Atlantic Union Bankshares Corp
NYSE:AUB
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Good morning. My name is Rusty and I'll be your conference operator today. At this time, I would like to welcome everyone to the Second Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remark, there will be a question-and-answer session. [Operator Instructions]
Mr. Cimino, you may begin your conference.
Thank you, Rusty 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. Consistent with prior quarters, operating metrics exclude the after-tax merger-related expenses for the Xenith acquisition. Important information about these non-GAAP operating metrics, including reconciliations to comparable GAAP measures, is included in our earnings release for the second quarter of 2018.
Before I turn the call over to John, I would like to everyone that on today's call we will make forward-looking statements, which are not statements of historical fact and are subject to risks and uncertainties. There can be no assurance that actual performance will not differ materially from any future results expressed or implied by these forward-looking statements.
Please refer to our earnings release for the second 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. At the risk of understatement, the second quarter was an eventful one for Union. We accomplished a number of ambitious objectives intended to position us for growth, better execute our strategic priorities and deliver the top tier financial metrics we expect to achieve in Q4.
During the quarter, we successfully converted the core data systems for Xenith with no material problems. We exited the mortgage origination business; sold the national scope marine finance business acquired from Xenith Bank at an attractive premium; sold a $206 million third-party consumer loan portfolio at par to reduce risk and improve liquidity; continue to build out the C&I teams across the franchise with five new C&I hires having started during the quarter and five more starting later this month; completed the Dixon, Hubard, Feinour, & Brown registered investment advisor acquisition in Roanoke; upgraded the treasury management platform to a state-of-the-art system competitive with the largest banks for small to mid-sized business; and close three branches as a part of the Xenith conversion and made the decision to consolidate an additional seven branches in the third quarter. We were able to do all of this while successfully completing the largest and most complex systems conversion in our company's history speaks volumes about the team we built and their capacity to execute an acceleration strategy.
We were also able to do all of this while improving our operating return on assets, operating return on tangible common equity, and efficiency ratio. Most important, we demonstrated discipline, focus, and intensity and executing against our 2018 strategic priorities and building out our franchise which we firmly believe will deliver sustainable, long-term shareholder value.
Rob will provide details on quarterly financial results in his comments, so I'll only speak to some key topics from the quarter keeping in mind the comparison to prior periods is impacted by the Xenith acquisition.
Union followed up on a strong start to the year with improvements to our profitability metrics on an operating basis even before realizing the full impact of the Xenith merger cost saves. I continue to believe that our operating results signal the underlying strength and earnings potential of this uniquely valuable franchise, Virginia's regional bank with the potential to become the Mid-Atlantic regional bank.
In terms of loan and deposit growth, average loan growth for the quarter annualized was 5.3% and average deposit growth for the quarter annualized was 7.7%. Linked quarter ending loan balances excluding the impact of the marine finance and third-party consumer lender divestitures grew by approximately 3% annualized and deposits grew by about 5% annualized.
I will point out as we build our commercial banking book; the new Union will most likely have more unevenness when comparing period ending balances given the normal fluctuations that occur among business clients within their C&I revolving credits and transaction accounts. Consequently, we'll begin to speak more of average balances than we have in the past.
Net loan growth did slow in Q2 as compared to Q1 due to seasonal fluctuations in our C&I product type that I just noted, a few planned payoffs from the sale of non-owner occupied properties we financed, and a few institutional market refinancings.
Also worth to mention is that the competitive dynamics in CRE lending increased incrementally, both in terms of pricing and structure. Over the course of the quarter, it became clear that market spreads compress somewhat presumably due to bank's trading and part of their corporate tax reform savings in an effort to build loan volume.
Post tax reform, Union elected to hold our ground to ensure we did not reduce pricing automatically as a function of lower tax rates. We've now made adjustments as we concluded this created a pricing gap with our competitors. Union does not seek to be the lowest priced provider but we will remain price competitive.
We also observed some relaxation of commercial real estate credit structures in the market, most evident among smaller competitors that we've seen some stacking of more aggressive pricing on top of weakened structures feels different and bears watching. From our perspective, Union will remain competitive on pricing and disciplined on structure and client selectively.
To be clear, we're not suggesting a dramatic shift is occurring here, it's incremental. But it may signal a competitive inflection point in CRE lending. This underscores the importance of our commercial and industrial banking diversification strategy.
Further detailing the commercial banking effort, quarter end C&I loan balances adjusting to exclude the marine finance floorplan outstandings of $19 million as of March 31, were relatively flat while owner occupied real estate grew by 4.6% annualized.
Total commercial loans meaning commercial and industrial plus owner occupied real estate product types averaged up about 5% annualized for the quarter. We continue to build up the pipeline during the quarter and we have a significant number of new commercial banking teammates rapidly getting up to speed, which I'll detail in a moment. Both bode well for future outstandings in our commercial banking product types at C&I and owner occupied real estate.
Market dynamics notwithstanding were encouraged by our loan pipelines, which are the largest we've ever seen, especially in the commercial banking categories of C&I and owner occupied real estate up significantly from Q1. Based on all that we know at this time, we continue to expect loan growth for the year to be in the upper single-digit range and that we should roughly balance loan growth with deposit growth.
Credit quality is strong. The economy in our footprint is steady and the leading indicators of credit quality within Union remain benign. As I've said since by arrival, I believe 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.
I'll also repeat that at Union, we believe it's important to set goals, communicate them, and track back to them. As a reminder, our six key strategic priorities for the year are diversify our loan portfolio and revenue streams; that's one; two, grow core funding; three, improve efficiency; four, manage to higher levels of performance; five, create a more enduring and distinctive brand; and six, integrate Xenith. Each objective is specifically defined in our Investor presentation available on the Investor Relations section of our website, so I will not detail them again here.
I will speak to our progress though, diversification. With the divestiture of the marine finance portfolio which was principally an indirect pay for retail banking product and the sale of a $206 million dollar non-core third-party consumer lending portfolio, diversification of asset classes will principally mean the buildout of our commercial banking operation which is our source of C&I and owner occupied real estate lending. This will take time to mature, but getting the right talent in position is the first step and we've taken that step. We are demonstrating our ability to recruit top talent in the C&I space and hiring is running ahead of schedule.
Let me provide some details on what has happened year-to-date. In total, we've added 19 new teammates as part of our C&I build out. This is in addition to the dedicated C&I talent we acquired through Xenith which was significant in Richmond and Northern Virginia. C&I hiring has principally been focused on our newer and larger growth markets of Coastal Virginia, Baltimore, Charlotte, and North Carolina's Research Triangle, but we've also supplemented smaller more established markets where we did not previously feel dedicated C&I teams such as in Roanoke.
The Research Triangle is a promising new market story acquired from Xenith. We just stood up a seasoned commercial banking regional office there with three other new teammates including the leader having all worked together in Raleigh as a commercial banking unit for a super-regional.
Of the 19 new dedicated C&I bankers referenced, 15 are in production roles, Relationship Manager, Team Leader, or Market Executive; two are Portfolio Managers; and one is a Treasury Management Product Manager; and one is a Senior Credit Officer. In almost all cases, these new teammates join from the super-regional and national banks that operate in our markets, we're demonstrating our ability to recruit particularly from the larger institutions as those bankers will consider joining Union, but likely not a smaller bank.
Central to our recruiting strategy is that in almost all cases, we hire talent that we know from our own experience having worked with them in our prior roles at the larger institutions or who we competed against in our markets and know no one another by reputation. Rarely do we need to use recruiters and that's a benefit of our compact franchise.
Moving on to the diversification of fee-based revenue that will principally be driven by our wealth management team enhanced by our registered investment advisor acquisitions and the ramp-up of our treasury management business which is integral to our C&I banking effort. Aiding this effort as our new treasury management platform is competitive with the national banks for small to mid-sized business. We believe their significant treasury management sales opportunities within our footprint and that these help build our growing commercial deposit base.
Next item is grow core funding with the divestiture of marine finance and our third-party lending portfolio, we are exactly where we want to be at our targeted loan-to-deposit ratio of 95%. The challenge from here is to grow both loans and deposits at our targeted rate at high single-digits for each. Union has demonstrated its ability to do both during the past two years and we consider this achievable.
Next to improve efficiency. Our efficiency ratio continues to decline as we achieve the targeted Xenith acquisition related cost saves. As previously stated, we expect to be below 55% in the fourth quarter. We're also making progress with improving the systems and processes within the organization to become more efficient and make banking with Union easier. We anticipate that these efforts will have positive implications for our efficiency ratio and profitability beyond Xenith related costs.
Next, manage higher levels of performance. This is becoming evident as we make meaningful progress toward our top tier financial targets, which as previously stated, we expect to achieve in Q4.
Create a more enduring and distinctive brand. We've made a strong brand entrance to the Coastal Virginia market which we Virginian's call Hampton Roads and are continuing our value proposition work. As a proof point, we're seeing strong initial growth in consumer checking account openings in Coastal Virginia and the other Xenith markets. We're making our presence known and our promotional efforts to introduce the Union brand in Coastal Virginia inescapable for those living there and we're pleased with the early results.
We've also refreshed our consumer banking website and are hard at work in making progress on building out a digital strategy so that we can feel the true omnichannel delivery system for customers.
A proof point of our progress creating a more enduring and distinctive brand is that during the quarter, Union was recognized by Forbes Magazine as The Best in State Bank in Virginia and was also recognized similarly by another national magazine, both of these come on the heels of the best bank in Virginia recognition we received earlier in the year from Money Magazine.
Integrate Xenith. We believe that Union has demonstrated a core competency in whole bank integration. The integration of Xenith was meticulously planned, executed well, and went smoothly. Core systems were converted over Memorial Day and we expect to complete virtually all merger related cost saves during the third quarter.
The two teams have come together as one and as I like to say, there are no legacy Union teammates and there are no legacy Xenith teammates. We all started together at the New Union on January 1, 2018.
While our 2018 priorities are the way forward for Union, we've also started work on a new three-year strategic plan that looks to be finished later this year and I look forward to updating you on our progress.
It's important to have both short-term and long-term work streams so we can build a franchise that delivers sustainable shareholder value over time. Union has achieved a great deal in the first half of the year and we intend to continue executing an accelerated strategy to realize the opportunities that lie before us.
We want to finish off the year by hitting on our financial targets and making additional progress against our six strategic priorities. 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 repeating what I've said before that we believe Union is a uniquely valuable franchise with a story unlike any other in our region. We have assembled the right scale, the right markets, and the right team to deliver high performance at a franchise that we believe can no longer be replicated.
I'll now turn the call over to Rob to cover the financial results for the quarter. Rob?
Thank you, John and good morning everyone. Thanks for joining us today. I'd now like to take a few minutes to provide you with some details of Union's financial results for the second quarter which were a bit noisy due to several strategic actions that the company took this quarter as John noted.
Please also note that for the most part, my commentary will focus on Union's financial results on an operating basis, which exclude after-tax merger related costs of $6.5 million in the second quarter and $22.2 million in the first quarter of this year.
In addition I will make reference to Union's financial results that are further adjusted for the strategic action items which impacted the current quarter including the divestiture of the marine finance division, resulting in a net after-tax gain of $16.5 million in the second quarter; Union's exit from the mortgage origination business, resulting in a net loss of $2.5 million from discontinued operations inclusive of pretax mortgage segment exit costs of $3.4 million; the sale of $206 million in third-party originated consumer loans at par; as well as approximately $600,000 in brand closure cost related to the company's decision to consolidate seven branches in the third quarter.
For clarity, I will specify which metrics are on a reported versus operating basis and which also exclude the financial impact of the quarter strategic transactions in my commentary.
In the second quarter, reported net income was $47.3 million and earnings per share were $0.72. On a non-GAAP operating basis, which as noted excludes $6.5 million in after-tax merger related cost, consolidated net earnings for the second quarter were $53.9 million or $0.82 per share.
For the quarter, the company's operating return on assets was 1.63%, operating return on tangible common equity was 20.2%, and the operating efficiency ratio came in at 51%.
Quarterly financial results and financial metrics excluding the impact of merger related cost as well as strategic transactions noted are as follows. Consolidated net earnings for the second quarter were $40.3 million, which is up $1.5 million or 4% from the first quarter and up $20 million from the second quarter of 2017.
Return on assets improved to 1.22%, up from 1.21% -- 1.21% in the first quarter and up from 93 basis points in the second quarter of 2017. Return on tangible common equity was 15.1% versus 15% in the first quarter and up from 11.5% in last year's second quarter.
And the operating efficiency ratio improved to 58.7% from 59% in the first quarter and improved from 63.1% in the second quarter of 2017.
As a reminder, 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 remain confident that once the cost saves from the Xenith acquisition are fully realized, which we expect beginning in the fourth quarter, that we will report financial results well within these targeted ranges.
Now turning to the major components of the income statement. Tax equivalent net interest income was $110.2 million, that's up $4.9 million from the first quarter and up $38.5 million from the prior year second quarter, driven by the acquisition of Xenith and increased levels of burning asset balances. The current quarter's tax equivalent net interest margin was 3.79%, that's an increase of seven basis points from the previous quarter.
Accretion of purchase accounting adjustments for loans, time deposits, and long-term debt added 20 basis points to the net interest margin for the quarter, in line with the first quarter accretion of 20 basis points. The seven basis point increase in the tax equivalent net interest margin was principally due to the 16 basis point increase in the tax equivalent yield on earning assets, partially offset by a nine 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 for yields, which improved by 15 basis points to 4.91% during the quarter due to the impact of increased short-term interest rates, a variable rate loan yields, and two basis points driven by higher accretion income in the quarter.
The quarterly nine basis point increase in the cost of funds to 83 basis points was driven by higher deposit cost, which increased six basis points from the first quarter to 54 basis points as well as increased wholesale borrowing costs reflective of rising short-term market interest rates during the quarter.
The provision for loan losses for the second quarter was $2.7 million or 11 basis points on an annualized basis, a decrease of four basis points compared to the previous quarter and a decrease of three basis points from the same quarter in 2017. The decrease of the provision from the first quarter of 2018 was primarily driven by lower levels of loan growth as noted in the current quarter.
For the second quarter 2018, net charge-off were $1.8 million or seven basis points on an annualized basis compared to $1.1 million or five basis points in the prior quarter and $2.5 million or 15 basis points for the same quarter last year.
Non-interest income increased $20.3 million to $40.6 million for the quarter ended June 30th, from $20.3 million in the prior quarter and that was primarily driven by the $20.9 million pretax gain on the sale of the marine finance division.
Excluding this gain, in the prior quarter is $1.4 million gain related to the sale of the company's ownership interest and the payment related company as well as security gains and losses from both quarters, non-interest income increased approximately $1.1 million or 6.2% for the second quarter when compared to the prior quarter.
The increase was driven by increased deposit account service charges, debit card interchange income, and higher wealth management fees resulting from the Dixon, Hubard, Feinour, & Brown registered investment advisor acquisition which as John noted closed on April 1st of this this year. These increases were offset by lower seasonal and service commissions of approximately $600,000 quarter-to-quarter.
On an operating non-interest expense basis, they came in at $76.9 million in the second quarter, that's an increase of $2.8 million or 3.8% from the prior quarter. The increase was primarily related to increased marketing expenses of $1.9 million, which was associated with the launch of Union Bank & Trust brand and Xenith's footprint and higher levels of debit card rewards expenses as well as the addition of the quarterly run rate expenses related to the registered investment advisor acquisition, again, which closed on April 1st.
In addition, the company incurred branch closure cost of approximately $600,000 during the quarter related to the decision to consolidate an additional seven branches in the third quarter of this year. These branch closures will result in the annual -- the annual run rate expense savings of approximately $2 million starting in the fourth quarter of this year.
Importantly, we remain on-track to hit our $28 million Xenith related merger cost savings target. Coming out of the second quarter, we have achieved approximately 80% of the saves on a run rate bases and expect to achieve the remaining in the third quarter going into the fourth quarter.
The effective tax rate for the three months ended June 30th was 19%, which compares to 10.3% in the prior quarter. The increase in the effective tax rate was primarily due to tax benefits related to stock compensation of approximately $1.2 million recorded during the first quarter as well as tax exempt income being a lower component of pretax income in the second quarter as compared to the first quarter, primarily as a result of the marine finance division gain.
For the full year, we're now projecting an effective tax rate of approximately 18%, that's up from 17.5% guidance we gave last quarter, driven by the changes in the components of pretax income I just mentioned.
Now turning to the balance sheet, total assets stood at $13.1 billion at June 30th,that's a decrease of $83 million from March 31st. The declining in period -- period end total assets was driven primarily by the marine finance division divestiture and the sale of third-party originated consumer loans which were partially offset by net organic loan growth during the quarter.
At quarter end, loans held for investment were $9.3 billion, a decrease of $516 million from March 31st, while average loans increased $129 million or approximately 5% from the previous quarter.
On a pro forma basis, excluding the impact of the marine finance portfolio divestiture and the consumer loan portfolio sale, loans held for investment increased $67 million in the second quarter or 3% on an annualized basis. Looking forward, as John has noted, we continue to expect upper single-digit loan growth in 2018.
At June 30th, total deposit stood at $9.8 billion, an increase of $120 million or 5% on an annualized basis from March 31st, primarily driven by increased non-interest bearing demand deposit balances.
From a credit quality perspective, non-performing assets decreased $1.6 million to $33.7 million during the quarter and that's comprised of 28 -- approximate $26 million in non-accruing loans and $8 million in OREO balances.
The allowance for loan losses increased $641,000 from March 31st to $41.3 million at June 30, primarily due to organic loan growth in the quarter. The allowance as a percentage of total -- total portfolio was 44 basis points at the end of the second quarter, 41 basis points at the end of the first quarter, and 56 basis points at June 30th of the prior year.
The year-over-year decline in allowance ratio was primarily attributable to the acquisition of Xenith. Of course in acquisition accounting, there is no carryover of previously established allowance for loan losses.
So to summarize, our second quarter operating results demonstrate a significant earnings capacity we envisioned as the Union and Xenith combination produced Virginia's regional bank and we are confident that we will achieve the financial benefits of the combination once the related cost savings are fully realized, again, which we expect to start in the fourth quarter of 2018.
Finally, please note that Union remains as committed as ever to achieving top tier financial performance and building long-term value for our shareholders.
And with that, I'll turn it back over to Bill Cimino who will open it up for questions from our analyst community. Bill?
Thanks Rob. Rusty, we're ready to take our first caller please.
[Operator Instructions]
Your first question comes from the line of Catherine Mealor. Your line is open.
Thanks. Good morning.
Good morning to you.
Good morning.
Let's get first started with expenses and just see -- Rob, if you could help us think about the kind of moving pieces of expenses this quarter, particularly with how mortgage would have impacted it. So, is there a way to quantify the amount of mortgage expenses that came out of the numbers this quarter? Because I'm assuming those are now in the discontinued operations line or maybe I'm wrong there. And so if that's the case, how much came out? And then, how are you thinking about kind of an expense run rate as we move into the back half of the year as we try to hit that efficiency goal? Thanks.
Yes. So Catherine, you're right, these -- mortgages reported in discontinued operations. But in terms of the run rate that was in the numbers, excluding the exit cost, it was about $1.3 million of expenses in the quarter related to the operations of mortgage.
In terms of the go-forward run rate on expenses, as we noted earlier this year or in a last call, we said about going into the fourth quarter, we expect to see running at about $73 million to $74 million. With the changes that we're seeing, of course, with Morgan divestiture or exit in other items, we expect to now be in the $70 million to $71 million range going forward -- coming in the fourth quarter and going forward from there.
Okay, great. Is there any -- that includes mortgage coming out anything from Shore and then full realization of cost savings by the fourth quarter?
Yes, that's right. So, Shore -- yes, Shore will be out of there. And that runs about $115,000 a quarter, which will start in the third. Additionally, as you know, we just closed another registered investment advisor acquisition -- Outfitter Advisors on July 1st. That's going to add about 400 -- about $350,000 in run rate. So, that's kind of a wash in terms of the run rate in expenses going forward. But it's taken out the mortgage and getting the additional remaining cost saves, which gets us to the $70 million to $71 million.
Okay, great, great. And then on a margin, can you help us think about the margin moving forward. I mean this is a really great margin expansion that we saw this quarter. You could argue that you maybe didn't see as much pressure on deposit costs as you would if you're growth wasn't stronger or if you didn't have the added liquidity from the sale of from some of those portfolios. So, how do you think about your trajection of deposit betas in the back half of the year as your growth likely improves? Thanks.
Yes. Well, in terms of the margin guidance going forward -- and I'll speak to the core margin, which came in at about 3.59% this quarter, obviously accretion will impact the reported headline number.
But in terms of going forward, recall that with the Shore Premier and our divestiture of the consumer home improvement loan portfolio, there will be some impact on the margin going into the third quarter. We expect that to be about four or five basis points of reduced margin, all things being equal.
Offsetting that as we do expect to see some expansion from additional earning asset yields improving and not having to move our deposit costs or cost of funds as much. So, we're projecting that we would be probably fairly close to a stable margin to slightly -- could be slightly positive slightly negative during the third quarter and then pretty much stabilized for the next fourth quarter as well. So, pretty much a stable margin, if you will, we see over the next several quarters.
Okay, got it. Thanks for the help.
Sure. Thanks Catherine. And Rusty we're ready for our next caller please.
Your next question comes from the line of Austin Nicholas. Your line is open.
Hey guys. Good morning.
Good morning.
Most of my questions were answered. But maybe just on expenses, were the $600,000 branch closure costs, were those included in the $8.3 million and merger costs or is that cost on top of those?
No, that would be additional cost. We don't include those as merger-related. That's primarily -- that's just related to the Xenith acquisition.
Yes, three branches, Mr. John. Asbury. Three branches were closed as a result of the Xenith-Union combination. The seven that we mentioned, that we're going to consolidate, all came out of the Union franchise and that were unrelated to the Xenith acquisition.
Yes understood. And then maybe while we're talking branches, as you look out to fourth quarter and maybe out to 2019, have you done any more work at looking at the branch network and any potential opportunities to trim it?
Yes, we do have an annual process that we grow through, Austin. That's really what resulted in the decision to consolidate the seven that we just did. When you look at this each year, I can tell you that with passage of time, the trend is clearly toward fewer smaller branches. And so we feel like branch optimization is just a way of life. It's not a one-time event. But we feel like we've done for the moment. And we will continue to look carefully, a feel for all network and we're getting to know the franchise that we picked up from Xenith. So, we really -- we've done nothing in terms of the legacy Xenith franchise other than the three overlaps we had here in Richmond. So, it seems reasonable to assume that we'll continue to do some pairing as time goes on.
Understood. And then maybe just turning to loan growth, I guess just to be clear on the upper single-digit growth guidance, is that backing out the divested marine business and then also the sold consumer loans? I just want to kind of the clear on the math there.
Yes, yes, you'd need to take that out of the base line. We're talking about start point minus the marine finance portfolio and the consumer third-party lending.
Basically, growing up our ending balance as of June 30th, because those are out of the -- by the ending--
Yes, of the -- something that's important to point out. If you look at the end of March, the Shore Premier Finance portfolio, while it was mostly consumer product type, there was $19 million outstanding in the C&I product type at the end of March that went to zero at the end of June because it was sold. That represented what was left of the floorplan business.
Understood. Okay. And then just on the home improvement loan sale, is that signaling any change in strategy there? Or is that just an opportunistic sale and the company is still continuing to originate those loans?
Well, we don't originate those. We do have a modest portfolio of alternative investments, which we use that for consumer product diversification. This particular product, it was very clear to us that we could replicate the 3.8% yield if we chose to do so in the securities portfolio in an investment-grade type with a comparable duration.
The fact that we're able to sell it at par was fantastic from our standpoint, because clearly it's not that it was a good portfolio, we weren't particularly concerned about the risk, but it had a derisking effort, it has a liquidity improvement aspect. And quite candidly, why would you invest in that when you could turn right around and replicate it in investment-grade securities and have that as dry powder. So, we were focused. It's not coincidental that we stand here today at exactly our targeted loan-to-deposit ratio of -- it was actually 94.8%. So, we felt like that was opportunistic and we were delighted to get that done.
Yes and these were not strategic assets, not really -- none of which were very small number, we're in our footprint and these are outside of -- the more of in national loans, and it also improved our returns on risk weighted assets considerably, as John mentioned, by -- even just by putting it alternative investments in the investment portfolio.
Say the capital benefit.
Yes, it has capital benefit as well. So, -- and just to answer your questions, Austin, specifically, we have exited our arrangement with this third-party lender, so won't be putting any new loans onward with this particular originator.
Understood. Great. Well thanks guys for the time and I'll hop off to allow others.
Thank you, Austin.
Thanks Austin. Rusty we're ready for our next caller please.
Your next question comes from the line of William Wallace. Your line is open.
Hi Wally.
Hi guys. Good morning. Maybe just following up real quickly on the last line of questioning. Are you -- as far as your balance sheet goes, are you guys done with the sale of non-strategic assets or are there other opportunities that you're investigating or pursuing?
Well, I would say there's nothing that we're actively pursuing. We clearly chose to -- on an accelerated basis, pair down these extraneous businesses to get us to our core. So, I feel like we are in the business that we need to be. And at this point in time, there's nothing obvious to us that is not a strategic fit for Union. It clearly made sense to get them done as we did. So, I would say that you're pretty much looking at the core franchise at this point.
Okay. And then the buyer of the consumer home improvement loan, was that a bank buyer?
It was a superregional bank.
Okay. Thank you. Okay and then I just -- I still have a couple of questions on the margin and expense. Maybe just starting with expense, Rob, you mentioned $1.3 million of expense for mortgage. Are saying that's $1.3 million that was above or outside of the discontinued line item or that was in discontinued?
No, what I was suggesting was -- it was excluded the exit cost that we incurred to divest of that business. So, it was kind of--
That was included in the discontinued line item.
Yes, it that was included in discontinued items. Just that bifurcated the exit cost versus the new considerable run rate this quarter.
Okay. But the run rate is whatever $77 million or $76.9 million, exclusive of merger cost. And then, I guess, you get $600,000 of the occupancy expense of the branch consolidation expense that's -- and you probably take out of that too, call it $76 million-ish going down?
Yes, that's right. That's going to go down over the next two quarters, right.
Okay. Then moving into 2019, I think, you said $70 million, $71 million in the fourth quarter and moving forward, does that mean that you anticipate you have some additional cost saves that would come off and offset just your normal pressures to expenses from annual salary adjustments, healthcare costs, et cetera, going up or we'll start experiencing normal pressure?
Yes, you would -- yes, so the $70 million to $71 million coming out of the fourth quarter, you would add in normal merit increase inflationary type expenses when you go into 2019 and beyond, but we come out of the year at that run rate and that's kind of what the base line is.
Okay.
And while into the noise issue, remember we you still have -- we had significant Xenith -- most of the Xenith teammates were still here in Q2. That's why a lot of those folks are rolling out and we are virtually all of that over with over the course of Q3.
Perfect. Okay, that's helpful. I appreciate that color on expense. And then maybe let's talk a little bit more about margin. And so just first of all just to understand. Rob, but you're saying that guidance, you're saying we'll have four to five basis points that comes out just from the sale of the consumer portfolios and -- so that gives us whatever that's new run rate. And then, you're saying flat from there moving forward or you're saying we get four to five back because of that?
No, I think we'll -- yes, so back that up and we will some -- we think there's some -- if you back that out, you could say we expect some expansion to offset that negative over the next quarter and then kind of stable from there.
So, in other way, this quarter, you could expect to see the margin not expand from this quarter but not decline.
Yes, okay. So, then with -- if we get another fed hike in September then, do we get another four or five basis points of benefit, do you think?
Well, I don't think it will be that much, but we do expect there will be some benefit going forward. We're kind of hedging the bit in terms of what the funding cost look like as we also take a look at both deposit betas and our wholesale cost that will also increase. So, not going to go and suggest it will be expansion of that level.
Okay. And so John, in your prepared remarks, at the very beginning of the call, it sounded like, if I'm kind of reading between the lines, you guys basically reduced your pricing because the competition has reduced yours and you are not competitive from a pricing perspective. So, you had to adjust towards the end of the quarter to be able to reaccelerate the loan growth to hit that high single-digit loan growth guidance that you have for the year, is that I mean--?
Yes, that's correct. I would not want to suggest that we are out there winning business based on price alone, that's not our strategy. But you have to be competitive. And admittedly, we found ourselves increasingly at the less competitive into the range. And we were experiencing the consequences of that. So, we have -- obviously, we will remain competitive then we've made adjustments.
That comes in the play as we talk about the fourth quarter as well not expanding. So, we are -- we will see what happens on that side.
Okay. So, you guys -- as I kind of think about the shift in the strategy to more of a commercial lender who is competing against the superregionals, are we talking -- is it market share that you're taking or are you seeing -- so are you seeing that the larger banks, are they adjusting their pricing down more aggressively than you had hoped? Or is it that you're up against other smaller bank type competition that is trying to take market share as well and that they're being less rational? Or is it a combination of just everybody is taking their pricing down?
Well, I would say that overall pricing has come down. And I'd ask Dave Ring to comment. My perspective is that the smaller banks are more of a player in the commercial real estate side, which is a good business for us. I would say that the more interesting things that we've observed that have gone on has happened among the smaller players. It is a market share take away, there's no question. David Ring had a commercial banking this year, how would you answer that, Dave?
Yes, I agree with John what you said. We see it. We're seeing more on the commercial real estate side than we are on the C&I side. And it's more selective. It's not across the Board, it's not -- but it's on a deal-by-deal basis. So, we've sharpened our pencils so we can convert more of our pipeline.
Okay. And then John you also mentioned that you've seen some change in structure that you're not -- you're suggesting you're not scared about it but you think it observes watching. What exactly are you seeing? And you guys are not changing structure, correct?
No, I would say that -- from our standpoint, we're not doing any particularly different. For the best clients, we'll flex the most. But from our standpoint, what I described is the stacking of very aggressive pricing, unusually aggressive on top of unusually aggressing structure feels different. And we're mostly seeing that among the smaller players probably because they don't have any other option, frankly. And Dave, I'll let you -- specifically, we've seen extended amortizations, we've seen higher loan to value, all the classic things we look for.
Yes, we've seen our competition trim that service coverage requirements. We're trying to make sure there's a cushion there when we're loans doing our loans. So, it's mostly in this debt service coverage loan-to-value calculations that we're seeing [Indiscernible] along with loan re-amortization schedules.
No, Wally I want to be clear. I also said there's nothing dramatic going on here. This is simply incremental, but it does feel a little different. So, I don't want to suggest that there's been any sort of massive change here and the markets have gone bananas, that's not true. But it is something that we're noticing.
And I think it's fair to say, based on the strength of our partner lines, which is tremendous at this point, there are plenty of good deals that we are more than willing to do and there are some things that we are not going to do.
Okay. And then--
I think you had one last question there Wally.
Yes, I had one last question. And thanks for all the time. So John, you've mentioned in the past from quarter-to-quarter, we are likely to see lumpiness variability as it relates to seasonality drawdowns, et cetera. Is there a metric in your C&I portfolio specifically that you track to gauge success and the growth of that portfolio despite seasonal factors? And if so, can you tell us what it is?
Yes, so there's several things. Now, bear in mind, I'm a 31-year banker and I grew up in this space, as did David Ring, as did John Stallings, so this is very normal to us. What's happening is that in revolving credit category of C&I, which is typically what that is, it's not exclusively but it's mostly -- particularly, given that we've inherited through -- thankfully, through the combination with Xenith, the good work there, including government contract finance, which tends to be borrowing-based related, you're going to see more ups and downs. And so we look at commitments, we look at utilization of commitments, we look at average balances. And quite candidly, Wally, we are still learning the rhythm of the new Union. And so we've got to kind of get used to what to expect based on this portfolio in terms of seasonal flows. And there are influences that go on from government contract. Dave, what would you add?
Yes, so there's -- we have some specialized lending categories now, which includes government contractor banking and that typically will peak in the fourth and first quarters and then it start to slowdown. And so that's something we're tracking to specific to that business.
Yes, something has to do with the government budget, timing of payments. Now with the systems converted, we have a very clean data post-conversion. It gets a little complicated to get a true apples-to-apples comparison of things like utilization and even commitments.
For example, if you have a borrowing base, there's a difference between what we call borrowing base availability and the committed amount. And so we're a little bit reluctant to be doing pro forma historical data that we would comment on publicly. But you'll see us to be more clear in terms of these metrics on a go-forward basis now that everybody is on the same system.
Okay, that's helpful. Thanks guys. I appreciate all the time.
Thanks Wally. Rusty, we're ready for our next caller please.
Your next question comes from the line of Laurie Hunsicker. Your line is open.
Thanks. Hi, good morning.
Good morning.
I wonder if we could go back to margin here. I just wanted to make sure that I am understanding your comments of reported versus core. And specifically around this, I just want to get clarity on the accretion income line. So, if looking at page three of your press release and I'm extrapolating that number, round number should drop of this, all else being equal, in the September and December quarters call it by $2 million or so in September, which suggest that your accretion income, which was round numbers 21 basis points on your margin, would then go down to 14 basis points, right. So, we would potentially see out of reported margin come seven basis points. And so when you were giving margin, was that around core margin or was that around reported margin?
It was core margin, Laurie.
Core margin? Okay.
Yes, you're correct.
Okay. So, then I'm thinking about, all else being equal, I'm kind of adjusting your comments from what is currently a 379 reported, if everything else stays flat adjusting for four to five basis point reduction in loan sales and then the rebound, round numbers, you are to around the net 372 or so reported versus 379 this quarter, just round numbers. Does that sound about the--
Yes, that's in the ballpark, Laurie, that we're--
Okay. Good. And then, in loan loss provisioning what was the amount, if we look back historically, that the two portfolios you had in there. What was that running on an annual basis, the two portfolios you sold, the consumer as well as the marine finance?
It was relatively small -- are you talking about the allowance itself?
Correct. Correct. What were you all provisioning?
Yes, so the loans was probably around 1% we were provisioning in a combined--
1% combined. Okay, good. Okay. And then just jumping over to expenses -- and I know you touched on this briefly, but can you just update us specifically on the cost saves in terms of where we sit as of the of end of 2Q, how much of that $28 million in pretax Xenith cost saves have been realized?
Yes, it's probably in the 55% to 60% range, Laurie. Because, as John noted earlier, a lot of the cost exact coming in the back half of this quarter, actually in June when -- since we did the data system -- the data conversion at the end of May.
So, we had a work through days typically at the end of June for a number of our teammates as well as achieving some of the core processing per unit cost reduction that we expect.
So, call it like 55%, 60%, probably 60% and that moves up. At the end of the quarter if we said, we start it right now; we'd be at 85% -- 80% to 85%. There'll be some more. But the rest of those costs will come out at a run-rate basis during the third quarter. We do have some teammates that will remain for a few months post-June 30 as well as we have some occupancy expenses that we still deal with, that we're trying to divest the properties and things so the recent costs associated with that.
Okay. Okay, great. And then the marketing expense line that jumped up this quarter, how should we be thinking about that going forward? Was there something unusual you made a push with respect to the Xenith acquisition or is this a better run rate?
Yes. No, this is -- this run rate is a little higher hike. So, I would expect you to see that come down in the $1 million to $1.2 million range from a run rate perspective. We did have -- there was some additional rewards costs in there that we don't expect to continue at that level as well as additional spending regarding the branding in the Xenith footprint. So, those were elevated costs this quarter.
And the rewards program reference, specifically as we change debit card rewards program vendors and so had a clean-up. So, people do have debit card rewards were given the last chance to use them before they effectively run away. And so that's part of what you're seeing that we have to while clean that up. So, that's--
And how much was that total?
How much of what total, Laurie, sorry?
I'm just looking at marketing expense line was $3.3 million. Was the differential between the $1.2 million run rate and the $3.3 million, was that all rewards program related?
No, it's a combination of both rewards and the additional spending related to the Xenith. Call it, two-thirds branding and a third rewards of that $1.2 million.
Okay. And then just also on expenses. The DHFB one-time cost of $770,000, was that in that total non-interest expense line at the bottom, the 2.174 or did--?
Say that again, Laurie. I'm sorry I missed the first part of that.
Yes, so the one-time costs associated with closing DHFB, the $770,000. Did that show up in the 2.174? I know was add in that other expense line?
No, that the Dixon, Hubard numbers are included throughout the various categories of expenses. That would be salaries and other types of expenses. So, that's not in the other category.
Okay. And so really just in that number, was this $600,000 branch consolidation cost was in that number?
Yes, right. Yes, that shows up in other for sure.
Okay. And then just one more question related to your branch closures. You took all of the costs now for the third quarter branch closures. Are we going to see some more one-time costs associated?
Yes, I should've mentioned that. We do expect to incur some additional cost in the third quarter just due the accounting rules around closing them since we're not closing them -- actually, we're scheduled to close them in August. So, there'll be some additional costs there. I think it could be in the $300,000 range or so.
Okay, great. And then can you just update us on your AUM now that you've closed Outfitters, where that stands against both as of June 30 and then with the close of Outfitters as of July 1st, where you stood?
In terms of assets under management?
Yes, correct.
Yes. So, we ended the quarter about $3.2 billion, and upwards is a value about 3 -- about $400 million. So, we expect to be at the 3.6 -- we're probably at the $3.6 billion as we speak now.
Okay, great. Thanks. I'll leave it there.
Thanks Laurie.
Thank you. Rusty we're ready for our next caller please.
Your next question comes from the line of Matthew Keating. Your line is open.
Good morning Matt.
Good morning. On the deposit competitive environment and sort of what you're seeing there from some of the larger banks in your footprint? And also, if you expect any impact from the upgraded treasury management platform on deposit growth as we move into the back half of the year? Thanks.
Yes, in terms of deposit pricing, we haven't seen a lot of pressure really for most banks, including the bigger banks. We are moving with the market, especially on the money market and our CD rates, but nothing out of the ordinary in terms of increased rates beyond what you would expect that the betas should be as market rates move.
In terms of the deposit growth, yes we do expect to get us on the improvement into deposit growth, that's part of our guidance on matching loan growth with deposit growth in the upper single-digit. So, that's definitely part of the plan.
Yes, I would -- this is John, Matt. I would say that traditional Union did not have focused effort on business-intensive or probably deposit-intensive businesses, we certainly do now. So, I'm going to ask Dave Ring to comment on this one. So, you do have an element. We're seeing it. It's happening right now. We are seeing more business deposits, including businesses you don't borrow at all, which is -- it was never our focus area for Union, but it certainly is now. Xenith was focused on that for sure. No question that the treasury management platform helps us in that effort.
We have a new platform and better services. So, we are able to sell deeper into the client base. And in order to pay for those services, they'll keep higher balances with us. And we're also seeing an increase balances from new client acquisitions. And like John said, deposit-only businesses that are using our service.
Right. And we're also seeing the professionalization at the treasury management effort. The new Head of Treasury Management Sales is fantastic. She is a career Virginia banker, came out of the large bank environment. The new product manager who just joined from Bank of America.
She was Manager at Payments at Bank of America and she is coming on as our Head of Product Management and she is already -- we're anticipating her arrival as we--
And our Head of Treasury Management joined, actually shortly [Indiscernible], he grew up at Bank of America and as a clear treasury management leader. So, we have had some significant changes in terms of the capabilities of the staff.
Great, that's very helpful. Thank you. Final question for me would be just on the Shore Premier transaction. As part of the consideration for those loans, you did receive shares from the acquiring bank. How did that come to be? And what are the plans for those shares, I guess? Thanks.
Yes, right now we have about $30 million of home shares as part of that transaction. In terms of -- going forward with that, so that currently shows up on our balance sheet. Going forward, because these are unregistered shares, we have to hold those shares for six months before we could divest them. Our plan would be that, at the end of six months, we would proceed in divesting those shares and liquidate those shares.
The good news from our point of view is that we've got price protections. There's no downside to us sure. I mean Home will make up any difference regarding related to what we sell shares at and what the original transaction pricing was at.
So, basically, we have a floor on the stock. We do also have the benefit of receiving the dividends, meantime, over the next couple of quarters. And if there's any upside in terms of what we can sell the shares, if Home Bancshares appreciate, we'd be able to keep the upside gain on those.
And Matt, to answer your question as to why we did it that way, it was helpful to Home Bancshares to have a portion of the consideration paid in their stuff. It was not our preference. We did not want that. However, in exchange for accepting that, we were able to get a better premium, which was 5%.
And so our conclusion was that it was clearly in the better interest of Union to do that because we had a guaranteed price. No downside, as Rob indicated on the shares. We keep the upside, we get the dividend and we get the better valuation. So, we felt like that was a win-win.
Makes sense. Thanks very much.
Thanks Matt. And Rusty I think we've got time for one more caller, we're running a little bit long.
All right. You're next question comes from the line of Blair Brantley. Your line is open.
Hi Blair.
Hey guys. Good morning. Just a couple of quick questions. In your expense guidance, how does the impact of not under the [Indiscernible] factored in there as well?
Yes. Yes, Blair, that's factored in there. We won't have to incur additional expenses related to model validation and other types of the cost associated with that, but that's already in the number.
What -- I mean can you quantify what those savings would be?
We estimate about $300,000 to $400,000 a year. It's what we had projected originally.
We think that the modeling that we're doing, the stress testing is a good risk practice and we're keeping it. But we do not have to hire a third-party, such as [Indiscernible] to validate anymore, and that's what Rob's point is.
Great. And then just lastly with the excess cash from this deal, has that been deployed yet or what's the plan there? What's that interest-bearing deposit balances at the quarter end?
In terms of the deploying the proceeds from the sales?
Yes.
Yes, so we're -- we've deployed a lot -- I would say all of it yet. We are investing that into the securities portfolio as we speak with the -- from a short-term perspective, we paid down federal home loan bank. And you could see that was down quite a bit at period end. We are in the process of reinvesting those proceeds in our securities portfolio. So, you'll expect to see that, that would increase over the next quarter.
And what those parts of it, are you following your similar kind of structure that you have for the portfolio now or are you seeing shorter?
No, they are pretty much in line with, generally speaking in terms of what our portfolio looks like today. We may have a bit more in mortgage-backed securities initially and that would be redeployed as cash flows into our loan, hopefully our loan growth.
Okay, great. Thank you. Appreciate it.
Thank you.
Thanks Blair. Thanks Rusty and thanks everyone for dialing in today. As a reminder, we'll have a replay of this call available on our Investor website later today. Thank you.
And this concludes today's conference call. You may now disconnect.