Atlantic Union Bankshares Corp (AUB) 2017 Q4 法說會逐字稿

Good morning. My name is Jennifer, and I will be your conference operator today. At this time, I would like to welcome everyone to Union Bankshares' fourth quarter earnings conference call. (Operator Instructions) Thank you.

I will now turn the conference over to Mr. Bill Cimino. Please go ahead, sir.

Thank you, Jennifer, 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 Xenith acquisition as well as the impact of the Tax Cuts and Jobs Act. Important information about these non-GAAP operating metrics, including a reconciliation to comparable GAAP measures, is included in our earnings release for the fourth quarter and full year of 2017.

Before I turn over the call over to John, I would like to remind everyone that on today's call, we'll 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 fourth quarter of 2017 and our other SEC filings for further discussion of the company's risk factors, important information regarding our forward-looking statements, including factors that could cause actual results to differ. At the end of the call, we will take questions from the research analyst community.

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

Thank you, Bill, and thank you all for joining us today. Before I get into the fourth quarter of 2017, I'd like to provide an update on the Xenith acquisition, which closed on January 1. We announced the acquisition on May 22 of last year, and noted how it checked off every one of our 4 strategic priorities of diversification, core deposit funding, efficiency and crossing $10 billion in assets. With the acquisition closed, we've created a Virginia-based regional bank for the first time in 20 years, something that's uniquely valuable to our teammates, customers, communities and shareholders. We passed our first test by having a smooth legal day 1 with the initial integration going well. I'm proud of the work our teammates have put in to ensure a seamless transition for our customers. There's much more work ahead as we focus -- as our focus shifts to the core systems conversion scheduled for Memorial Day weekend. I'm confident in our playbook, and together, we can make the transition as seamless as possible for our new customers and as easy as possible for every teammate.

With our differentiated competitive positioning and expanded capabilities and markets, we continue to believe we're capable of going head-to-head with out-of-state-based superregional and national banks that dominate the market share in Virginia. I continue to say to our clients, prospective clients, business community and recruits at Union that no one calls us from Charlotte, Atlanta, Winston-Salem, San Francisco or anywhere else to tell us what we can and can't do to serve our markets. We decide, and any client has opportunity to meet the decision makers. I say this because it resonates, and I say it because it's true.

Turning to our earnings report, Union delivered another quarter of strong loan and deposit growth and improvements through our profitability metrics on an operating basis, particularly in return on tangible common equity. Rob will provide more financial details in his section, so I'll speak to some key achievements both during the quarter and for 2017.

On a linked-quarter basis, Union achieved improvements of 7.0% in operating net income and 6.1% in operating earnings per share. On a full year 2017 over 2016 basis, Union achieved improvements of 7.9% in operating net income and 7.9% in operating earnings per share. Union also saw outstanding annualized quarter-end balance growth of 14.1% in loan growth and 6.4% in deposit growth. And for the year, as compared to December 31, 2016, we had a 13.2% increase in loans and a 9.6% increase in deposits.

Looking at fourth quarter profitability metrics compared to third quarter, operating return on assets improved by 6 basis points, operating return on tangible common equity increased 62 basis points and the operating efficiency ratio remains steady at 62.1%. Overall, credit quality improved in the fourth quarter due to a number of sales of OREO, both in foreclosed properties and former bank premises, and past due loan levels declined. We took a valuation adjustment for the King Carter OREO property during the quarter as it's now under contract for sale, and it's expected to close during the first quarter.

As we saw during 2017, the economy in our footprint remains steady, and the leading indicators of credit quality within Union remain benign. As I've said before, I continue to believe that problem asset levels at Union and across the industry remain below the long-term trend line, but we see no early indications of a downturn in portfolio level credit quality at this time. It's too early to say what economic impact of tax reform will be in our footprint, but we believe it will be a positive catalyst over the long term.

We were pleased to see Xenith had a strong fourth quarter. I want to compliment CEO, Gaylon Layfield, and his team for remaining focused on serving their clients leading up to the merger closing, and their performance shows the enthusiasm among our new teammates from Xenith and their clients for joining with us to form the new Union. Xenith saw operating earnings increase by $19.7 million in 2016 to $28.7 million in 2017. Loan balance has increased 13.5% annualized from the third quarter. And for the year, loans increased by 1.7%. Deposits declined by 9.1% annualized from the third quarter and 1% for the year, primarily due to repricing strategies on high-cost accounts, a number of which were single-service customers. Core demand deposit accounts at Xenith averaged up 7% for the year, demonstrating that the Xenith team did well at growing their most important depository relationships.

Turning to the bigger picture. 2017 was a year of change and growth for Union. We began the year with a well-planned and well-executed CEO transition, added strength and depth to our executive leadership over the course of the year and finished by transforming Union to Virginia's regional bank through the Xenith acquisition. At the risk of understatement, 2017 was an eventful year at Union.

Throughout 2017, I updated you on our 4 focus areas: diversification, core deposit funding, efficiency, and preparing to cross the $10 billion asset threshold. Let me provide a final update on each, and then I'll turn to our 2018 priorities.

Diversification. I remain confident in our ability to further diversify our loan portfolio and income streams. On the loan portfolio diversification initiative, we gained momentum and saw impressive growth in our commercial lending categories of C&I and owner-occupied real estate. The Xenith acquisition and changes to the executive ranks will accelerate our progress on this in 2018.

Outstandings for our C&I loan type increased by 10% linked quarter. In my experience, I would expect the fourth quarter to be seasonally strong for C&I. And while we have some of that, our growth largely resulted from the progress our team has made in building new commercial relationships this year. Importantly, commitments grew by 40% annualized linked quarter, and this bodes very well for future balance growth.

To this point, C&I line utilization increased to about 38%, up from 30% in the third quarter. Owner-occupied real estate outstandings grew by an impressive 17% annualized for the quarter, and that remains a key commercial banking product type for small and midsize businesses. We continue to believe there's significant upside in commercial loan categories as more small and medium-sized and lower middle-market companies are becoming aware of our expanded capabilities at the Union, and new relationships are developing. This will ultimately fuel growth in the commercial banking loan categories of C&I and owner-occupied real estate, and just as important, in core deposit and treasury management fee income. I continue to expect this will eventually be the largest driver of future growth at Union as the effort matures, the Xenith teams fully integrate, and we expand in our new markets and that we acquired with Xenith.

On the fee-based revenue initiative, I believe the wealth team is making steady progress toward their objectives. In 2017, we added depth to the team with 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 increase our fee income stream, but not the only path.

Second priority, 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're focused on improving our retail banking depository offerings, increasing our deposit-intensive small and medium-size business relationships and enhancing our treasury management capabilities where we believe we can offer a superior treasury solution with better and in-person support. I'll also point out that we recently realigned our business banking teams to our commercial channel under the leadership of David Ring from retail, and that should foster better cooperation with the commercial bankers and better results.

Deposit growth did trail loan growth during the fourth quarter, with deposits increasing 6.4% annualized, with average deposits increasing a very respectable 9.3% annualized. Union traditionally does see some seasonal deposit reduction in transaction accounts in December, so that is not at all unusual. Deposit growth is driven by interest growing (inaudible) money market and planned deposits. As a reminder, 49% of our deposit base comes from transaction accounts, an unusually good profile. I'll say again, we had a great opportunity to build our deposit base with deposit-intensive commercial business. This has not traditionally been a primary focus at Union, but it certainly is now.

Third objective, efficiency. We're making headway on the efficiency ratio organically at Union, which currently stands at 62.1%. In the fourth quarter, the operating efficiency ratio declined 72 basis points from the prior year's fourth quarter on a consolidated FTE basis. And for the full year, it declined by 103 basis points. Further efficiency improvement remains a significant opportunity for the company and will move down meaningfully as efficiencies are captured post-core systems conversion with Xenith. Xenith aside, numerous opportunities for efficiency improvement remain at Union and were identified through our peer benchmarking work done last year and are being executed on a path independent from the integration work.

And last, preparing to cross $10 billion in assets. We completed our multiyear preparations for the $10 billion crossing, which has now occurred with the Xenith acquisition. We're very proud of the team that made this happen and thankful for the foresight of our predecessor, Billy Beale, and our Board of Directors for undertaking this years before my arrival and years before we knew we would partner with Xenith.

As I hope our investors noticed, at Union, it's important for us to set goals, communicate them and track back to them. We're a disciplined management team and as you can see, Union made good progress on our first 3 focus areas and completed the fourth one.

Now let's shift to 2018 priorities, of which there are 6: 3 continue from last year and 3 are new and logical next steps for us. Continuing into 2018 are diversifying our loan portfolio and revenue streams. We define that as increasing commercial lending growth, which includes both commercial and industrial and owner-occupied real estate in order to better balance the total loan portfolio over time, and growing fee-based products and services to becoming less reliant on spread income. Second priority, grow core funding, defined as funding loan growth with deposit growth and attaining a 95% loan-to-deposit ratio over time and growing core deposits with a particular focus on increasing commercial and small business operating accounts. Third, improve efficiency is measured by efficiency ratio and do so by leveraging technology to lower cost, improve quality and support growth and build scalable, replicable processes. And new for 2018 is the fourth, manage to higher levels of performance by achieving and sustaining top-tier financial performance and investing in talent, developing people and aligning compensation and incentives with corporate goals and objectives. Fifth, create a more enduring and distinctive brand by creating differentiated client experiences that make banking easier and continuing to build our brand at existing and new geographies. And last, integrates Xenith to include leveraging commercial expertise at Xenith and new market opportunities and achieve our cost-save targets at a successful conversion.

Our 2018 priorities are the way forward for Union as Virginia's regional bank that also serves Maryland and North Carolina. Our geography offers a competitive advantage by giving us a powerful franchise that we believe cannot be replicated in our home state of Virginia, with options to grow the franchise organically in Metro DC, Maryland and North Carolina. As a secondary strategy, it is likely we will eventually have further M&A opportunities, should it make strategic and financial sense to pursue them, both in these new markets and as infills to our existing markets.

Finally, I'd like to talk about the leadership team. As you may recall, we made some high-profile and key hires over the last 5 months, starting with John Stallings as President and David Ring as Head of Commercial shortly thereafter. We just announced on Friday that Sara Rountree has joined as Head of Digital Strategy, and we're thrilled to have her on our team. Sara has followed a similar career path as our other key hires in that they all have experience at a larger financial institution before coming to Union.

We have one last key role to fill, and that's our Head of Retail Banking. We're in the final stages of that search and like the others, it's generated enormous amount of interest from among the large and very-qualified candidates pool. I've mentioned this before, but in addition to our unusually dense and compact franchise, one of the differentiators for Union over other banks our size is the experience of our leadership team. All are new to Union within the last 6 years. All are accustomed to dealing with the greater complexities of a larger institution. They're not trying to figure this out for the first time at Union and are able to develop, teach and coach teammates on the skills they need in a small regional bank that is scaling up. This is an energetic team with a positive can-do attitude at the top, and nothing is off the table when it comes to achieving the priorities we've laid out. I'm highly confident we have the right talents in place to lead Union forward.

To summarize, Union had a strong fourth quarter on both year 2017 performance, with solid growth in loans, deposits, operating earnings per share and operating income. And we made meaningful progress on our focus areas while efficiently crossing the $10 billion asset threshold with the Xenith acquisition. The integration is going well, and core data systems conversion is scheduled for Memorial Day weekend. I feel comfortable with our loan growth momentum. Our lending pipeline looks strong heading into the first quarter and beyond, and I could feel the energy within our team. 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.

As we enter 2018, Union is well positioned as a growth platform in Virginia, Maryland and North Carolina. We believe we have a story unlike any other in our region, having assembled the right scale to right markets and the right team to deliver high performance. You won't always hear such lengthy comments from me on these calls, but for those who know the new Union story, a lot of good things happened at our company in 2017, and I wanted to share them with you.

Last week, the Board of Directors held our winter planning retreat in Norfolk to celebrate our expansion into the important Hampton Roads market. We had the opportunity to meet with a large number of our new teammates from the Hampton Roads area at the event, and the mood was electric. As the new year begins, I can say with confidence that there's never been a better time to be at Union, and I cannot wait to prove out the logic of our strategy in combination with Xenith.

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

So 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 Union's financial results for the fourth quarter and for the full year of 2017. Please note that for the most part, my commentary relates to Union's financial results and do not include the financial results of Xenith since the transaction closed on January 1, 2018. I will, however, briefly touch on Xenith's results at the end of my prepared remarks.

Reported net income was $15.2 million, and earnings per share was $0.35 in the fourth quarter. On an operating basis, which excludes $1.4 million in after-tax merger-related cost and $6.3 million in nonrecurring tax expenses related to the Tax Act, consolidated net earnings for the fourth quarter were $22.8 million or $0.52 per share. On an operating basis, return on assets was 1%, return on tangible common equity was 12.3%, and the efficiency ratio was 62.1% in the fourth quarter.

On a full year basis, 2017 net operating earnings were $83.6 million, and operating earnings per share were $1.91. These operating results exclude $4.4 million in after-tax merger-related cost and a $6.3 million in nonrecurring tax expenses related to the Tax Act.

Turning to the major components of the income statement. Tax-equivalent net interest income was $76.2 million, up $2.3 million from the third quarter and up $4.7 million from the prior year's fourth quarter, driven by increased levels of earning asset balances. For the year, net interest income was $290.8 million, up $15.4 million or 5.6% from 2016.

The current quarter's tax-equivalent net interest margin was 3.64%, an increase of 5 basis points from the previous quarter. Accretion of purchase accounting adjusted for loans and borrowings added 10 basis points to the net interest margin in the quarter, up 2 basis points from the third quarter. The 5 basis point net interest margin increase from the third quarter was due to the 7 basis point increase in tax-equivalent yields on earning assets, partially offset by a 2 basis point increase in the cost of funds. The quarterly net increase in earning asset yields was primarily driven by higher loan portfolio yields, which improved by 6 basis points during the quarter due to the impact of increased short-term interest rates on variable rate loan yields, higher accretion income and higher loan fees. The quarterly 2 basis point increase in the cost of funds to 68 basis points was driven by higher deposit costs, which increased 2 basis points as well from the third quarter to 44 basis points.

The provision for loan losses for the third quarter of 2017 was $3.7 million, an increase of $661,000 compared to the previous quarter, and an increase of $2.2 million from the same quarter in 2016. The increase in the provision for loan losses was primarily driven by loan balance growth during the quarter.

For the fourth quarter of 2017, net charge-offs were $2.7 million or 15 basis points on an annualized basis as compared to $4.1 million or 24 basis points for the prior quarter, and $824,000 or 5 basis points for the same quarter last year. For the year, net charge-offs were $10.1 million or 15 basis points compared to $5.5 million or 9 basis points in 2016.

Non-interest income declined by $293,000 or 1.7% to $17.2 million in the fourth quarter from $17.5 million in the prior quarter, primarily driven by lower mortgage banking revenue of $187,000, seasonally lower insurance-related income of $127,000, and reduced levels of security gains of $166,000, partially offset by increases in customer-related fee income of $214,000, and wealth management fees of $139,000. We also recorded a loss of $65,000 in the quarter related to the sale of our 51% interest in Johnson Mortgage Company.

Mortgage banking income declined approximately $187,000 or 8.1% to $2.1 million in the fourth quarter compared to $2.3 million in the third quarter. And that related to seasonally lower mortgage loan originations as well as fair value adjustments associated with the interest rate lock derivative. The fair value of the interest rate lock derivative declined $209,000 in the current quarter as a result of seasonally lower levels of locked mortgage balances at year-end. Mortgage loan originations decreased by $5.4 million or 4.3% in the current quarter to $121.9 million.

Excluding Xenith merger-related costs of $1.9 million recorded in the fourth quarter and $732,000 recorded in the third quarter, operating noninterest expense increased $1.3 million from the prior quarter to $58 million in the fourth quarter. The quarterly expense increase was driven by higher incentive compensation and profit-sharing expenses of $420,000 as well as increased OREO and credit-related expenses due to higher valuation adjustments and higher foreclosed property legal costs.

During the quarter, the company entered into a contract to sell its long-held King Carter OREO property, and as a result, recorded a OREO valuation adjustment of $980,000. This sale is expected to close in the first quarter of 2018. In addition -- on the expense front, professional fees increased $205,000 related to higher consulting and legal fees. And also, technology costs increased $194,000 due to higher data processing charges.

As noted, during the fourth quarter of 2017, the company recorded $6.3 million in additional tax expense based on the company's preliminary analysis of the impact of the Tax Act. The company also recognized tax benefits of approximately $2.5 million during the quarter, primarily related to the reversal of the company's state tax net operating loss valuation reserve as a result of state tax planning strategies implemented in the fourth quarter. Of the $2.5 million benefit, $2 million related to state tax -- state net operating losses, which were reserved toward prior years and approximately $500,000 related to state net operating losses incurred in 2017.

Now turning to the balance sheet. Total assets stood at $9.3 billion at December 31. That's an increase of $888 million from December 31 of the prior year. The increase in assets was driven primarily by net loan growth.

At quarter end, loans held for investment were $7.1 million, an increase of $243 million or 14% on an annualized basis from the prior quarter. Loans held for investment increased $834 million or 13.2% from the prior year level, while the full year average loan balances increased $745 million or 12.5% from the prior year. The quarterly loan growth was broad-based across commercial and consumer loan categories, with the exception of multifamily and nonowner-occupied loan balances. Looking forward, we are projecting upper single-digit loan growth for 2018.

At December 31, first, deposits were 7 point -- or $7 billion, an increase of $110 million or 6.4% annualized from September 30 levels, deposit balances were up $612 million or 9.6% from December 31, 2016, levels driven by strong year-over-year growth in checking, money market and time deposits. On a full year basis, average deposit balances increased $591 million or 9.7% from the prior year.

Turning to credit quality. Nonperforming assets decreased approximately $500,000 to $28.4 million during the quarter, comprised of $21.7 million in non-accruing loans and $6.6 million in OREO balances, which includes $1.4 million of former bank locations. The allowance for loan losses increased by $1 million to $38.2 million at December 31, driven by loan growth in the quarter. The allowance as a percentage of total loans of the loan portfolio remains steady at 54 basis points at quarter end.

Now let me provide a brief update on Xenith's financial results for the quarter. Xenith recorded a net loss of $55.8 million in the fourth quarter due to the impact of the after-tax merger-related cost of $5.5 million and nonrecurring tax expenses related to the Tax Act of $57.2 million. Excluding these items, Xenith's net operating earnings were $6.9 million for the fourth quarter of 2017, a decrease of $1.2 million compared to $8.1 million in operating income in the third quarter. The decline in net operating earnings from the prior quarter is primarily driven by higher provision for credit losses of $865,000, which resulted from loan growth during the quarter, and lower security gains in the fourth quarter as compared to the third quarter. The current quarter's tax-equivalent net interest margin was 3.53%. That's an increase of 2 basis points from the previous quarter, driven by higher earning asset yields 4 basis points, offset by a 2 basis point increase in the cost of funds. We -- as John mentioned, we were pleased to see that Xenith's loan balances grew by $82.4 million or 13.5% on annualized basis from September 30 levels to $2.5 billion at year-end, which coupled with Union's strong loan growth, suggest that we have strong momentum going into 2018 as the companies come together as the new Union.

So in conclusion, Union's fourth quarter and 2017 financial results demonstrate a continued progress towards our strategic growth objectives as we generated solid loan and deposit growth and the company's operating profitability metrics improved. The Xenith transaction closed January 1, and the integration work is going well. We remain confident we will achieve the financial benefits of the combination once the cost savings are fully realized, starting in the fourth quarter of 2018. 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 to open it up for questions from our analyst community.

Thanks, Rob. And I'm looking at the clock, so we're going to try get to as many questions as we can today. Jennifer, we're ready for our first caller, please?

Your first question comes from Austin Nicholas of Stephens Inc.

Yes. So maybe just -- nice loan growth in the quarter and stronger in a period-end basis. In the outlook for upper single-digit loan growth for 2018. Just to confirm, that's on a stand-alone basis for Union. That's not the pro forma company, I guess. Or any assumptions in Xenith in that?

That is -- that would be -- Austin, we are projecting that on a combined basis with Xenith.

Understood. Okay.

As we talk about '18, we'll keep reminding you, we're now talking about the new Union .

Sure. Okay. Great. And then maybe just on the expense side of things. Could you maybe give some clarity on the expense, call it core expense growth going into the first quarter, and maybe just specifically on the OREO line? I assume that should normalize down closer to that $1 million or lower, as you have some lower balances and those properties kind of move out of the bank.

Yes, that's right, Austin. Yes, the expenses during the quarter were impacted by the OREO valuation adjustment for King Carter, the sale that we announced. But you'll see that come down quite a bit. Obviously, we're not left with much OREO, at least from the Union side. I think we're about 6 -- a little over $6 million at quarter end. From that point of view, we've got a couple of properties that are under contract that will close in 2018, so you'll see that number coming down even further. From that point of view, you wouldn't see any valuation adjustments since -- at least on the sales contract, (inaudible) taken a bit or we would already recorded that, or we expect that the proceeds will equal what our book value is. So you'll see that come down quite a bit for sure next quarter. Now the other aspect of that, and I should point this out from an overall perspective is, King Carter was costing us about $300,000 on an annualized basis to operate. So that -- those numbers, well that expense goes down from an OREO expense perspective. So if you think about the trade-off there, (inaudible) is pretty good on that.

Interesting. Okay, that's helpful. And then maybe just on the margin, it looks like if -- on a core basis, the margin was up pretty nice quarter-over-quarter, call it, 3 basis points on a core basis. Maybe as we look out to the first quarter, could you maybe give us some guidance on where the core -- we could expect the core margin to be both, maybe on a stand-alone basis and then when you layer in Xenith?

Yes. So as we said in the past, and I kind of, at this point, sticking to what we've mentioned in the past. We expect the core to hover on legacy Union side in the 3.50% to 3.53% or so lanes is what we've been talking about. When combined with Xenith, it's kind of in that range going forward. I will point out though that, that's kind of related to what we said in the past, assume the 35% tax rate. As we go forward now with a 21% tax rate, we are going to -- from an FTE, fully taxable equivalent basis, we're going to have to take a haircut related to our tax-exempt income (inaudible) Union book or -- and our loan municipal tax-exempt loan book. And that's going to cost us about 6 basis points, we estimate. So all things being equal, if we were at 3.52%, 3.53%, prior, we'll be in 3.46%, 3.47% range on a core basis. With -- and that will be on a combined basis as well. Obviously, we're going to get accretion income. We think that's 12 to 13 basis points on top of those core numbers that I mentioned.

Okay. Great. And then maybe just one quick last one. Are there any changes to the initial Xenith credits or interest rate marks that you could share with us?

Yes. We don't have anything that we could share publicly at this point. We have been evaluating the original market we said as we announced the acquisition. Obviously, interest rates have been changing. We'll be in a better position, obviously, coming out of the first quarter to be able to provide more clarity on that. At this point, we're not in a position to be...

Austin, you didn't ask this, but to reiterate something Rob said in his comments, we would reaffirm the cost save estimates. We have a clear line of sight to the cost save estimate. We will do that.

Thanks, Austin.

Right. The next question is from Catherine Mealor with KBW.

John, you talked in the past about profitability targets. I think you said in the past, you have a goal of getting to a 1.20% ROA, 14% ROTCE and then a mid-50s efficiency ratio by the end of this year. How do you think about those targets when we layer on lower tax rates?

The lower tax rates have lifted our boat to the rising tide of lower tax rate (inaudible) in both. Rob, you want to answer it?

Yes. Well, Catherine, we're obviously looking to be in the top quartile of our peer group. Obviously, with the new tax, the impact of the new tax rate, we don't know what those levels are. But in terms of our internal modeling, as we mentioned, our ROA, well, we said coming out of the year, we'll be at a 1.20% ROA. We think there's probably 15 to 20 basis points on top of that with the tax rate change. ROTCE, we said we'd come out of the year at 14%. We think there's 2% to 2.5% on top of that. We would bake in the impact of the tax -- the lower tax rate going forward. That's how we're thinking about it. Of course, we will continue to evaluate what our peer group looks like. And that, we probably won't be able to do that until the first quarter results are reported.

So said differently, Catherine, we're not going to declare victory on our old targets due to the lower tax rate. We're going to raise our targets.

Great, great, understood. And what is, Rob, what is the expected tax rate for next year?

Yes. So an effective tax rate, we -- it's going to -- we're still evaluating it. Could move a bit. I would say it's not going to move much, but we're talking about an 18% effective tax rate next year combined.

Thanks, Catherine.

Casey Whitman with Sandler O'Neill.

Just digging more into the loan growth you guys took this quarter. Just wondering, could you maybe talk about the increase in consumer loans specifically you saw this quarter? And what drove that?

Yes. Consumer and other actually include -- and we're -- and this is appropriate per the line item. But embedded within consumer and other, we actually include, strangely because this is the way it works, institutional, university government-type finance. And we had about $50 million from several, a few universities, 1 small municipality that is embedded in that category. So that means we -- the commercial bankers like Mr. Stallings, who I'm looking at, and I, we look at that and say, that's commercial. So we actually have a better commercial story than you even think once you understand that. That was really one of the drivers. Rob, you have anything you would add from a consumer standpoint?

Yes. I think we did have a bit of growth in our third-party alternative lending channels during the quarter. But it wasn't nearly as much as what you're describing.

And we're looking at -- I'd like to better strip that out so it's more clear for other versus consumer.

Okay. And just looking at your margin this quarter, any specific loan categories driving the better yield this quarter? And then you mentioned higher loan fees contributing this quarter. Do you think that level is sustainable?

Yes. So Casey, just on that point, it was worth about 1 basis point, the loan fee quarter-to-quarter. That can be a bit volatile quarter-to-quarter, but within plus or minus 1 or 2 basis points is usually what we look at. The other question was in terms of...

Higher yield.

Would like to have a higher yield. Yes, it was -- it's actually pretty much across the board in terms of -- certainly, our variable rate commercial loans improved pricing as market rates have risen over the last 6 months and also the quarter. We're seeing a pickup in our HELOC yield as well and some other consumer-related loans. So it's really picked up across the board.

Thanks, Casey.

Joe Gladue with Merion Capital Group.

I guess, just wanted to, I guess, ask you again about the sort the windfall from the lower tax rate. And what the plans for it in terms of the -- are there capital returns or (inaudible) buybacks, and any other uses for that?

Joe, this is John. I'll start, and I'll ask Rob to join me. In general, we would expect to use that additional profitability as growth capital. We certainly are a growth story. And so that will fuel our growth story. We continue to have thoughtful discussion about an opportunity it presents to address some of the lower-compensated roles within the bank, and we will go about that in a thoughtful manner. I do want to point out that Union Bank, for years, Union has had a profit-sharing plan that is -- rewards our teammates, who are not otherwise eligible for incentives. And so that can be meaningful for particularly the lower pay grades. And also, there's an employee stock option from whichever he participates in. So Union already has a vehicle in place to share the wealth and include profitability among its teammates. And that has -- the profit-sharing, again, is designed for teammates, who don't otherwise have incentive opportunities. So the mechanism is there. The more profitable we are, the more there is to share, so we already kind of have that built in. That's my immediate reaction. Rob, what would you add to it?

Yes. I'd agree. I think that some investment in our teammates that we're going to be making as well as into the sort of -- some other options from the community investment bank.

Thanks, Joe.

Your next caller is William Wallace with Raymond James.

I'd like to maybe dig in a little bit more on the loan growth. You're guiding high-single digits. You grew your portfolio low teens this year. It looks like Xenith, low teens. I'm just curious, should we interpret your guidance as management conservatism? Or is there the prospect of some rejiggering of Xenith's loan portfolio that could slow the growth rate on a combined basis?

To your question, we will -- as we did last year, we began last year by guiding toward high single digit, and then we concluded that we were able to see that. And therefore, we revised our guidance upward. We'd like to begin this year in the same fashion. We -- a lot of moving pieces here. I got to tell you, Wally, things are going very well in terms of the overall integration. So there's not any singularly large thing that we're looking at, at Xenith that we would say, that's going to go away. So we'd like to be conservative, and we'll come back to you next quarter and tell you what we're seeing. And if we gain confidence that we can sustain a greater than that growth rate, then we'll tell you.

So if you were to kind of look at the fourth quarter's loan growth from Xenith and Union combined, where did you see -- on a dollar basis, how was the loan growth in the Hampton Roads market, the Richmond market, Frederiksberg market, Northern Virginia and Baltimore, and then kind of maybe rural Virginia?

Well, let's see. Maybe what I'll -- let me first speak to Union. If you look at it geographically, not surprisingly, central Richmond is going to be the largest one, metro Richmond. This is one of the strongest, probably the strongest economy in Virginia right now, metro Richmond. And it's probably the place where we've most rapidly gained traction since it's our home turf at Union. And the C&I story, just in terms of Union itself, did add C&I bankers to its team last year, and we've always done that. But I just feel like, quite candidly, we hit a tipping point after the Xenith acquisition was announced in terms of how we were regarded within the business community. The Union story's playing very well, and we saw a pickup. And we were, in some respect, even a bit surprised that some of the larger businesses were very interested in Union, and that's healthy. So I'd say, central Richmond, we saw growth, really in most of our markets from the Union franchise: Charlottesville, Frederiksberg, et cetera. It usually follows where we have market share. Hampton Roads, I'll point this out, Hampton Roads for Union was actually a pretty good growth market. Really, we're more on the peninsula, and our Charlotte LPO has done well. So it felt reasonably broad-based out of the old Union franchise with the largest performance coming out of Richmond area. Within Xenith, and I'll speak mostly to the third quarter. Within Xenith, where did the growth came from? The growth came out of their C&I efforts, their commercial efforts. And in order of ranking, it was metro -- what they call Greater Washington, what we called Greater Washington, based in Northern Virginia. That was one. Richmond was 2. Hampton Roads was 3. So that is a really good story. And so Wally, I feel like we've hit the tipping point. We are a legitimate contender as a small commercial bank to go after this market. And the Xenith -- our new teammates, who've come from Xenith, now have a balance sheet 4x their size. So we'll continue to be very transparent in terms of how this is playing out. I don't want to overplay this point, but I'll tell you one thing, I'll go ahead and share. I'm sitting here looking our pipeline, our pipeline -- and this is Union, not Xenith, I'm just looking at Union today. The Union pipeline right now, let's call it beginning of the year, is about comparable in size to the same pipeline a year ago, but here's the difference: A year ago, Union's loan pipeline was 73%, commercial related; 27% -- pardon me, commercial real estate related, 73%; 27%, C&I related. This year, it's 55%, commercial real estate related; 45%, in round numbers, C&I related. So you get the point. This is evidencing, it's a proof point that we are executing a diversification strategy. This is a good, leading indicator of which you can expect. Now this won't be a straight line, linear growth story. It'll have some degree of fluctuation, but we're feeling very, very good about our ability to execute the diversification strategy.

And then I have one follow-up question on the noninterest expense line. I assume we're not going to get most of the cost cuts until the conversion. And Rob, you mentioned I think in your prepared remarks that fourth quarter, we should probably see a good run rate. I'm wondering if you'd be willing to guide us towards what a expense line should look like after cost saves.

You mean in terms of a quarterly run rate perspective.

Yes. Right.

Yes. It should be in the, well, the 75-ish range, in that area, plus or minus.

And you think fourth quarter we're there, as you hit your targets.

That's correct. That's correct, Wally.

Okay. Great. And then my last question is the $2.5 million benefit for state net operating loss, losses that had previously been booked. Can you talk a little bit about what exactly that was and is this -- did you -- is it something that you caught when you've been -- when you're looking at the tax strategy, whether it's tax reform or what?

Well, actually, we've been looking at this for a bit of time. As you may know, banks in Virginia don't pay a state tax. They pay a franchise tax. So the only state income tax we pay relates to nonbank subsidiaries, Virginia subsidiaries. So we've been generating -- and that -- the biggest piece of that is our parent company as well as our mortgage company. And we've been generating losses from the parent perspective that would offset the mortgage over the last several years. And we think basically putting -- not allowing ourselves to take the tax benefit there. We've been putting evaluations. 0 gets it 1 for long. But we've been evaluating tax planning strategies, which could help unlock that -- the value of those valuation reserves or state NOLs. And we finally came up with a strategy that we want to pursue, and we're able to do that. Basically, what it means is we'll be putting income into nonbank Virginia subsidiaries to allow us to utilize those going forward.

So this was a catch-up from historical -- basically, like a valuation reversal you're thinking...

Yes, it is. It is. About $0.5 million of that was 2017 operating losses that we incurred, and about $2 million was prior to this.

And Rob, just to clarify. So that means that in '18 and going forward, there's a lower run rate.

Yes. So we'll continue to get at that to probably $0.5 million until we can generate enough earnings in the 8 subsidiaries, nonbank subsidiaries, to utilize it, I guess, I should say.

And that's included in the 18% tax rate.

Yes, our effective tax rate. That's right, Wally. That's included for next year.

Okay. So if I kind of back out the noise around tax reform, this tax strategy is 26.5%, is that kind of where you ended up in the fourth quarter on a, call it, core basis?

On a core basis, we're about 27.1% or 27.2%.

Your next caller is Laurie Hunsicker with Compass Point.

I just wanted to go back actually on Wally's question on expenses. And I just wondered if you could step us through. If we just start with the OREO, the $1.74 million, which I know is outsized. Congratulations on, by the way, on getting King Carter sold. But in other words, I'm backing out their credit valuation. I'm backing out, you said, King Carter was, round numbers, costing $300,000 a year. That number roughly comes down to $600,000 for the quarter. It included -- cause I know you have outsized taxes. So call that another $200,000. So I'm down to $400,000 or so as what would be a run rate.

Yes, that's correct, Laurie. You're in the...

Is that right? Okay. And then if I'm backing out the merger charges, I mean, roughly, even applying growth and even looking at Xenith and saying, okay, Xenith's been running, round numbers, $19.5 million a quarter. I'm layering in your 40% or $28 million pretax annual cost saves. I'm coming up with a noninterest expense number closer to $73.5 million a quarter fully baked. And just wanted to know what is the delta difference? Is there some windfall, tax windfall reinvestment spend that you're doing? Is there still spend coming from the $10 billion cost? Obviously, you don't have your first DFAST submission until July of '19. Just help me think about what I'm missing here.

Albeit, you were in the ballpark. We've got, as John mentioned, we will be -- just some reinvestment of the tax savings in our teammates and other things, so you could probably add into your numbers. And obviously, merit increases and inflation, that plays into that as well. So on ballpark, at that level, you're pretty close to where we think we'll be.

Okay. And so the -- basically, your tax windfall reinvestment, if we think about that in the expense line, that's the entire difference.

Let me think about that. It's...

Or maybe asked another way, what is your dollar amount that you're projecting in the noninterest expense line from just infrastructure reinvestment, wage inflation? Just a broad number.

In terms of the full year run rate, it's about $4.5 million to $5 million all in.

$4.5 million to $5 million. Okay. That's helpful. And then if we can just go back to OREO, and your credit is pristine here. I just want to make sure I've got this. So your old Stellar branches went from $2.3 million to $1.4 million. How many are left in that?

Well, that's 3 properties in there, one of which is under contract. The biggest component -- the biggest one is about $1 million, which is under contract. We expect to close that. It may not -- it's got a long fuse on it, so it may not be the first quarter. But probably in the second quarter is what we're thinking. So that'll be about $1 million. Yes. So basically, the other ones, we are out and doing marketing. We think there's some opportunities there, so you can see that. It's possible to see that go away pretty much in 2018 at the end -- by the end of 2018. Certainly, in the first quarter, we'll get most of that out.

And then the other $1 million drop in OREO linked quarter, that was $1 million to King Carter. So King Carter is now theoretically, December 31st, it's on your books at a million coming off?

That's right. That's right.

Okay. Okay. And then just in terms of -- what -- where did your assets under management stand at December 31?

It's at $2.6 billion at the end of the year.

$2.6 billion. Okay. And you guys had record fees. How should we be thinking about that line item?

Well, as we project forward, we're looking at solid growth in the fees coming off of that. Obviously, we had some pretty decent growth in the last half of the year. So fees will be up year-over-year and above where we were projecting, like 7% to 8% growth in the fees, fee line.

Yes, that's correct.

That's Bob Martin, Head of Wealth Management.

Yes, Bob's (inaudible)

As we said before, as a strategy, we continue to be interested in the acquisition of smaller, registered investment advisers. And we may have opportunity this year along those lines.

Yes, that wouldn't include any of our acquisitions of RIAs.

Yes. Laurie, John Stallings here. One other thing that's driving it is a terrific, improved partnership between commercial banking and wealth. I think they're sure are an example of where we're teeing up wealth partners with commercial banking clients and finding opportunities.

And the institutional capability, Bob. With the addition of some new talent there, we began, I think, upped our game and our reputation that comes with capability.

Okay. Great. And then just jumping back over to Xenith. The marine finance books, they have round numbers of $300 million. What have you all decided to do with that?

We don't really have any thing that -- any specific plan at this point that we're able to share, Laurie. This, as I said all along, we want to get our arms around that business. And certainly, by all accounts, it's a well-run business, and we'll have more to say about that as we better come to understand it.

Okay. And then, obviously, they took some merger charges this quarter, too. Can you just remind us, Rob, where we are in terms of onetime merger charges that are still expected?

Yes. So we had -- and after that, basically, we said there'd be about $33 million of merger cost from day 1 due to the conversion-related costs. So we're probably more than halfway there in terms of -- if you think about investment banking fees we paid, legal fees, other fees that are more success -- transaction success fees, we've incurred those. So I would say, about -- it's probably 1/3 to 40% left, which would include severance expense, retention bonuses and then conversion-related termination fees and that sort of thing.

Okay. Okay. Great. And then, obviously, Xenith brought over 3 large PE investors, so round numbers there at $13 million or 20%. What is the latest in terms of your interaction with them? And how should we be thinking about those shares?

Well, we would say that both Union and the PE firms want to have an orderly exit of their stock, and do it efficiently. We'll provide an update on that when we're in a position to do so. And that's all we have to say for now.

Thanks, Laurie.

Your final question will come from Blair Brantley with Brean Capital.

Just quickly, have you noticed -- have you seen any change in the size of credit that you guys are putting on the books now? Have you gone...

I would say that to some extent, what's happening -- I'll ask John Stallings and Dave Ring maybe to chime in. We do have an effort, which we call, corporate. The corporate to us generally means lower middle market, which I'll define as companies with sales above $100 million. So we are seeing some additional opportunities in larger credits. But to size it for you, excluding the 2 university deals that we did, the longest new-funded balance we saw -- the largest new-funded balance we saw last quarter in C&I was about $11 million. And then it dropped from there in the $5 million, $7 million range. So we are not out dropping on the books $30 million and $50 million outstanding types of credits. But as a strategy, as a $13 billion bank, we are able to do something that has not been done in Virginia since the days of Crestar, who I used to compete against and Bob Martin worked for them. We are Virginia's regional bank. We can absolutely go head to head with the large players. And John, you can speak to this probably better than anyone because you ran the largest player. So you'll see us be active in small, mid-sized, into that lower middle market in Virginia.

Yes. Blair. One thing --2 things I'll say about that. One, the vulnerabilities as we go up market of our competitor, we call them the big 4, are such that we have a chance really, to penetrate at a quicker clip than ever before in terms of the calling we're doing. One of the things that's been so obvious to me since joining up 4, 5 months ago, is in collaborating with the Xenith team, there's really very much a -- the whole is greater than some of the parts. As Dave works closely with the Xenith and Union teams, the new Xenith teammates are finding connectivity and overlapping calling efforts, which allow us to put our best teams forward, both relationship managers and the prospecting efforts, the right partners to essentially put forth a better calling effort. I think the opportunities continue to be great in early-stage pipeline, and I think even current pipeline, John alluded to it earlier, I think will bode for us to continue to play bigger in the C&I space.

I would say, 6 months ago, John, we were getting feedback even before you joined, which I'll sort of paraphrase, feedback through competitors, people you know, like, what are you doing here? And they don't ask that anymore. And so you come out of SunTrust. You ran SunTrust here in Virginia, which is in fact, the old -- that's what's left of that old Crestar franchise. We got a lot of folks out of that organization. Dave Ring, as a reminder for those who either didn't know or don't recall, Dave Ring ran what was Wachovia commercial from Virginia to Massachusetts. Dave is actually known -- people knew him as the boss. So those bankers, if they've been around for a while, they'd be at Wells Fargo today. Some of the folks from Xenith I grew up with at Nations Bank, which became Bank of America. So we've got it circled in terms of the -- we have some folks out of BB&T. Our new head of the commercial bank operation, Andy Hodges, who joined us in Hampton Roads, grew up at BB&T. So this is a really good assemblage of talent here that has a pretty clear view on this market.

Yes. And we have -- this is John again. We have strong talent already, but it's really opening up some opportunities where we're getting a lot of inbound calls, whether it's straight up, do you have room for me, or more subliminal or intermediaries connecting us with people that are interested in joining our team. Dave Ring, any comments on the point about larger opportunities?

We're going to -- our strategy is to continue to grow safely, so to maintain a very granular portfolio. So I don't think we're going to pursue large, chunky deals to grow. We're going to continue to just have an aggressive calling effort, and then spread it out.

Also, I want to make sure, Dave, speaking on (inaudible), even though it wasn't asked. We are not just a credit shop. We did not use the term lender. There are no lenders at Union Bank. We discontinued that job code. So we only have bankers, relationship managers. Talk about the treasury effort, the depository strategy around commercial business as well.

Yes, I mean, part of our long-term strategy is to not only develop new business, new lending business but to use our bankers to get a holistic relationship with clients. So we're not only looking at prioritizing prospects in the market to grow the loan business, but those prospects must have other business that we want to go after, such as deposits. We want to avail them to things we do, which we don't do a lot of today, like foreign exchange. We want to continue to grow using derivatives to protect risk against interest rate growth -- raising -- rising interest rates for our clients and develop treasury management products that really target the 0 to $150 million revenue size company. So we want to stay right in our sweet spot. We think that will help us grow very safely.

Correct. And then other things we'll talk about later through our wonderful Northern Virginia operation that came to be a part of us through Xenith. They're sitting there in the largest cluster of nonprofits in the country. And so we do, in fact, have a nascent, nonprofit depository strategy. We've got some other sort of niche-and-specialty focuses we'll talk about later on. So this is really getting well organized. So bottom line, when I look at Union, probably what excites me more so than anything else is really this talent pool. We have people who have grown up here at Union, and we have people who joined us from elsewhere. It's a bit of a melting pot. There's certainly a discernible culture, and this is going to be a great opportunity for our team and some potential new teammates. That's my pitch.

Thanks, Blair. Thanks, everyone, for joining us today. We look forward to talking with you next quarter. Have a good day.

Thank you, ladies and gentlemen. This does conclude today's conference call. You may now disconnect.