's feeling reasonably steady. We do continue to gain, I think, a little bit more than our fair share of that side, reasonably well diversified. We can generally pick and choose, and most of those are coming out of our core Virginia markets. A little bit out of Northern Virginia, not much.

Your next question comes from William Wallace with Raymond James.

I'd like maybe a little bit of clarity on the fourth quarter margin guidance, Rob. If deposit costs are stabilizing and third Q loan -- 3Q loan yields were negatively impacted by seasonality, I would expect then we'd get a bounce back on loan yields in the fourth quarter, which would suggest that we should see margin up 2 to 3 basis points. Why would it be flat to down 1 basis point?

Well, we call it flat. We call it up 1 bp -- we're talking basis points here, 1 bp up, 1 bp down. The other -- really depends on how loan growth comes in and whether we can match our deposit growth at the same pace. If not, we have to go and borrow with the Federal Home Loan Bank, and that is obviously a higher-cost source of funding, whether relatively short term perhaps because we can get that deposit engine to match the loan growth. So it's kind of a bit of a hedge on how the funding is going to come in and the cost of the borrowing, wholesale borrowing costs versus deposit costs.

Okay. So you would anticipate, in your kind of budget, that you might have to fund wholesale and hope that you can have upside if you're able to drive deposits to fund the loans?

Exactly right, yes.

Okay. On the deposit side, I'm curious maybe if you could give us an update on what percentage of your deposits are retail versus -- or consumer versus commercial and how that will change with Xenith.

Yes. Well, overall, looking for a chart that shows that, but we -- overall, we're 60% consumer and 40% commercial. And if you look at -- on various products on the demand deposit side, it's mostly -- it's more commercial than consumer. And then the other products are kind of 50-50 on interest checking and then money markets. So that is kind of consumer is a bit heavier.

To clarify, noninterest checking skews towards commercial, yes.

Yes. DDA. Yes. DDA skews to commercial. So overall, we love to -- with the focus on C&I, we love to see that continue or change over a period of time to be a bit heavier on the commercial side, the C&I. Especially on noninterest-bearing deposits, we'd love to see that happen. And John, you probably can talk a bit more about that.

Sure. So if you look at Xenith, while you're well aware of the 2 legacy components of what I'll call new Xenith. Legacy Xenith was a branch-light business bank. So that was clearly a commercial deposit-intensive operation. Legacy Hampton Roads was kind of the opposite, being a relatively large, overall retail-intensive bank in the Hampton Roads. They had a meaningful consumer franchise. So I think as they come in, proportionally, they're going to add more of a business flavor due to legacy Xenith, but Xenith was smaller than Hampton Roads. So the way I think about it is we have an enormous effort underway now to focus on deposit-intensive commercial business. That's underway now at Union. Candidly, that's just never been a focus area. It's not that we don't do it. Clearly, we do it. But it just sort of happens, and it's not been as sharply focused an effort as what I want us to see and what's underway now. At the same time, we pick up learnings from legacy Xenith where they have things like deposit-only relationship managers, strategies around nonprofits, deposit-intensive businesses that may not borrow at all. And these were areas that we just didn't have a lot of focus or accountability for. So I feel like we are opening up opportunity. I feel like, from a small business or business banking standpoint, we've looked at that too much through the lens of lending and not enough through the lens of a deposit-rich environment. Those small businesses in this country don't have that, the depositors. And so I think that's the right way to think about it. So we are very enthused about the opportunity we have to continue to expand it. And I know there's a lot of talk about how commercial businesses are more rate sensitive. And that's true when you're talking about money market accounts, but I'm talking about operating accounts, which is typically noninterest-bearing checking. The core operating accounts of the businesses are remarkably stable, and those are pretty low cost. And as we continue to expand our treasury management offerings, we become more and more of an attractive destination for businesses' noninterest-bearing operating accounts. And meanwhile, (inaudible) retail, so we continue to expand the retail offerings and focus.

If you're successful in your push to drive meaningful growth in the commercial operating accounts, wouldn't you anticipate that those accounts would also come with relatively sizable dollars that would be money market or no?

But -- it depends on the nature of the business. I mean, I would say yes. But I mean, candidly, when I think about typical -- it depends on the business' borrowing profile. The truth is you may have businesses that don't have lots and lots of excess liquidity to their net borrowers. If they have an operating line of credit and they're borrowing on a line of credit, I wouldn't expect them to have much in the way of a money market. At the same time, we love deposit-intensive businesses. So to be clear, we are all-in for commercial money market accounts, but I want to make certain that we've captured the operating account. You're not really the bank unless you're the one who holds the operating cap or they're transacting on you. So it's hard to know right now, candidly, Wally, in terms of what exact mix to expect. But I would say we have opportunity to grow consumer deposits. We have opportunity to grow noninterest-bearing checking or commercial business, and we have opportunity to grow business money market as well.

Okay. Maybe it's better to wait until Xenith closes to kind of talk about the successes that you're seeing, given that it seems like, right now, you're driving deposit growth through promotions, and that's -- it's negatively impacting deposit costs. But it sounds like -- and correct me if I'm wrong, but it sounds like your core kind of existing deposit customer base, you're not seeing much pressure on the betas there?

Yes. That's right, Wally. I would agree with that statement.

Yes. We haven't really -- I think the important thing to watch is watch the mix of our deposit base. We still have transaction accounts, which is really important. Now some of those are interest-bearing checking versus our core in round numbers, and that's going to be more rate sensitive. But I think that one of our strategies is that we are doing things we've not done before because we are chasing low double-digit loan growth, trying to create low double-digit deposit growth. And we're seeing high single-digit deposit growth, which is actually a very good outcome. And meanwhile, you have to step back and just think about how many households are we doing business with, particularly on the retail bank. Is that growing? Or is that shrinking? Or is that flat? It's growing about 3%. It's not shrinking. It's growing, about to see it grow faster. And there are strategies underway in retail banking to make that happen faster. And of course, we're very excited about the additional value proposition that we will bring to the table with our greater resources and product set as we get into the Greater Hampton Roads where Xenith, I think, has done a nice job there, but they've done it on a shoestring.

Yes. I would also say, Wally, just -- we like the loan growth. We want to fund that. We think there's really strong upside in the growth of the balance sheet. And that's going to drive up some of the...

And remember, Xenith is more liquid than we. So our loan-to-deposit ratio will drop below 100% when we close Xenith in 2.5 months.

Right. Right. And so that's a great segue to my last question, which is that you gave some margin color for '18 and some expense color for '18. Do you think, once Xenith closes, that you can drive low double-digit growth in 2018 on a pro forma on the loan side?

What we would like to say -- I don't think we're prepared to move off of what we've said before, which is we are expecting high single-digit growth.

Yes. Yes. We would...

We would like to stand by that based on what we know right now and hopefully have the opportunity to exceed that. And we'll know more as we move on.

Yes.

Your next question comes from Laurie Hunsicker from Compass Point.

Just wondered if we could start on credit. And certainly, your credit is looking pristine, but if you could just help us with -- obviously, we saw the drop in commercial real estate nonperforming loans in that nonowner-occupied category. Is that the credit relationship that came in last quarter, the $2.6 million?

You mean in terms of the nonaccrual yield? That would...

Correct. Yes, in terms of nonaccrual.

Yes. That would be part of it just based on the loans we discussed in the prior quarters.

Yes. That's a piece of that. It's really nonaccrual last quarter that ties back into the traditional relationship that we've been talking about all year.

Okay. And then that -- the total on that relationship, if I remember, was $6 million. Do you have a new total on that relationship?

No. Actually, it was more like 9-ish. The current exposure, and I'll use that word, in terms of what would be on the books is more like $6 million.

Is more $6 million. Okay. Okay. And then same question on REO, and I guess maybe -- and Rob, you were running through these numbers pretty quickly. The REO expenses of $1.139 million was obviously huge, especially because you don't have tax payments in this quarter. I mean, so 2 questions. If we're looking at that on a go-forward basis, all else being equal, if we're kind of thinking about that for the December quarter when you do have a tax payment, $200,000 is maybe a good run rate or $300,000, something like that, versus the $1.1 million?

Yes. I would say about $350,000 to $400,000 probably a good run rate. As you -- as I mentioned, and maybe I talked too quickly on what I've noted there, but we had about $760,000 related to -- we had some sales, and we took a loss of about $140,000. And then we've got -- took some valuation adjustments of about $560,000 or so related to properties, some of which are now under contract. I mentioned we have about $3.4 million under contract at quarter end. $900,000 of that actually closed last week. So some of the valuation adjustments related to those properties going under sale.

Okay. And then of those that...

I wouldn't expect to -- so from that point of view, I would not expect to see those levels going forward.

Okay. Okay. Great. And then of the $3.4 million, obviously $900,000 closed. But is all of the $3.4 million expected to close in the fourth quarter?

No. It looks like about $1 million relates to some properties or some work that has to happen on some of the properties. Probably won't be until 2018 event, but it is on the contract. It's about $1 million for that, I think. The others are going through a due diligence process. Hopefully, those would close during the fourth.

Okay. And then where does King Carter stand currently?

No changes to King Carter. It's about $2 million still. We continue to evaluate options there, but we have not made any changes there.

Okay. And then what about your shuttered branches? Obviously, that came down a little bit.

Yes. Actually, yes. So we did have -- some of the OREO sales in the quarter were related to that. That $900,000 that I mentioned has already closed in the fourth quarter. That was related to that. And another $1 million is under contract. So you're going to see that number come down pretty substantially in the fourth quarter.

Okay. Okay. Great. Okay. And then just sort of last question here. As we think about credit, I mean, your reserves to loans, obviously, you posted nice loan growth in the quarter, but your reserves to loans is now sitting at 54 basis points. How do you think about a floor on that?

Of course, you have to think about the market portfolio.

Yes. So yes, if you consider the market portfolio, it's probably about 75 basis points. Yes, we're looking at that very closely as we speak, especially as we're going through the Xenith transaction. We follow the -- our process of the way we calculate that. And we continue to evaluate qualitative adjustments that would be additive to whatever the historical loss rate calculations would indicate and the benign credit quality items would indicate. In the near term, we don't have much trust issues from a credit point of view, but we continue to evaluate that. I would not expect to see that. I'll put a number on it. Below 50 basis points is probably a good number.

It's a good floor, okay.

You only have so much discretion in terms of -- instinctively, you would like to qualitatively dial it up. We can only defend so much of that.

Yes.

Right. No, I'm just thinking from the standpoint that your charge-offs exceeded your provisions and how we think about that.

Yes.

That's right. I think you'll need to watch what it looks like in the quarters to come because that was a couple of things. That's basically -- half of those charge-offs were related to 2 credits that we've been working through since Q1, one of which is now gone, by the way. That is -- that one is completely resolved, leaving us one.

Got it. Okay. That makes sense. Okay. And then on loan growth, double-digit loan growth guide, that's great. Can you help us think about the C&I as we look going forward? Obviously, that was down 10% annualized linked quarter. How do we think about that within the framework?

Yes. Well, remember, as I said before, when you say C&I, you're talking about not the totality of commercial banking dealing with operating companies and employing people. You're talking specifically about commercial loans that are not secured by real estate. Most of them are...

Correct, just that $550 million C&I book, yes.

Yes. So I wouldn't read too much into the seasonal decline because that was utilization -- we saw utilization drop about 5 basis points during the quarter, utilization meaning what percentage of the commitments are actually borrowed. The commitments themselves that are outstanding grew 22% linked quarter. So that's going to prime the pump for future growth. Plus, the pipeline is strong, Laurie. And again, we'll have to get comfortable -- I'm used to this, having been in very large superregional commercial banks. You have to get comfortable, but you're going to have more seasonal movement on the C&I side. You won't see much on the owner-occupied real estate side, which grew 7% annualized. So I think we have upside. And the truth is that we're just kind of building our data points here at Union as we continue to expand this effort. So I am -- I feel like, of all categories, this is an opportunity that is opening to us like never before. And it's also an area that we've always been interested in, but we've not had as much dedicated focus. And then of course, everything gets accelerated as we bring in Xenith, which has mature, dedicated C&I teams that have backgrounds in larger bank environments, specialized lending units like government contracting. They get a balance sheet 4x what they're accustomed to having. They have more treasury management, more resources, a larger franchise. So there's a lot of good stuff going on there. And then our 2 new leaders -- John Stallings is extremely familiar with that market across Virginia. Dave Ring brings a ton of expertise to the table, and he's been in environments just like Union that are in a build mode, building the commercial bank effort. It's my background, too, that at Union Bank, the CEO, the President, the Head of Commercial, we are all large-bank C&I bankers by background. We are very focused on this. We are very serious about executing on this opportunity. And this is a differentiated story. I don't know of anyone in our market area that sort of has the focus, the story and, frankly, I think, the credibility that Union Bank does in terms of the smaller institutions to be able to take market share. And here's a point I love to make: don't forget, who dominates market share in Virginia? It's Bank of America, Wells Fargo, SunTrust, BB&T. When I talk about C&I, this is not coming from the little bitty banks. They can't do it. This is -- we're going head-to-head with the big guys, and we think that we can be successful there.

Okay. That's helpful. And I guess to that point, as you continue to grow your platform with just really high-quality leadership, how do we think about your next acquisition? How do you think about where you want to take yourself, what size? And I realize Xenith hasn't even closed, but as you look going forward over the next 2 or 3, 4 years, how big do you see yourself growing both organically and then possibly through acquisition?

I think -- let me answer it the way I always answer it. The most important thing, obviously above and beyond executing successfully Xenith and integrating it, the most important objective of this company is the organic performance of Union Bank. You're growing the bank one consumer at a time. Not really see us as an acquisition machine, but I do believe that if we continue to do what we say we're going to do, and that's what we intend, that we're going to have opportunities. It is an attractive story. We are getting some degree of inbound interest that I don't want to talk about, of people who would like to better get to know us and understand what we're doing here. So that bodes well. We don't have any particular size objective. So I think it's dangerous for us to sit here and say we want to be an x billion-dollar bank. Now that we're above and beyond the $10 billion asset threshold post-Xenith, we really need to be thinking about what really matters, which is, what are we going to do for our shareholders? We know as a company, we're going to be evaluated -- you're not going to evaluate us based on how big we become. You're going to evaluate us based on how we perform and what we do for our shareholders. Now those things are going to be correlated. I do think that we'll be able to continue to extract value, open up new markets through acquisition. So we still think about contiguous states. I believe that we will have opportunity to do infill within Virginia. I think that's -- that is very real. And I think that few people would be in a better position than Union to have an accretive transaction in market where we can extract a lot of cost, consolidate or close branches, that sort of thing. And we're keenly interested in opening up new growth markers. We're keenly interested in North Carolina. Our new President, John Stallings, used to run SunTrust in the Raleigh, Eastern North Carolina area. Still knows a lot of people down there. I've spent time in Charlotte and Winston and Asheville, for that matter. I've lived in Roanoke. There was a point in my career when I would spend more time in North Carolina than I had in Virginia. So at any rate -- and we're looking at Maryland. So that's sort of how we think about it.

Great. And sorry, Laurie, we probably got time for one more caller. So I'm going to have to...

Can I just ask you one super quick question? Your branch closures, and I missed this because you spoke too fast, your onetime costs were how much?

$65,000 for the quarter.

And your last question comes from Blair Brantley with Brean Capital.

Most of my questions have been answered. Just coming back to that benchmarking effort you guys finished, how do we think about those efforts there and how that translates towards the bottom line? Or does that just keep kind of operating expense growth in a more measured pace?

Well, I do think that there are real opportunities to take costs out as a result of the benchmarking study, Blair. So what was happening is we had a large number of recommendations. We have a prioritized list of those recommendations. Some of them, candidly, have to be pushed post-integration of Xenith. There are some that are running on an independent track, aren't really competing for the same resources as Xenith, but many are. And in that case, Xenith has to win. We have to prioritize the Xenith integration at the top of the queue. So there are things -- I think it's giving us sort of a kind of a laddered approach to opportunities to extract cost. And maybe I'll answer your question this way: were it not for the Xenith acquisition, you would expect to have seen the operating efficiency ratio go down as a result of various initiatives that are related to the benchmarking study that we did. And then the study has been helpful to us in so many respects I won't really get into in the interest of time. But I'm awfully glad that we had the foresight when we engaged it to have been benchmarked as not just against banks, say, 5 to 10 but also those that are, say, 10 to 15 because that will be the new peer group. So we don't want to get into too many specifics, but we do think we have the ability to continue to extract cost organically out of the Union franchise. And a lot of this, I should point out, is better leveraging technology. I'm critical of Union Bank in terms of the number of manual processes that we have, and we have a bad habit of having to affirm more FTE against our growth. We're a growth company. As we grow, we keep putting more FTE against processes. We shouldn't have to do that. We should be more reliant on technology, having more scalable platform. And you should see more operating leverage coming out of our growth. And I think we'll be able to do that.

Okay. Great. And then just one other quick follow-up. In terms of the Xenith integration and that process, any big surprises there in terms of keeping talent and any type of moves on that end?

So far, so good. No material issues to report. I would like to think that the mood over there is pretty good. That's certainly what I see as I spent time with them. John, Dave Ring and I, we've all been there. We make the rounds. We stay visible. That is a good team. And we are so excited about the story. So I think that, again, the additional capabilities we bring to the table are helpful. They know we're serious about the commercial effort, which is very, very important to the legacy Xenith folks because that was built to be a C&I platform. And they know how fond we are of the Hampton Roads market. So, so far, so good. We love that team.

Your last question comes from David West with Davenport & Company.

I think the only question I have left was maybe specific on the Xenith deal. You talked in the past about their marine portfolio. Having a little more time with that, do you -- still anticipating retaining that portfolio?

Yes. I would say at this point, we continue to learn about it. I think they've got a good track record with it. We are comfortable with the people that we have met there and their processes for sure. An honest answer, David, is that we'll know more about it on the other side of the merger. So there -- and I'll just leave it at that.

Thanks, everyone, for dialing in today. So reminder, a replay will be available at our website, investors.bankatunion.com. Thank you, and we'll talk to you next quarter.

This concludes today's conference call. You may now disconnect.