Atlantic Union Bankshares Corp (AUB) 2018 Q1 法說會逐字稿

Good morning. My name is Dennis, and I will be your conference operator today. At this time, I would like to welcome everyone to the Union Bankshares First Quarter Earnings Conference Call. (Operator Instructions)

I will now turn the call over to Mr. Bill Cimino, Vice President of Investor Relations. Please go ahead, sir.

Thank you, Dennis, and good morning, everyone. I've 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 excludes the fourth quarter charge related to the revaluation of the company's deferred tax assets resulting from the Tax Cuts and Job Act of 2017. Important information about non-GAAP operating metrics, including a reconciliation to comparable GAAP measures, is included in our earnings release for the first quarter of 2018.

Before I turn the call over to John, I would like to remind you and everyone on today's call that 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 first quarter of 2018 and our other SEC filings for further discussion of the company's risk factors and other important information regarding our forward-looking statements, including factors that could cause actual results to differ.

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 thanks all for joining us today. Before I get into the first quarter, I'd like to provide an update on the Xenith merger. The integration work is progressing well and importantly, I'm pleased to report that we've not experienced any unexpected turnover to date. Our team is energized and off to a great start since the merger closed on January 1. We're on track and well prepared for core system conversion over Memorial Day weekend. I'm confident in our integration playbook, and I want to thank our teammates for all the hard work they've put in to make the transition as seamless as possible for our customers.

Turning to the earnings report, Union is off to a strong start to the year as demonstrated by our financial results, with solid loan and deposit growth and meaningful improvements to our profitability metrics on an operating basis even before realizing the full impact of the Xenith merger cost saves. I believe our first quarter performance sets the pace for the year ahead and signals the underlying strength and earnings potential of this uniquely valuable franchise, Virginia's regional bank.

Rob will provide more financial details in his sections, while I'll only speak to some key achievements during the quarter, keeping in mind that the comparison to prior periods is impacted by the Xenith acquisition.

For the first quarter, on an operating basis, Union earned $38.9 million or $0.59 a share. I'm pleased to report that our first quarter profitability metrics improved meaningfully during the quarter when compared to last year's fourth quarter. We are on track to meet our top-tier financial performance targets in the fourth quarter, once the Xenith related cost savings are fully realized.

Operating return on assets improved by 21 basis points to 1.21%. Operating return on tangible common equity increased 263 basis points to 14.95%, and the efficiency ratio dropped below 60%, improving 2.3 percentage points to 59.8%.

On a pro forma basis, assuming the Xenith acquisition closed on December 31, 2017, Union grew linked quarter annualized loans by 9% and deposits by 6%.

While we did grow loans faster than deposits, the gap is manageable, and we continue to believe we're capable of matching the 2. Overall credit quality continued to be very strong. The economy and our footprint remained steady, and 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 the long-term trend line, but at this time, we do not see any early indications of a downturn in Union's portfolio level credit quality.

At Union, we believe it important to set goals, communicate them and track back to them. With that said, let me provide an update on our 6 previously declared 2018 priorities.

First is diversify our loan portfolio and revenue streams, which we define as increase commercial lending growth, which includes both commercial and industrial and owner-occupied real estate product types, in order to better balance the total loan portfolio over time and grow fee-based products and services to become less reliant on spread income.

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. On a pro forma basis, linked quarter outstandings for our C&I loan type increased by 14% annualized, and owner-occupied real estate grew by 11% annualized. As a reminder, owner-occupied real estate is a key loan product type for small and midsized businesses.

C&I line utilization remained steady at 40%. During the quarter, we announced a new Head of Commercial Banking in Southwest Virginia based in Roanoke. He joins us from a similar role at SunTrust in the same area and brings a strong C&I background. His predecessor will now focus his full-time energy on building out our North Carolina strategy, as he previously led commercial banking for a North Carolina-based bank. We've also hired a Raleigh, North Carolina-based commercial banking leader with a strong C&I background, as we start building out a branch-light business model in North Carolina. We're a few days away from sharing details on this hire. We've also added an experienced team leader to our commercial operation in Hampton Roads, which means Coastal Virginia, who'll enable us to more keenly focus on C&I opportunities in that important market, the second most populous in Virginia.

We continue to believe there's significant upside in commercial loan categories, as more small and medium-sized and lower middle-market companies become aware of our expanded capabilities and the relationships develop. This will also fuel growth in core deposits and treasury management fee income. As I've said before, I do expect new commercial and industrial banking clients will eventually be the largest driver of future growth as this effort matures.

On the fee-based revenue initiative, the wealth team is making steady progress toward their objectives. We announced 2 acquisitions of registered investment advisers in the first 4 months of 2018, 1 in Roanoke and 1 in Northern Virginia. We believe this is the fastest path that meaningfully increase our wealth management fee income stream but not the only path.

With 2 acquisitions, we'll have more than $3.6 billion under advisement, and we've established a strong growth platform for the business. At this time, we're going to take a pause in pursuing additional registered investment adviser acquisitions, so that we can focus on successfully integrating the 2 companies into Union and confirm that the wealth management investment strategic thesis is sound and performing.

Our second priority is to grow core funding to find us 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. We want to grow our core deposit base to manage our loan-to-deposit ratio to our targeted 95% level over time.

In the near term, I would expect us to continue to have a loan-to-deposit ratio just above 100%. Currently, our loan-to-deposit ratio is 101%, down 1 percentage point from the prior quarter's Union stand-alone ratio. We're focused on improving our retail banking depository offerings, increasing our deposit-intensive small and medium-sized business relationships and enhancing our treasury management capabilities. We've realigned our business banking teams to our commercial channel from a retail channel in the fourth quarter and changed their incentives to focus more attention on deposit gathering, which is appropriate for that channel and should foster improved coordination between our commercial and retail teams in both client coverage and our prospecting efforts.

Deposit growth did trail loan growth during the first quarter, with pro forma deposits increasing 6% annualized. Union traditionally sees slower deposit growth in the first quarter due to seasonal factors, which helps explain some of the variance between the loan and deposit growth. Except for NOW accounts, deposit growth was broad-based in all categories.

As a reminder, 44% of our deposit base comes from transaction accounts, which provides a lower deposit beta profile as compared to many competitors. I also remain convinced we have a great opportunity to build our deposit base with deposit-intensive commercial businesses including those that have no borrowing needs at all. These opportunities take time to bear fruit, but we're making good progress in this important focus.

Our third priority is to improve efficiency as measured by efficiency ratio and do so by leveraging technology to lower cost, improve quality and support growth and build scalable, replicable processes. As noted, we're making headway on lowering the efficiency ratio on an operating basis with it dropping below 60% during the quarter, a first for Union.

We expect to see further improvement leading up to the fourth quarter annualized run rate, at which time cost saves from the Xenith acquisition will be fully reflected in our results. In the meantime, we're continuing to make progress on the other efficiency opportunities that we've previously identified. As examples, we're taking a comprehensive look at the branch footprint and we're reviewing all of our physical space needs in search of other opportunities to reduce occupancy expense.

Turning to the systems and processes aspect of this priority. As part of the core systems conversion in May, we're upgrading our treasury management platform to the latest generation. The new platform will enable us to compete well with the largest financial institutions for our target market. Also, late this year, we'll begin implementation of nCino, which we believe to be the best-in-class commercial loan origination system. This will further streamline our loan approval processes, allow us to better track productivity, eliminate manual paper processes and improve both turn times and quality.

Our fourth priority is manage the 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. Broadly speaking, we realigned our 2018 short-term management incentive compensation programs to match our top-tier financial targets that we expect to achieve on a run rate basis beginning in the fourth quarter. As a reminder, our top-tier financial targets are a return on assets of between 1.3% and 1.5%, a return on tangible common equity of between 15% and 17% and an efficiency ratio below 55%. We are intensely focused on achieving these objectives, and as our first quarter results indicate, we're on track to achieve these objectives beginning in the fourth quarter. We've also better matched job-specific goals with corporate priorities. Examples are assigning business bankers higher deposit goals and further increasing the focus on C&I opportunities for our commercial bankers.

As a reminder, in addition to a companywide ESOP program, Union has had a profit-sharing program in place for over a decade, enabling teammates who are not eligible for incentive compensation plans to share in the profitability of the company. This creates a shared focus among all teammates that correlates strongly with achieving our financial targets and increasing shareholder value.

Our fifth priority is to create a more enduring and distinctive brand by creating differentiated client experiences to make banking easier and continuing to build our brand in existing and new geographies. Our marketing plans are ramping up nicely, as we prepare for Xenith's brand transition to Union Bank & Trust, and we introduce our brand to new geographies and customers. We recently announced 2 significant sponsorships related to our entrance into the Hampton Roads market, that's coastal Virginia, including a naming rights deal for the Union Bank & Trust Pavilion, which is a popular outdoor amphitheater in Portsmouth, Virginia, and our sponsorship of the large-scale Patriotic Festival occurring the first weekend in June. Both are outsized opportunities to create brand awareness for Union and our company by special offers for our customers. We also have new advertising in development that we'll launch just ahead of our brand and systems conversion starting in early May.

As you may know, Money Magazine recently rated Union the best bank in Virginia, and that credential features prominently in our advertising. This recognition is a very real proof point of the value proposition Union offers our customers and differentiates our brand from the competition.

Our sixth priority for 2018 is to integrate Xenith. This includes leveraging commercial expertise in new market opportunities and achieving cost saves in a successful conversion.

As I mentioned before, the integration has been meticulously planned. It's being rigorously executed, and we expect it to go smoothly. We're leveraging the Xenith C&I capabilities in Northern Virginia and Richmond with the Union brand, the larger lending capacity we have and the broader product lines. We're also focused on building out our C&I capabilities in our other markets. We've a line of sight to achieve our cost save targets and expect to hit them on a run rate basis beginning in the fourth quarter.

Our 2018 priorities are the way forward for Union. 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 the opportunities to grow the franchise organically in Metro DC, Maryland and North Carolina. As a secondary strategy, it is likely we will have further M&A opportunities that make strategic and financial sense to pursue, both in contiguous markets and as infills to our existing footprint.

Our teams are energized about being a part of the new Union, as we're sometimes called, and I believe we have an attractive offering with differentiated competitive positioning and expanded capabilities. I also believe Union is simultaneously capable of going head-to-head with the out-of-state-based superregional and national banks that dominate market share in Virginia and with the smaller banks that lack our resources and capabilities. And I think we've demonstrated that Union is an attractive destination for top talent throughout our markets with numerous high-profile hires having been made.

Union started off the year on the right foot with our first quarter results demonstrated by a solid growth in loans, deposits, operating earnings per share and operating net income, and we're making meaningful progress on our 6 priorities.

Integration is going well, and core date systems integration remains on track for Memorial Day weekend. I feel comfortable with our loan and deposit growth momentum, and our loan pipeline looks good. It looks strong and well balanced. 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 close by saying, we believe Union is a uniquely valuable franchise with a story unlike any other in our region, having assembled the right scale, the right markets and the right team to deliver high performance.

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

Thanks, John, and good morning, everyone. Thank you 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 first quarter. However, before we get started, I'd like to share some data points as it relates to the Xenith acquisition that should also be kept in mind as we review the quarter's financial results.

The fair value of assets acquired equaled $3,249,000,000. And the fair value of liabilities assumed equal $2,868,000,000. Total goodwill arising from the transaction equaled $420 million. Gross loans acquired equaled $2,507,000,000 with a fair value of $2,459,000,000. The loan mark came it at approximately 2% or $51 million. Total deposits assumed equaled $2,546,000,000 with a fair value of $2,550,000,000. Core deposit and tangibles acquired totaled $38.5 million. Since this is our first quarter with consolidated numbers including Xenith, I don't think it would be meaningful to discuss the year-over-year or linked quarter trends. Although, I will make references to trends in areas that make sense to do so.

We will have a more robust linked quarter discussion for the second quarter call. We should also note that for the most part, my commentary relates to Union's financial results on an operating basis, which excludes $22.2 million in after-tax, merger-related cost in the first quarter of 2018, and it also exclude $1.4 million in after-tax merger-related cost and $6.3 million in nonrecurring tax expenses related to the Tax Act in the fourth quarter 2017 results. For clarity, I will specify which metrics are reported and operating in my commentary.

In the first quarter, reported net income was $16.6 million and earnings per share were $0.25. On an operating basis, consolidated net earnings for the quarter were $38.9 million or $0.59 per share. The company's operating profitability metrics improved markedly during the quarter. Our operating return on assets improved to 1.21% from 1% in the fourth quarter and was up from 92 basis points in 2017's first quarter.

Operating return on tangible common equity was 14.95% versus 12.32% in the fourth quarter and was up from 11.2% in the last year's first quarter. The operating efficiency ratio declined to 59.8% in the first quarter from 62.1% in the prior quarter and down from 65.2% in the first quarter of 2017.

As John noted, we remain committed to achieving top-tier financial performance relative to our peers. We are targeting an operating return on assets in the range of 1.3% to 1.5% and operating return on tangible common equity within a range of 15% to 17% and an operating efficiency ratio below 55%.

We are confident that once the cost savings from Xenith acquisition are fully realized beginning in the fourth quarter, that we will be well within these targeted ranges.

Now turning to the major components of the income statement. Tax-equivalent net interest income was $105.3 million. That's up $29 million from the fourth quarter and up $36 million from the prior year's first quarter, driven by the acquisition of Xenith as well as increased levels of earning asset balances. The current quarter's tax-equivalent net interest margin was 3.72%. That's an increase of 8 basis points from the previous quarter. Net accretion of purchase accounting adjustments for loans, time deposits and long-term debt added 20 basis points to the net interest margin in the first quarter. That's up 10 basis points from the prior quarter, primarily due to the Xenith acquisition. The 8 basis point increase from the tax-equivalent net interest margin was principally due to the 40 basis point increase in the tax-equivalent yield on earning assets that -- which was partially offset by the 6 basis point increase in the tax-equivalent cost of funds.

The quarterly net increase in earning asset yields was primarily driven by higher loan portfolio yields, which improved by 24 points -- basis points during the quarter due to the effect of increased short-term interest rates on variable-rate loan yields and 8 basis points driven by higher accretion income. The increase on loan yields was partially offset by lower taxable equivalent yields due to the Tax Act, which reduced earning asset yields by approximately 6 basis points from the prior quarter.

The quarterly increase of 6 basis points in the cost of funds to 74 basis points was driven by higher deposit costs, which increased 4 basis points from the fourth quarter to 48 basis points. Changes in the overall funding mix between quarters increased the cost of funds by another 3 basis points. The provision for loan losses for the first quarter was $3.5 million or 15 basis points on an annualized basis. That's a decline of $211,000 compared to the previous quarter but an increase of $1.5 million from the same quarter in 2017.

For the first quarter of 2018, net charge-offs were $1.1 million or 5 basis points on an annualized basis, which compares to $2.7 million or 15 basis points in the prior quarter and $788,000 or 5 basis points for the same quarter last year.

Noninterest income increased $5.1 million or 29% to $22.3 million for the quarter ended March 31, 2018. That's up from $17.2 million in the first quarter -- or in the prior quarter, primarily driven by the acquisition of Xenith.

Other operating income does include a gain of $1.4 million related to the sale of the company's ownership interest in a payments-related company.

Operating noninterest expenses in the first quarter were $76.3 million including $3.2 million in core deposit and tangible amortization and approximately $800,000 related to OREO property valuation adjustments.

As John noted, we remain on track to hit our $28 million merger cost savings target, with the majority of the saves realized after the systems conversion in the 3 [indiscernible] consolidation scheduled for May. Our effective tax rate for the 3 months ended March 31 was 10.3%. During the first quarter of 2018, tax benefits related to stock compensation of approximately $1.2 million were recorded. Excluding these tax benefits, the effective tax rate for the 3 months ended March 31 was 17%. Looking forward, for the full year, we're expecting an effective tax rate of approximately 17.5% in 2018.

Turning to the balance sheet. Total assets now stand at $13.1 billion at March 31, which is an increase of $3.8 billion from December 31, 2017. The increase in assets was driven primarily by the acquisition of Xenith and also by net organic loan growth during the quarter. At quarter-end loans held for investment were $9.8 billion, an increase of $2.7 billion or 37% from the prior quarter.

On a pro forma basis, as if the Xenith acquisition occurred on December 31, loans held for investment increased $215 million or 9%. The quarterly loan growth was broad-based and diversed, as John mentioned earlier.

Looking forward, we continue to expect upper single-digit loan growth for the full year 2018. At the end of the first quarter, total deposits were $9.7 billion, that's an increase of $2.7 billion or 39% from December 31 balances. On a pro forma basis, again, as if Xenith acquisition occurred on December 31, total deposits increased $137 million or approximately 6% on an annualized basis. Deposit balance growth was driven by increases in demand deposits, money market and savings account balances.

Now turning to credit quality. Nonperforming assets increased $6.9 million to $35.2 million during the quarter, which is comprised of $25 million in nonaccruing loans and $10 million in OREO balances, which includes $2 million of former bank locations. The quarterly MPA balance increase was primarily driven by the assumption of Xenith-related OREO properties during the first quarter.

The allowance for loan losses increased $2.4 million from December 31, 2017, to $40.6 million at [March] 31, primarily due to organic loan growth. The allowance as a percentage of the total loan portfolio was 41 basis points at March 31, 54 basis points at December 31, 2017, and 59 basis points at the -- at March 31, 2017. The decline in the allowance ratio was primarily attributable to the acquisition of Xenith. Of course, as you know, in acquisition accounting, there is no carryover of the previously established allowance for the -- for loan losses from the Xenith portfolio.

So to summarize, our first quarter operating results demonstrate the significant earnings capacity we envisioned as the Union and Xenith combination produced Virginia's regional bank. We demonstrated continued progress toward our strategic growth objectives, as we generated solid loan and deposit growth during the quarter, and the company's operating profitability metrics improved meaningfully.

The merger integration work is on track, and we remain confident that we will achieve the financial benefits of the combination, once the cost savings are fully realized starting in the fourth quarter of 2018. Finally, please note that Union remains as committed as ever to achieve a top-tier financial performance and building long-term value for our shareholders.

And with that, let me turn it back over to Bill Cimino, who will open the lines up for questions from our analyst community.

Thanks, Rob. And Dennis, we're ready for our first caller, please?

Your first question is from the line of Austin Nicholas with Stephens Inc.

Maybe just dig into the NIM a little bit. As you look out through the next couple of quarters, could you maybe give us an idea of how you're thinking about the margin, maybe ex-accretion as well as reported with accretion?

Yes, sure, Austin. As you know in our release, we do provide a schedule that shows what the expectations for accretion income are. So you see that, that is expected to decline a bit over the next few quarters and into next year, but we do expect on a reported-basis to see some expansion of the margin, probably in the 3 to 4 basis point range, primarily because -- as we've noted, we've seen some increase in the short-term interest rates, and that's been very positive on our earning asset yields, primarily on the loan book, which -- on a variable rate book, which is about 48%, reprices quickly. So that's a positive going forward. We do expect a couple -- for the remainder of this year, we're expecting 2 more moves by the Fed, 1 in June and 1 late in the year. So the June move will help us as well on the earning asset side. We've also seen as you probably noted as our deposit basis are pretty low, we haven't had to move the deposit rates very much at all. I think we've been in the 15% to 20% range, depending on the type of deposit that we're talking about. So that should bode well. We don't see that, that's going to increase materially going forward. So we get some expansion on the earning asset yield. Some increase in the cost of funds. But we should see some expansion in the next quarter -- in the next couple of quarters.

Understood. And I guess that 3 to 4 NIM expansion, is that kind of between now and the end of the year? Is that how you're thinking about that? Or -- I assume that's not per quarter.

It’s actually -- I would say, we probably will see that coming in the second quarter and the third quarter.

Got it. Okay. And then I guess maybe just on the -- I think maybe, John, it's maybe a question for you, the branch-light business model that you referenced in North Carolina. I know you mentioned by putting out a press release on that, but is there any additional color you can give us on the strategy there?

Yes. We've been saying for a while now, as we think about our expansion opportunities in North Carolina, we think based on the landscape, this is going to be more of, what I call, an organic build-out as opposed to an M&A strategy. We will never say never, but it's difficult to envision us making any sort of move in North Carolina that would create density anywhere near what we see in Virginia. As you know that market has been pretty picked over from an M&A standpoint. What we have now with the acquisition of Xenith is we do have a physical presence in Raleigh. Union has maintained an LPO in Charlotte since -- probably, perhaps, 2 years ago, a little less than that which has performed well. And I'm going to ask John Stallings, our President to sort of summarize where we go from here with the build-out at Carolina.

Yes, Austin, its John here. One of the things, I'd point to is comments that John has made on prior calls and with you, I know, as it relates to the talent out there and Union being a place where we're finding opportunities to explore conversations and a lot of interest in teaming up. In the case that John alluded to in his earlier comments, we're able to get a career -- leader career relationship management commercial banking space to commit to join us just a few days ago. We've not put a press release out but truly exciting. I spent 15 years in that market at Raleigh-Durham and competed with this individual and John Asbury actually worked with him in a prior role as well, and the fact that we could win that degree of leadership head-to-head with some other competitors was another indication that there's a ripe opportunity for us to expand, especially for C&I in that space. We're seeing a lot of excitement as it relates to what we can do with our not-for-profit space, municipalities, business banking and then the traditional C&I opportunities as well.

Yes, and so the initial focus will be Charlotte, where we've added some additional resources recently; Raleigh, as John Stallings mentioned. No current plans for [indiscernible] [Borough] but we're exploring that, and then we're also aided by the fact that the person who will lead the overall expansion effort used to run commercial banking for a North Carolina-based bank and is very familiar with that market. I've lived in North Carolina many, many times and done business there for a long time. John Stallings was down there for very long time. We are really familiar with that market, so we'll go about it selectively.

Your next question is from the line of William Wallace with Raymond James.

Maybe just kind of following up on the North Carolina commentary. The -- you -- so if I understand in your prepared remarks, you're replacing the Roanoke business leader with the new hire, and that business leader is now going to run the North Carolina expansion for you guys.

Yes.

Okay, he's going to move to -- he or she is going to move to Raleigh?

No.

So out of Roanoke?

Yes. He will lead the overall effort. So we have -- what we'll have will be our Regional Heads based in North Carolina, and our leader will effectively organize the overall strategy from there.

Okay, and what bank did he run commercial banking for if you can say, if they are -- especially if they're gone?

NewBridge.

NewBridge?

Yes.

Okay. Okay, so you've hired a leader in Raleigh. Is there -- should we expect there to be a buildup of a team there?

Wally, it's John again. Definitely. We absolutely -- one of the key benefits of this particular person is his ability to attract talent. And as I mentioned, I think the Union story, the new Union story is really a compelling one, [the sign] that caused him to choose us, and he's really very prepared to help win some more boots in the ground.

And don't forget both Union and Xenith independently had resources, commercial banking resources in Raleigh. They weren't that large, but clearly, what happens now is now we have a legal branch, and we have more scale, and quite candidly, a better story. Union has 7 branches in North Carolina, but the retail branches are really, other than Raleigh, are more in the Eastern part of the state. We'll focus the commercial effort at this point on Raleigh, Charlotte, and we'll contemplate Greensboro High Point of the triad.

Okay. And then maybe segueing into -- I've got a lot of questions around expenses. You've closed in a wealth management acquisition and announced another one, you're building up lending teams in North Carolina, and then you've got all the cost saves coming from Xenith, so maybe if -- Rob, if maybe the best way to position this is, if we kind of look at your anticipated hires, you've got nCino coming in, you've got cost saves coming out with Xenith, if we're to look at our fourth quarter models, what should we be thinking about is the right expense base with the investments that are coming or have come minus the cost saves?

Yes, Wally, in terms of answering that question, you can expect the run rate of between $73 million and $74 million in the fourth quarter. That will be inclusive, obviously, of cost savings to the good and then some additional expenses related to the 2 wealth acquisitions we made and some new hires. Don't expect a huge increase related to the new hires, because we're -- there's opportunities to look at across our organization our lending teams in general, and there may be incremental hiring, but I wouldn't expect a wholesale hiring.

I would say, this is John Asbury again, aligning resources with the opportunity is the right way to think about this.

Yes.

Okay, and then as you consider new hires and their contribution to the model, what's your expectation for how long a C&I lender can get up to speed and at least be net neutral to the bottom line?

Wally, John, again. What I would say is that it's all about the prospecting and the degree which they can connect with their existing centers of influence and former clients and nonclient prospects they called on in their past, and I think the people we're talking to can get off to a pretty quick start. And in some of the recent hires we've made, we've seen that absolutely, so to pen down a particular date might be hard, but certainly, we can see some return on net investment within 6 to 8 months, John?

Yes, I think that's very reasonable. Wally, to be very clear, we're not talking about some massive build-out. We're not going down there to hire 20 people, so this will be phased in, and that'll be done very, very planfully, and with each step, we'll make sure, it's working as expected. So this is nothing that's a dramatic new market expansion. But at the same time, we do have the opportunity within our overall expenditures, which we had planned for to make these adds. We've been signaling this for a while, this shouldn't surprise you.

No, no, it didn't. I'm just trying to put it all together and just make sure that conceptually, I understand it, so definitely not surprised. Okay, so I wanted to talk about the loan growth and the deposit growth. So you reiterated your high single-digit loan growth. You also said that you anticipate loans-to-deposits to remain just over 100% over the near term. I calculated roughly almost 3% loan growth on an organic basis, which would suggest that you're already seeing runoff on the Xenith portfolio, if you're still reiterating high single-digit growth, or you expect the growth rates to slow. So 2 question. One is, are you pushing -- are you transitioning the loan mix that was acquired with Xenith? And are you seeing some of the maybe commercial real estate customers or whatever customers that you've targeted leaving the balance sheet? And two, if your loan growth ends up exceeding your expectations, would you put it on your balance sheet, even if your deposit growth is not hitting your expectations? So in other words, would you take that loan-to-deposit ratio up? And if so, to where?

Okay, let's -- you had a couple of concepts -- I don't -- yes -- we'll have to get with to you. I don't understand your math, Wally. So let me reiterate what I said. Let's think about -- let's assume that Xenith and Union had merged as of December 31. On a pro forma basis, had we been one on December 31 to the end of March, we grew loans annualized 9%. Does that make sense?

Yes, the way I did it was I took the $2.459 billion fair value market out of the first quarter numbers and then grew it based on 12/31 number, so I guess that includes some growth within Xenith's footprint. But regardless, the question is still the same. Is what if your loan growth exceeds your targets and you're struggling to grow deposits in line with loans?

So let me -- well, let me come back to that. I wouldn't say we're struggling to grow deposits. We've grown deposits on a compound annualized growth rate of -- core deposits of 9.5% at Union for the last 2 years. We grew deposits -- core deposits 9% last year. We grew core deposit 6% annualized in Q1 on a pro forma basis in what is traditionally the seasonally slowest quarter of the year. So yes, we feel pretty good about our ability to grow deposits. The issue is that we are able to grow lending faster than deposits, but before I come back to this, I want to close out Wally, we're not seeing any material unplanned runoff or loss of anything. The Xenith integration is going well. The Xenith -- go back and look at what happened in Q4. Xenith had -- Xenith accelerated their lending growth in Q4 as did we, and it continued nicely in Q1, so all is well. There's no big remix. There's no big purposeful rundown of anything that's material, so we're feeling really good about the combined performance of the organization. So that's good. We would reiterate based on everything we know now, we expect to see our organic loan growth in the high single-digits for the year, and we're feeling confident. Pipelines look good. We have no reason at this point to believe that won't be the case. Now, your question is, what if loan growth accelerated from here, how high would you less your loan-to-deposit ratio go? And so Rob, I'll look to you, but as we talk about this, we have the capacity to go up if needed.

Yes, so I would -- it's not our choice to do so, but we would increase our loan growth -- if the loan growth comes in, we would probably go up to a 105% loan-to-deposit ratio. Knowing that we'll be able to bring that down over a period of time, and that's the thing we have to keep in mind is the engine of deposit gathering from the commercial side is going to continue to improve over time, so we could run for a relatively short period of time at those levels. I don't expect that will happen but...

We could let it rise some. But realistically, we want to get that down. John, you had a comment?

Yes, one thing just to add to what Rob just said. One of the really telling statistics is the mix of our pipeline. John mentioned this in his prepared comments, but if you look back a year, Wally, the ratio of CRE to non-CRE, namely C&I and owner-occupied real estate in our pipeline was 70-30. And year later, it's 50-50. And the point is that with the focus on C&I, non-CRE -- and alongside CRE growth opportunities, we're getting more opportunities to pitch deposits, the [economic] from treasury and payments. And the neat thing is that, without getting into too many details, the pipeline is actually bigger than it was a year ago. With that mix, you can really tell our prospecting efforts in the non-CRE side have really picked up.

Yes. So Wally, again, it's a very fair question. We think about it every single day. But we don't feel constrained on lending growth right now. But I would reaffirm what do we think is going to happen. We think we're going to grow lending 9 -- pardon me, high single-digit annualized. And we think we have the ability to match that in terms of core deposit growth over the course of the year. We can't promise that, but we're not talking about a big delta, if for example, we were saying we're going to grow lending 20%, which we're not going to do, that would be a different conversation. Thanks, Wally. And again, come back to us, and we'll look at your math on the loan growth.

It's just of which quarter you take it out off, that's all.

Yes.

Got it, yes.

Your next question is from the line Joe Gladue with Merion Capital Group.

I just wanted to I guess get a little bit more color on some of the asset quality figures. Looking at the increases in nonperforming loans, I guess, it was concentrated in I guess C&I and residential. I guess more looking at the residential increase, fairly decent percentage and just wondering if that was just 1 or 2 large loans migrating to nonaccrual? Or is that -- was a broader-based, a larger number of loans?

Yes, Joe, I know it's admittedly difficult to compare quarter-to-quarter, because what you're looking at is you're looking at Union stand-alone for Q4, and then you're looking at Union combined with Xenith in Q1, so pretty much everything you see in terms of increases from a problem asset standpoint have to do with the addition of Xenith. So it's not really [been comparable]. We would say most of the problem on activity that we solved during Q1 was, in fact, consumer-related, fairly granular, not 1 or 2 big things. And I think it's important. Probably best to focus on proportions versus absolute dollars like charge-offs, for example, or annualized 5 basis points. That would give you, I think, the best way to look at it, and clearly, it'll become easier once we gets to Q2, because then you've got a clean shot of new Union Q1 versus new Union Q2. Would you add anything, Rob?

Yes, I think that's the way to look at it. I think the ratio, past new ratio was about 42 basis points in the last quarter. On a stand-alone basis, it was about 39. So we're hovering in that 40 basis points range, so it's not really a big increase at all. But from your comments, John, right on in terms of the granularity of the past news and commercial -- consumer-related.

Okay, of course, and normally I guess these -- with the acquisition, these things come on and when they're fair valued, they don't come on as nonperformers, so I guess I'm still a little bit confused by that answer.

Yes, certainly, the Xenith performing book would be counted in our nonaccrual loans going forward so not necessarily impacted by the mark.

All right. And I guess just that the -- I imagine the early-stage delinquencies is all related to the Xenith acquisition, that was fairly broad-based across categories, is that correct?

Yes. And one thing that I will point out is that if you look at seasonal patterns, you always see that mortgage payments, in particular, you [can't] just see more slow payment in Q1 on a seasonal basis, but we would say in terms of what we're seeing from a asset quality standpoint, any of the issues that we experienced in Q1 are pretty darn granular. There's no -- there's no real lumpy thing in there.

Your next question is from the line of Laurie Hunsicker with Compass Point.

I just wanted to follow-up to Wally's question on loan growth. So just simply put is we're thinking here your loans are $12.1 billion. Is it conceivable you could hit $13 billion by the end of this year?

Well, sure. Yes, certainly it's possible, Laurie, in terms of the growth that we're seeing, high single digits, could be a little higher than that, you could see that happening.

Okay. And then, just as we're going through the income statement, in your other, other category within noninterest income, it looks like you had the $1.4 million related to the sale of interest in a payment-related company. Was that legacy Xenith? Or rather was that legacy Union or was that Xenith?

No, that was legacy Union. Back in 2014, we made a investment in a payment-related company. We had about 23% ownership in that. That recently was bought by a venture capital group and as part of that sale, we recorded a gain so, say, with that interest.

So the company was sold. It wasn't (inaudible) asset but just our component.(inaudible)

Just our component was, yes, sold to a venture-capital group that could make larger investments in that space.

And Laurie, one thing I was going to add to your earlier question about loan growth, one of the things that, that's really been exciting for us is the geographic diversity of that growth. All of our markets but for one are up, some significantly. I think that bodes well in terms of the opportunities to get the most out of this year.

Okay, great. And then, again, just staying on the income statement here. Just looking your REO was up substantially this quarter, $1.5 million. Is that line -- and I realize it's jumpy because of the tax payments that come in 2Q and 4Q, but if we drop that down to like a $500,000 or so run rate, or should we thinking about that more elevated? How should we think about that line?

Yes, of course, the addition of Xenith was the number one thing you're looking at and so the absolute dollar increase.

Yes, Laurie, you definitely could bring it down substantially, the $400,000 and $500,000 per quarter is probably appropriate.

It's the good run rate, okay. Good, all right. And then, just more macro, John, can you talk about, obviously, you're still in the final phases here of Xenith digestion, so congratulations on that, but can you talk about in terms of whole bank M&A. How your thoughts around North Carolina could potentially proceed? And what would be an asset size target bank that would get you excited about it, assuming the financial metrics were right?

Sure. Fair question, Laurie. So I -- is -- I always begin an answer to a question like this, let me begin by saying the highest priority for Union is the organic performance of the bank and at this point, I would say, organic performance includes a successful integration of Xenith, and so we convert systems over Memorial Day weekend. We need to see that go well. We think it will. We have no reason to believe otherwise. Overall, big picture, I will say Xenith has gone as well as or probably better than what we would have expected, thanks to those good folks over there and the leadership, so with that behind us, we could begin to think again about inorganic opportunities and as we assess the landscape, our -- this is not a forever conclusion, but our current thinking on North Carolina is, as we've thought about and as we've done some planning, we just don't see a lot down there that seems to make sense. Now your specific questions, how low would you go? It's very difficult to imagine why it would make sense for Union to go below, I'm going to say, Rob, $1 billion?

Yes.

If we were to do another acquisition. Just look at the step up and value. Look at the step up in the performance of Union on a financial basis that resulted from the combination with Xenith. You're seeing early evidence of that now. It's very real. You're seeing us extract costs and provide more operating leverage and frankly, just more value creation. So it's a lot of work to do one of these, and if things go as well as I expect them to go, we will likely declare, we do in fact have a core competency in integrating a whole bank acquisition, and so we would somewhat be emboldened to think about another opportunity at some point provided that it makes financial and strategic sense, and we won't do anything that doesn't. So hard to think about doing something under $1 billion. That does not mean we would never do it. It simply means that we would question, why would you do that? Why -- does it have enough payoff? And then, we still think as we assess the landscape that if we could do anything from an M&A standpoint, we would first think about consolidating Virginia, and we think about Northern Virginia as being sort of the last frontier within the Commonwealth and then we would think about Maryland, because we do think there are concepts that would enable us to expand this [branch] franchise into Maryland and effectively transform Union into the first mid-Atlantic regional bank in 20 years, mid-Atlantic being defined as Maryland, DC, Virginia with apologies to our friends in Pennsylvania that we do not consider mid-Atlantic. North Carolina, so it's not out of the question from an M&A standpoint, but If I would have to bet, I would bet that you would see us move in Virginia or Maryland before down there.

And what is the largest you'd go in terms of assets?

Yes, I think the sweet spot is probably in the size of what Xenith was. $2.5 billion to...

$3 billion is probably perfect. We don't really have any [literally] contemplated, frankly, anything that would be substantially north of that, which doesn't mean that we wouldn't, but we think we see opportunities that are somewhere in that north of $1 billion and below...

$3.5 billion.

$3.5 billion to $4 billion. We think we've just demonstrated. We think -- but we think Xenith will be a proof point that we're well able to do that. We're not in any hurry, Laurie, to just for the record. And we don't feel the need to do anything. Unlike before, where we were facing the $10 billion asset threshold. At $13 billion, that is no longer an issue, and we don't see any compelling reason why we have to do anything from an M&A standpoint, but we think we could to create value and to further improve the value and performance of our franchise. We like density. We like the compactness of this franchise. We don't apologize for the scarcity value that it creates, because we think that also translates into market power, and we think that there's nothing else quite like it, and we think you can't replicate our franchise, so we would like to continue to increase density and to create, what I would like to call, a fortress of the franchise in this part of the country.

Okay, great. And last question just on Xenith. I realize that a lot of the cost saves still have yet to play through. Can you just share with us in the first quarter, whether it’s a dollar or percentage, how much of Xenith cost saves actually were baked into that number?

Yes, Laurie, it's about 40% of the run rate, would've come through in the first quarter. So you see that continue to go up in the second quarter. And by the end of the third quarter, we'll be at 100%.

Okay, so basically, you had about $2.8 million then come through in the first quarter?

Yes, that's about right.

Your next question is from the line of Bryce Rowe with Baird.

John, just wanted to, I guess, follow up on one of the comments you made in your prepared remarks around the branch franchise and continuing to evaluate it from a -- kind of an efficiency perspective, is there -- is that kind of a continuous look? Or are you in the process of kind of undergoing an evaluation that will end at some point here in the near future?

Yes, good question. It's both. I would say that we will always be thinking about the appropriateness of the branch franchise, the branch network. Given that we have now closed the Xenith acquisition, that certainly gives us the opportunity to step back and relook at everything and quite candidly, we've had some changes, as you know, in leadership structure of the retail bank which always creates a fresh set of eyes as well. Nothing is off the table at Union Bank. So we look at everything, and I would say that yes, there has been a -- sort of a discrete effort to take a fresh look at the branch network appropriateness and at the same time, that's just a part of our kind of continuous budgetary process and strategic planning.

And Bryce, this is Bill. Just a reminder, we've got 3 branches that'll close as part of the -- over Memorial Day weekend as part of the core systems integration. That was already baked into the cost saves for this year, but we are going to close 3 over the systems conversion.

There's nothing dramatic coming to be clear. But at the same time, we do believe that there are opportunities to improve efficiency. The trend is clearly toward fewer, smaller branches over time, but the crown jewel of the Union Bank franchise is this wonderful deposit base, core deposit base that we have, and we wouldn't have that were it not fora robust branch network, so we have to strike the balance.

Got it. Okay. And then, Rob, just wanted to clarify your answer, I guess, to Austin's question about the margin. In the margin guidance, you talked about 3 to 4 basis points. Is that 3 to 4 basis points per quarter for second and third quarter or across the next 2 quarters?

It'll be across the next couple of quarters is our estimate right now. Now, our current forecast also was considering a flatter curve. Of course, recently we've seen some steepness in the curve, so it could be -- could improve from there if we get some steepening of the curve, but that's our current outlook.

Today's final question will come from the line of Blair Brantley with Brean Capital.

Can you just give us your updated thoughts on the mortgage business and what's the plan there?

Updated thoughts on the mortgage business are that we continue to seek opportunities to improve the financial performance of our mortgage business.

You plan on sticking with it for now?

We are looking at opportunities to improve the financial performance of the business, and we do think it's important that Union be able to offer a residential mortgage product to its customer base. It is not an area that we're looking to do a big expansion in perhaps to anticipate that question.

Okay. And then just real quick, I just wanted to get a view on loan pricing trend, the kind of the competition out there? And maybe get some detail on what you're seeing in your -- in terms of spreads on some of your 5- and 7-year type products versus the variable rate products out there?

Yes, John Stallings, we've -- maybe I'll get you to comment on this one. I would say that we just did a market-by-market review, or region-by-region review of competitor behavior, market behavior. It's -- I don't see anything going on that strikes me as especially different. How would you...

Yes, it's John. I think that's correct. I think the spreads have held up. The issues are always with the better credit opportunities where it gets a lot hotter and more competitive, but overall, we've been able to preserve spreads, and -- but same time, the competition is pretty tight for the better deals.

That's not really that different. I know one of the questions we get a lot is are we seeing banks who can [feed] away the benefit of tax savings. It's hard to say that's true. Again, it's always been competitive. It remains competitive. I wouldn't say that we've seen any sort of plunge by any means in the spreads.

Yes, the only thing I'd add to that is it just seems like there's continued, sort of, positive mood among our commercial banking clients in terms of maybe interpretation of a stable economy to some degree a rising environment and maybe a bullishness of moving along projects they might have sat on for a while. That would be the only thing I'd add. And government contracting was noted as one area in particular we're seeing a nice (inaudible)

Yes, I was just up in Northern Virginia with our team there, and I think we have something like a 100 clients show up to an event that we held and a large number were, in fact, [having] a contractor. I was surprised at how bullish they were in terms of their growth outlook, and that was interesting. We're getting similar reports out of the Hampton Roads area, which has a material amount of contractors, more military, shipbuilding-related admittedly, but it seems like the mood is actually pretty good. Rob, from your chair, in terms of the spreads, do you see anything that feels all that different?

No, not really. We look at it every month in ALCO and haven't really seen any deterioration at this point, just adding to John's comments on that.

All right, thank you guys.

Thanks, everyone for dialing in today. As a reminder, a replay of this call will be available in our investor website, investors.bankatunion.com. Thanks, and have a good day.

Ladies and gentlemen, this does conclude today's conference call. Thank you for your participation. You may now disconnect.