Atlantic Union Bankshares Corp
NYSE:AUB
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Good day, and thank you for standing by, and welcome to the Atlantic Union Bankshares Second Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there'll be a question and answer session. [Operator Instructions] Please be advised that today's conference is being recorded.
I would now like to hand the conference over to your host of today's call, Bill Cimino. Please go ahead.
Thank you, Justin, and good morning, everyone. I have Atlantic Union Bankshares' President and CEO, John Asbury; and Executive Vice President and CFO, Rob Gorman, with me today. We also have American National Chairman, President and CEO, Jeff Haley, on the call. Other members of our executive management team will be here for the question-and-answer period. Please note that today's releases and the accompanying slide presentation are available to download on our investor website, investors.atlanticunionbank.com.
During today's call, we will comment on our financial performance using both GAAP metrics and non-GAAP financial measures. Important information about these non-GAAP financial measures, including reconciliations to comparable GAAP measures is included in the appendix to our slide presentation and in our earnings release for the second quarter of 2023.
We'll make a number of forward-looking statements on today's call, which are not statements of historical fact and are subject to risks and uncertainties. There can be no assurance that actual performance will not differ materially from any future expectations or results expressed or implied by these forward-looking statements. We undertake no obligation to publicly revise or update any forward-looking statement.
Please refer to our earnings release, the press release announcing the proposed merger and two slide presentations issued today as well as our other SEC filings for further discussion of the company's risk factors and other important information regarding our forward-looking statements including factors that could cause actual results to differ from those expressed or implied in any forward-looking statement. All comments made during today's call are subject to that safe harbor statement.
At the end of the call, we'll take questions from the research analyst community. And now I'll turn the call over to John.
Thank you, Bill, and good morning, everyone.
Today, we're excited to announce the planned merger of American National Bank headquartered in Danville, Virginia into Atlantic Union Bank. American National has $3.1 billion in assets and it's a high-quality community bank with an exceptional 114-year history, a strong core deposit base and outstanding asset quality.
This is a company and leadership team we have long admired and know well and the relationship between our two banks spans decades. We're eager to share our thoughts on this and we will do so after Rob and I provide abbreviated comments on the strong Q2 results for Atlantic Union. Following that, American National Bank Chairman, President and CEO, Jeff Haley, will join us for a discussion of the merger.
It was a solid quarter for AUB, making this a easier and hopefully shorter conversation. So let's begin. Last quarter, we spoke of the failures of non-traditional niche banks and how that shook confidence in the American banking system. Thankfully, we now see fewer so-called bank crisis headlines and our clients, our markets, our company and the economy as a whole are demonstrating resiliency.
Broadly speaking, we saw our deposit base hold steady, better-than-expected loan growth and admittedly a seasonally strong second quarter, good expense management, modest net interest margin compression and impressive asset quality trends, all of this being a proof point that our franchise remains strong even in these uncertain times.
We see the current environment as another confirmation of our long-term strategy of being a diversified, traditional, full-service bank that makes a positive difference in our markets with a strong brand and deep client relationships.
We provide economically beneficial services and financing that help people and help businesses. It's a straightforward business model. It works and it's proven the test of time over our 121-year history. This is why soundness, profitability and growth in that order of priority remain our mantra and informs how we run this company.
The remixing of noninterest-bearing deposits to interest-bearing deposits did continue over the quarter, though at a slower pace. Quarter-end noninterest-bearing deposits were 26% of total deposits. That's a decline of 2 percentage points linked quarter. Total deposits were steady and recovered from a seasonal dip, finishing down slightly at 1.1% linked quarter annualized, up 6% year-to-date and up 1.8% year-over-year.
Q3 customer deposit growth is off to a good start with a loan-to-deposit ratio of 90.6% as of yesterday. Fully taxable equivalent net interest margin declined 5 basis points to 3.45% from 3.50% linked quarter. While our cost of funds rose by 32 basis points, this was largely offset by increased earning asset yields of 27 basis points. By comparison, our Q2 fully taxable equivalent net interest margin of 3.45% was still up from 3.24% year-over-year.
We do expect deposit betas to remain under competitive pressure due to the rising rate cycle but remain manageable as was the case in the second quarter, helping us with NIM management is that approximately half our loan balances are variable rate and that we liquidated some securities in the first quarter to reduce higher-cost wholesale borrowings.
Now let's dig into the macroeconomic conditions and then our quarterly results. Thankfully, inflation appears to be on an improving trend that we expect the Fed is not yet done with its rate tightening cycle. On a positive note, while for purposes of forecasting, we continue to plan for a mild recession, it now seems the possibility of a soft landing has improved over the quarter. Macroeconomic environment remains sound in our footprint, and we do not expect this to change in the near term.
Our markets appear to be healthy, and our lending pipelines, while down modestly from a year ago, remained good and are better than we would have expected. Virginia's last reported unemployment rate of 2.7% in June improved from 3.2% in March and as usual, remains below the national average of 3.6% during the same time.
We are not anticipating any materially negative near-term shift away from these lower unemployment trends and overall benign credit environment but as always, continue to closely monitor the health of our markets.
We are focused on generating positive operating leverage. That is growing our revenue faster than our expenses. Our results were noisy during the second quarter due to certain charges associated with the previously disclosed strategic cost savings initiatives we took during the quarter, which we expect will lower our expense base on run rate by an annualized $17 million. We expect that the lower expense benefit will begin to be realized in August.
Setting aside these impacts, our adjusted operating noninterest expense run rate was down from the first quarter, reflecting seasonal trends. At the start of the year, we guided to mid-single-digit percentage adjusted operating noninterest expense growth for 2023, but after the strategic cost-saving initiatives that we took, we expect to be flat year-over-year for 2023. Rob will speak to the outlook in this section. Here are a few financial highlights for the second quarter which Rob will detail later.
On a year-over-year basis, we generated positive operating leverage of approximately 1% as adjusted revenue growth was up 5%, while adjusted operating noninterest expenses increased 4%. I'd also like to point out that pretax, pre-provision adjusted operating earnings increased 8% year-over-year.
We posted annualized loan growth of approximately 13% point-to-point in what is traditionally our second strongest quarter led by growth in C&I. Year-to-date, loan growth was 8%. Lending production was up across C&I and CRE in the quarter. Construction lending production slowed from Q1 and was the lowest in over two years, and that's partly by design on our part, and part by developers choosing to delay or in some cases pause projects.
Our pipelines are holding up pretty modestly down from a year ago and remain healthy and balanced. At this time, we expect full-year loan growth to be in the mid-single digits during 2023, while our pipeline levels continue to imply that we may do better, despite the strength in Q2, we continue to suspect opportunities will take a lot of the pull through, especially if rates continue to rise.
Further, the wind-down of our indirect auto lending took effect beginning in June, and we currently project the run rate - or pardon me, the runoff will generate about $200 million of liquidity annually for the next three years and that will seek to recycle into our relationship lending.
Additionally, we're expecting some larger payoffs in what is normally a seasonally slow Q3, leading us to believe that the pace of loan growth will come down materially from what we saw last quarter. We do see opportunities in this environment to continue to acquire new clients in addition to serving existing client needs. While the economic outlook in our footprint and borrower demand could change, for now, we expect to remain in a moderate loan growth mode in 2023.
Credit was a good story as we reported annualized net charge-offs at 4 basis points for the second quarter, down from 13 basis points in the first quarter. As a reminder, the majority of first quarter charge-offs is attributed to a memory care facility loan originated by our predecessor Zenith Bank. Last quarter, we moved this to held-for-sale with the expectation of selling the note, but we're pleased to see the client reengage on its resolution, make a sizable loan curtailment, so we moved it back to loans held for investment.
We have yet to see any sign of a systemic inflection point on the asset quality metrics, which remain benign. While we continue to expect a normalization in asset quality at some point following a long run of minimal net charge-offs, we remain confident in and are pleased with our asset quality.
In sum, we thought this is a solid quarter for Atlantic Union Bank. The banking system showed its resiliency and we did too. We remain confident in our positioning for the remainder of the year and our ability to navigate challenges, both expected and unexpected. As usual, with uncertainty comes opportunity, and we do see opportunity. Atlantic Union is a diversified traditional full-service bank with a strong brand and deep client relationships in stable and attractive markets. We remain on solid footing and we are resilient.
I'll now turn the call over to Rob to cover the financial results for the quarter. Rob?
So thank you, John, and good morning, everyone. Thanks for joining us today.
Please note that for the most part, my commentary will focus on Atlantic Union's second quarter financial results on a non-GAAP adjusted operating basis, which excludes the $3.9 million in pretax costs recorded in the second quarter for the strategic cost-saving initiatives as well as pretax loss on the sale of securities of $13.4 million and the pretax $5 million legal reserve, each of which was recorded in the first quarter.
In the second quarter, reported net income available to common shareholders was $52.3 million, and earnings per share - per common share were $0.70. Adjusted operating earnings available to common shareholders was $55.4 million or $0.74 per common share for the second quarter, which was an increase of $8.2 million or 17.3% from the first quarter and up $4.1 million or 8% from the second quarter of 2022.
The adjusted operating return on tangible common equity was 17% in the second quarter, which was up from $15.2 in the prior quarter. The adjusted operating return on assets was 1.16% in the second quarter, which was up 16 basis points from the first quarter. And on an adjusted operating basis, the efficiency ratio came in at 55% in the second quarter, down slightly from 56% in the prior quarter.
Turning to credit loss reserves. As of the end of the second quarter, the total allowance for credit losses was $136 million, which was an increase of approximately $4.5 million from the first quarter, primarily due to loan growth in the second quarter and the impact of continued uncertainty in the economic outlook. The total allowance for credit losses as a percentage of total loans remained steady at 90 basis points at the end of June.
The provision for credit losses of $6.1 million in the second quarter was down from the prior quarter's $11.9 million provision for credit losses, primarily driven by lower charge-offs. Net charge-offs decreased to $1.6 million or 4 basis points annualized in the second quarter and from $4.6 million or 13 basis points annualized in the first quarter. The year-to-date net charge-off ratio was 8 basis points on an annualized basis.
Now turning to the pretax pre-provision components of the income statement for the second quarter. Tax equivalent net interest income was $155.8 million which was down approximately $1.5 million or 1% from the first quarter, driven by higher deposit costs due to increases in market interest rates as well as changes in the deposit mix as depositors continue to migrate to higher costing interest-bearing deposit accounts.
These decreases were partially offset by an increase in loan yields on the company's variable rate loan portfolio due to increases in short-term interest rates during the quarter as well as by the impact of average loan growth.
Second quarter's tax equivalent net interest margin was 3.45%, a net decrease of 5 basis points from the previous quarter due to an increase of 27 basis points in the yield on earning assets, which was more than offset by a 32 basis point increase in our cost of funds.
The increase in the second quarter's earnings asset yield was primarily due to the 27 basis points increase in the loan portfolio - loan yields, which had a 22 basis points positive impact on the second quarter's net interest margin. And the positive impact of changes in the earning asset mix between quarters added 5 basis points to the second quarter's net interest margin.
The loan portfolio yield increased to 5.62% in the second quarter from 5.35% in the first quarter, primarily due to the impact of increases in short-term market interest rates on variable rate loan yields. The 32 basis point increase in the second quarter's cost of funds to 1.74% was primarily due to the 33 basis point increase in the cost of deposits to 1.61%, which had a 29 basis point negative impact on the second quarter's net interest margin.
The deposit cost increase was driven by changes in the deposit mix as depositors migrated to higher cost in interest-bearing deposit accounts during the quarter, increased levels of higher cost broker deposits as well as by increases in interest-bearing deposit rates driven by rising market interest rates. Noninterest income increased $14.6 million to $24.2 million for the second quarter primarily due to the $13.4 million pretax loss on the sale of securities recorded in the prior quarter.
Adjusted operating noninterest income, which excludes gain and loss on sales of securities increased $1.2 million in the second quarter, primarily due to an increase of approximately $900,000 in loan-related interest rate swap fee income from the prior quarter due to higher transaction volumes, an increase in loan syndication revenue of approximately $259,000 as well as increases in several noninterest income categories including certain service charges, debit interchange fees and fiduciary and asset management fee income. These noninterest income increases were partially offset by a $405,000 decline in mortgage banking income due to a decline in our gain on sale margins during the quarter.
Noninterest expense decreased $2.6 million to $105.7 million for the second quarter from $108.3 million in the prior quarter. Adjusted operating noninterest expense, which excludes amortization expense related to intangible assets in the first and second quarters, expenses incurred associated with the strategic cost savings initiatives in the second quarter and a legal reserve associated with an ongoing regulatory matter recorded in the prior quarter. Noninterest adjusted expenses declined by $1.5 million to $99.5 million in the second quarter.
The quarterly decline in adjusted operating noninterest expenses was primarily driven by OREO-related gains recognized in the current quarter of $879,000 as well as reduced branch closing costs of $466,000 as compared to the prior quarter. In addition, salaries and benefits expenses were reduced by $1.4 million due to seasonal decreases in payroll-related taxes and 401(k) contribution expenses. These expense declines were partially offset by increases of $1 million in professional services expense related to LIBOR transition and other strategic projects. $466,000 in marketing and advertising expense and $424,000 in technology and data processing expense increases.
At period end, loans held for investment, net of deferred fees and costs were $15.1 billion, an increase of approximately $483 million or 13% on an annualized basis for the prior quarter driven by increases in commercial loan balances of $454 million or 14.8% linked quarter annualized and consumer loan balance growth of $28.5 million or 4.9% annualized.
At the end of June, total deposits stood at $16.4 billion, a decrease of $44 million or approximately 1% annualized from the prior quarter due to the impact of customer behavior in response to inflation and higher market interest rates, resulting in a decline in demand deposit balances, partially offset by an increase in interest-bearing, checking like balances, customer term-deposits and broker deposits. At the end of the second quarter, Atlantic Union Bankshares and Atlantic Union Bank's regulatory capital ratios were well above, well-capitalized levels.
In addition, on a pro forma basis, we remain well capitalized as of the end of the second quarter, if you include the negative impact of AOCI and held-to-maturity securities unrealized losses in the calculation of the regulatory capital ratios. For the most part, we are sticking with the full year 2023 financial outlook referenced in our first quarter's earnings call.
We expect to generate loan growth in the mid-single-digit growth range. We continue to project that the full year - fully taxable equivalent net interest margin will fall in the range of between 3.35% and 3.45%, driven by the updated assumption that the Federal Reserve Bank will increase the Fed funds rate to 5.5% tomorrow and maintain it at that level throughout 2023.
In addition, we continue to project that our through-the-cycle deposit betas will approximate 40%, which will be more than offset by the projected through-the-cycle loan yield beta of approximately 50%. As a result of loan growth in our fully tax equivalent net interest margin projection, we continue to expect fully taxable equivalent net interest income to increase by mid-single digits in 2023 for full year 2022 levels.
We also expect that the company will generate positive adjusted operating leverage in 2023 due to the expected mid-single-digit adjusted operating revenue growth outpacing expected relatively flat adjusted operating noninterest expense growth in 2023 for full year 2022 levels as a result of the strategic cost saving measures we took earlier in the quarter.
In summary, Atlantic Union delivered strong financial results in the second quarter despite the challenging banking environment, we find ourselves in. As a result, we believe we are well-positioned to continue to generate sustainable, profitable growth and to build long-term value for our shareholders in 2023 and beyond. We're now excited to turn our attention to providing details of our merger announcement with American National Bank.
For this discussion, John and I will be joined by American National's Chairman and CEO, Jeff Haley.
Thank you, Rob. And we are excited. Now that we've hit the high points for the quarter.
Let's talk about the partnership with the venerable American National Bank. As noted on Slides 2 and 3 of the presentation for those watching, the merger will be addressed in a proxy statement of American National and a prospectus of Atlantic Union to be filed with the SEC, we urge you to read it when it becomes available because it will contain important information.
Information regarding the persons who may under the rules of the SEC, be considered participants in the solicitation of American National shareholders in connection with the proposed merger and will be set forth in the proxy statement prospectus when it is filed with the SEC.
Now let me begin by saying how excited we are to join with American National Bank. We have long admired this team and company and it is one of Virginia's premier community banks with a rich 114-year history and a deep commitment to its communities. We share a common legacy with our own 121-year-old history, and we have a highly compatible culture. We'll ask Jeff Haley to speak about this and the strategic rationale from his perspective in just a moment.
This merger is between two institutions with a decades-long relationship and a deep friendship between our banks and our respective management teams that began years ago, long before my time. When it comes to strategy, I think of AUB as less opportunistic and more intentional. We'll now make the case for why that is so with this combination. If you recall our shareholder value proposition, you can see why we believe this transaction delivers on every one of our points.
We have worked hard in our company to build a leading regional presence in Virginia and we believe this transaction will further that objective by increasing our scale, density and scarcity value in Virginia, while also creating something we have long sought and that is a platform to grow in North Carolina.
This is an investment and one that will enhance our financial strength through increased profitability, a larger core deposit base and improved liquidity. We will enhance our growth potential in Virginia and North Carolina. If this were a Virginia-only franchise, that would be compelling enough. But the critical mass this achieves in North Carolina creates an opportunity we can build on there for years to come.
Together, we'll bring new products and services to the legacy American National footprint, especially in commercial and industrial banking. The transaction will further differentiate our financial performance by adding scale, efficiency and talent. All of this is aided by American National being a traditional high-performing bank renowned for its customer experience, granular core deposit base and exemplary asset quality, we will be stronger together. Combined, we add to our already powerful franchise, a stronger still presence in Virginia, unrivaled by any other Virginia bank.
I would argue, it will also make us the leading Virginia-based bank in the Western part of Virginia providing more convenience, options and capabilities to our customers and those communities. This will also better position us to deliver top-tier financial performance for our shareholders. Rob will speak to this momentarily.
As mentioned, we will add to our scarcity value in Virginia, increase our future options as it provides a meaningful North Carolina presence in the Piedmont Triad region. By combining that with our four branches in Eastern North Carolina and our Charlottesville production office, we will be well positioned to drive an expansion strategy in North Carolina over time.
Importantly, this combination delivers. It delivers on our stated goals for M&A even in the current rate environment. Our goals, which we have publicly stated for years are: one, a three-year tangible book value earned back using the crossover method, two, immediately accretive to earnings per share, excluding onetime charges and three, an 18% or better internal rate of return. We believe we are checking all of these boxes.
We also believe that execution risk will be mitigated by the unquestioned quality of American National's franchise in our mutual familiarity and decades-long institutional relationship and personal relationships among the management teams. Said differently, we've known each other well for a very long time. For those of you who are unfamiliar with American National, I would like to introduce Chairman, President and CEO, Jeff Haley.
Jeff, thank you so much for joining us for this call. May I ask that you speak please to who is American National? And why did you decide to partner with Atlantic Union?
So John, I've been called, American National has been called a lot of things. I've never been called venerable. I think that was a compliment.
That is a compliment.
So look, this is an exciting day, I think, for both companies. And those that don't know me or the company, so we were founded in Danville, Virginia in 1909. 25 years ago, we were doing business in just Danville, Virginia. We're about a $200 million community bank. My colleague, my predecessor, Charlie Majors, and I take this company from a little Danville Bank to $3 billion, two states, 11 markets. And one of the things I'm most proud of is that over that period of time, we've gone through all types of economies. And there's not a dent, there's not scrape, there's not a scratch on this company. I think we've done a phenomenal job.
As it relates to this transaction, I do need to highlight, we have an incredible Board of Directors that have been by our side for many years, and they've always been shareholder-focused. To supplement that I've got a great management team and then another group of teammates that help us run this company every day
The way I look at my job is I tell everybody, I manage a three-legged stool, the shareholders, the customers and the employees. And along with our Board, we've gotten to the point where even with our incredible performance, our incredible reputation, we felt as though we were losing relevance not to just our shareholder but our customers in the way this industry is changing rapidly.
My concern was that we needed to do something and there were really no other better options than partnering with what I believe taking two of the best banks in Virginia over 200 years of experience, both high-performing companies, putting them together to solidify Virginia, but then to also set the springboard for continued expansion in North Carolina.
This is, in some ways, a sad day, but it's because of 114 years of a company being based in Danville, Virginia. But that is more personal from the three-legged stool perspective, this is an incredible transaction. I am so excited to be doing it. These are not new people to us. These are dear, dear friends of ours that we've known, as John said, goes back four decades. But I mean, I know John, I know Maria, I know Rob, I know Shawn, I know Dave Ring, I mean these are friends of mine and I am a little bit today like a proud father, letting my child go to college. I'm a little sad, but I'm so excited about the opportunities for everyone involved in this transaction.
So John, I hope that helped and gave everybody a little bit of insight to where our head was.
Yes, it certainly did give insights. Need I say any more about why we respect this company and this leadership team. That's as clear as pictures could be painted. From our perspective, if you're going to do a bank merger in this environment, this is exactly what you would want to do. All right. I have a few more comments and Rob will get into the financial aspects of it, and then we'll - Jeff, Rob and I and others will be available for questions.
So as should be evident, we have a great respect and admiration for Jeff and his team and are deeply appreciative that American National's Board of Directors chose to partner with us. Through the years, we've often conferred and learned much from each other and will now do so like never before. We're grateful that post-closing, Jeff has agreed to stay on with us for two years as a consultant on our regional community banking strategy in the American National legacy markets, which will be led by American National executives. His intimate knowledge and experience there will be invaluable.
Further, aside from his consulting role, we are pleased and grateful that he will serve as our representative to Danville, Virginia Charitable Trust currently administered by American National that over the years, have provided significant contributions to not-for-profit organizations in that community.
No one knows that community better than Jeff. Stepping back and looking at the map on this slide, it should be evident while we are interested in adding this company to the Atlantic Union Bank family, it's a hand-in-glove fit to our franchise that should be evident.
Slide 8 shows combined depository market share, starting with Virginia. Data is on the left, this further solidifies our clear positioning as the number fourth player in Virginia, eclipsed only by the three mega banks that on a combined basis account for 50% depository market share here per our calculations. Through the years, we have transformed Atlantic Union Bank to be the challenger to these companies while also remaining nimble enough to compete against the small banks too. Notice the difference between us and the next largest competitors.
We think this is as fine an example as you will see of what scarcity value looks like. It looks exactly like this. On the far right, you can see how fragmented North Carolina depository market share is below the top four. While our presence there will be small on a combined basis, we will have a critical mass to build from, and we see room to run. Bottom line, American National is in good markets with meaningful upside for growth as we bring to bear new products, services and more balance sheet capacity. On Slide 10, we detail the various markets, and we'll let you review them on your own. But you should be able to see how we complement each other very well.
To wrap up my remarks, this is going to be a great partnership. This is a rebirth. In such an uncertain environment, we believe there is no better partner for us in American National, a high-quality Virginia stalwart of a community bank that we know and trust. On a personal note, I'm excited to see us build density in Southwest Virginia and enter the south side of the state.
The three largest cities in Virginia, where we currently do not have a physical presence outside of Northern Virginia, our Lynchburg, Danville and Martinsville. American National will fill a missing piece of the Virginia jigsaw puzzle for us in terms of our franchise. Additionally, I know, respect and care about these markets because I am a native of Southwest Virginia, myself, this is the area of the state, I call home.
Earlier in my career, I led commercial banking for the same Virginia markets in which American National operates while based in Roanoke and under their potential. Further Southside Virginia is arguably one of the best-positioned markets in Virginia for industrial development given its land availability, skilled workforce, proximity to the Piedmont Triad and long history of manufacturing. We can make good use of our C&I capabilities, the American National franchise.
And last, for those who didn't know this, actually I still consider myself a North Carolina banker. Having begun my career at Wachovia Bank and Trust in Winston-Salem, in 1987. I've learned this business in the Piedmont Triad, I know the potential of that region and I am delighted to see us expand there.
I'll now turn the call over to Rob for more details.
Yes. Thanks, John.
Let me switch gears to outline the expected financial impact of the merger from the strategic aspects of the transaction, which, as John just noted, we believe, are very compelling. I'll start by outlining the transaction structure and some of the key financial terms over the next few pages.
On Slide 11, we recap the transaction structure and key terms of the transaction. In terms of the transaction itself, it's a 100% stock deal with a fixed exchange ratio of 1.35 common shares of AUB from each share of American National's common stock. This works out to approximately 16% pro forma ownership of the combined company by American National's shareholders.
That translates into an aggregate transaction value of about $417 million to be paid or $39.23 for Americans National share based on a 10-day weighted average closing share price of Atlantic Union stock ending last night. This represents a per share market premium for American National shareholders of 24% over yesterday's closing stock price.
The applied transaction metrics represents a price to tangible book value multiple of 174%, a price to 2024 forward consensus earnings plus cost saves multiple of 8.4 times and a core deposit premium of 7.2%. We believe this is a fair price to pay to acquire such an outstanding banking franchise.
Upon closing the transaction, two members of American National's Board of Directors, Nancy Agee and Joel Shepherd will join Atlantic Union's Board. And as John noted, Jeff Haley will serve as a consultant to our leadership team. In addition, we will operate the former American National markets under a regional community banking model which will be led by two key American National Bank executives who know these markets very well.
The transaction is expected to close in the first quarter of 2024, subject to customary closing conditions and the receipt of required regulatory approvals and American National shareholder approval. In addition, we are targeting the second quarter of 2024 to complete systems conversions.
On Page 12, we lay out the key transaction assumptions. Balance sheet marks include a gross loan credit mark of $25.4 million or 1.13% of loan balances and a day two CECL reserve adjustment on non-PCD loans of $19.7 million, the so-called double count. We're also modeling a negative loan interest rate mark of approximately $120 million, $8.4 million write-up of American National's owned branch and office real estate based on broker opinions and market value and a total liability write-down of $13.7 million related to time deposits and trust based on the current level of interest rates.
Intangible purchase accounting adjustments included a core deposit intangible asset of $87.2 million, which is approximately 3.75% of non-time deposits. In addition, we reported a wealth intangible asset of $7.5 million. In addition, we are also assuming that the $68 million in unrealized investment portfolio losses embedded in American National's accumulated other comprehensive income or AOCI as of June 30 is realized through income over a six-year period.
Turning the page. As John mentioned earlier, we have been very public about our discipline around mergers and acquisitions in terms of the key financial targets that we expect when we enter into any merger transaction. And I'll summarize those here as a reminder. Immediate earnings accretion to EPS, an earn-back of tangible book value dilution, if any, of three years or less and an internal rate of return of at least 18%.
As you can see, we expect the transaction of American National to check each of these boxes with projected EPS accretion of approximately 19%, an earn-back of tangible book value dilution of 9.7% in less than three years and an internal rate of return of more than 18%. When considering our prior transactions, we've realized that the 9.7% tangible book value dilution is higher in comparison, but is primarily driven by the significant rise in interest rates over the last 15 months which under purchase accounting requires us to record a higher-than-usual interest rate mark on the loan and investment portfolio.
The earn-back of that dilution, however, is still less than three years due to the outsized EPS accretion of 19%. This is a result of the higher interest rate marks flowing back through earnings as essentially risk-free net accretion income.
Excluding these interest rate marks, the tangible book value dilution would be less than 5% EPS accretion would be approximately 5%, and the earn-back period would still be under three years. In addition to the right of the page, you can see that on a pro forma capital ratio basis, we will remain well capitalized from a regulatory capital ratio perspective at the close of the transaction.
As noted on Slide 14, we went through a very comprehensive due diligence process as we do in any merger transaction. The process including the formation of a cross-functional due diligence team have reviewed all aspects of American National businesses over a four-week period. In addition, we engaged third-party expertise to review credit, interest rate and real estate market valuations as well as tax and legal matters in connection with the transaction.
In terms of the credit due diligence of American National, you can see we were very comprehensive in terms of the magnitude of the review of its loan portfolios. American National has historically been a very clean bank from a credit perspective and results from our third parties review found that to be the case.
Our due diligence team met with their American National counterparts in each of the areas, you see listed here, and came away with a very strong understanding of the culture and business operations of American National, which will allow us to plan for a smooth integration of American National into the Atlantic Union franchise.
With that, that concludes my prepared remarks on the merger's expected financial implications and I'll now turn it back over to John for his closing comments.
Thank you, Rob. We've given you much to consider this morning. So I have no further comments. At this point, we are ready to take your questions.
[Operator Instructions] And our first question comes from Catherine Mealor from KBW. Your line is now open.
Good morning, Catherine.
Good morning, and congrats on the deal.
Thank you.
Wanted to start just with first AUB-specific question. Just on - can you help us walk through the cadence of how we'll see the $17 million of cost savings flow in through the back half of this year and then into next, kind of maybe the run rate of expenses that we'll be hitting as we exit '23 and then going to '24?
Yes, Catherine. In terms of the - how that's coming into the expense base or coming out of the expense base, I should say. We saw about $500,000 or call it, $2 million on an annualized basis come out of Q2. As John noted, the majority of the cost savings will kick in post-August 1, because that's when after a 60-day notice period that we're reducing our teammate count. That will kick in August 1.
So the next - in this third quarter, we should see about $3.5 million of that annualized $17 million come out. And going to the fourth quarter, you'll see the full effect of that, which is about $4.25 million. So it's kind of coming in, but Q3 will start to see a really shift in and Q4, you see the full annualized base - annualized or quarterly run rate of the annualized savings.
And it's really done at this point. There's essentially nothing material left to do. Everything has been executed.
Okay. Great. And then just as you think about - I guess my second question just on the deal. Is there any way to help us think about the timing of how the pace at which we'll see the $120 million loan mark on American National flow-through earnings?
Yes. So we are projecting that, that earnings will come in over four years on Sum-of-the-years' digit basis. The contractual if you look at the loan portfolio, it's about five-year maturity on a contractual basis, but the duration of that portfolio is more like three years. So we are using four years for that assumption.
Catherine, one thing I'll point out that may not be evident or perhaps is a surprise to those who don't know, American National. The duration of this loan portfolio is comparable to our own. Unlike what we often see in the market, American National does not do long-term fixed-rate loans. Typically five years or less is what they do. And that's part of why the math is working here and the rate marks are manageable.
That, of course, plus the fact that they're 15% of the asset size. So this will come back quickly in terms of the rate marks. If they were doing what we sometimes see 10, 15, 20-year fixed-rate commercial real estate plans this would be a very different conversation. This probably wouldn't be a conversation that's happening today, but that's not done. One of the many things we admire about them.
Yes. That's helpful. And that's why the earn-back is manageable at three years. So that's great. I mean, as you think about just big picture, the two companies together, how does this - you don't need to put specific targets, but how does this alter your kind of - your outlook for ROA, ROE efficiently, I'm assuming it's going to be enhancing all those metrics, but how do you kind of think - how the two companies come together where that may trend as we move through '24?
Yes. So as we look at that, Catherine, it's a material improvement to what we've used consensus estimates for this - for the discussion today. And you'll see that which we kind of outlay on Page 7 of the presentation, that ROA is - should be going up from a consensus perspective of AUB about 20 basis points or call about a 1.25%. ROTCE is looking at about a 19.5%, 20% return on tangible common equity and we think the efficiency ratio will hover back towards the 50% mark once we get the full cost savings in. So fairly material improvements in the returns and the financial metrics that we always are looking at to be in a top-tier financial performer.
And when do your conversion is slated? Is it too early for that?
Well, we're looking at likely in second quarter. It really depends on if we can close the deal early in '24, which we're expecting.
Okay, great. I'll step back, congrats on the deal. Thank you.
Thank you, Catherine. And Justin, we're ready for our next caller, please.
And thank you. And one moment for our next caller. And our next caller is Casey Whitman from Piper Sandler. Your line is now open.
Hi, Casey.
Hi, good morning.
Good morning.
Good morning. Maybe just starting with your earnings this quarter. Can you sort of walk us through the progression of the margin throughout the quarter and sort of how it was faring in June or even at the end of the quarter? Just to sort of give us an idea of where we're headed in the third quarter.
Yes. So as you seen what we reported was a 5 basis point decline in the margin quarter-to-quarter, the [indiscernible]. If you look at it from where June, the month of June is coming out, it's still hovering in that 3.45% range. But we are expecting that over the next two quarters, we report Q3 and Q4 that we're going to get down to the, call it, the 3.35% range, give or take, a couple of bps due to continued deposit cost increases.
The good news there is we also, as John mentioned, have some mitigating factors due to the variable rate loan book that we have. We are anticipating the Fed will move tomorrow another 25 basis points. So that will bode well from that point of view. But you should see probably bottoming out in the fourth quarter, about 3.35%, give or take, a couple of bps.
Okay. And you might - may have this, but do you have like an expected range you can give us for the pro forma margin? Just to sort of help us out with all the markets and we're not - I know there's a lot of moving parts there, but just any sort of range you can give us to go off of will be helpful.
I mean in terms of the deal impact. Yes, we think - sorry, go ahead.
In terms of where the margin - the pro forma margin, the combined margin might be running just given what we know today.
Yes. So including the accretion that we noted is that comes back through interest income. We think we're going to be around 3.60% to 3.65% reported margin once we close the deal.
Okay. Helpful. And then also remind us, you still have more of the expense stuff coming through in the third quarter just on the cost saves. Is it about $7.5 million left?
Yes. So again, we should have - we should be close to $3.5 million coming out if you go back to the last year, $3.5 million run rate coming out in the third quarter and then because it's a partial quarter with FTEs not dropping until August 1. We'll see about $4.25 million expense on a quarterly basis coming out in the fourth quarter. And then that would be the $17 million if you annualize that --
Yes, sorry, the onetime costs.
The onetime costs -
Yes. So the onetime cost, we're going to have another $6 million or so in the third quarter, and then there won't be any beyond that. That primarily relates to some lease termination costs as well as some costs associated with renegotiating our core contract or core systems contract, which we used a third-party firm to help us with that.
Okay. All right, great. Thank you.
Thank you, Casey.
Justin, we're ready for our next caller, please.
Thank you. And one moment for our next question. And our next question comes from Stephen Moss from Raymond James. Your line is now open.
Good morning.
Good morning.
Congratulations, Jeff and John on the transaction here. Thank you. Judging by the presentation, it sounds like the deal was negotiated here. Just curious, when you put these balance sheets together, are you - do you think you'll be restructuring the securities portfolio?
Well, we're going to take a look at that, Steve. We haven't assumed anything there. As you know, upon closing, we have mark-to-market the securities portfolio. We are evaluating alternatives to restructure portfolio more in line with how AUB has managed over time. But a lot of that's going to depend on where rates are at that point in time. But it's certainly possible and we're evaluating options there.
Okay. That's helpful. And in terms of the - in terms of - I'll following up on the margin here and just deposit pricing, just curious what the tone is that you're seeing these days? It seems like Truist is more aggressive here. And just curious on your thoughts as to what you're seeing in the last month or so?
Yes. I think to your point, we've seen more aggressive pricing on deposits from bigger players, including BofA and Truist, as you mentioned. So we usually look to the big players to follow them from a deposit pricing perspective. So we've increased our deposit levels on both on CDs and money markets during the quarter to basically match the Truist of the world. Interestingly enough, I think we're seeing less - as the quarter has gone on and through today, I'm seeing less and less pressure on deposits, I should say. But we'll see how that plays out, but there was a lot of adjustments coming through earlier in the second quarter. It's kind of stabilized a bit at this point in time.
I would agree with Rob, on that point. It's still highly competitive, but we seem to be out of the frenzy for whatever reason. We'll see what happens with the next rate increase. It seems better. I would not quite say we're at an equilibrium on it.
But we will adjust according to the larger players in the market. That's kind of our way we handle that.
Okay. Just instructive. As you know, Steven, the fact that half of our loan book is variable rate is what allows us to somewhat offset at least mitigate this rising rate environment, and that's part how we were able to manage the compression issue. That and quite candidly, not positioning ourselves as the highest rate in the market in order to drive deposits. Like every other bank in America, we maintained a very delicate balancing act in terms of managing the value proposition and the rate with the funding requirements. We do not want to offer the highest rates out there simply to try to drive deposit growth. That strategy will not work over time.
Right. And so in terms of - and I guess on the other side of the equation here in terms of the balance sheet with loans. You guys had really good loan growth this quarter, north of 4% year-to-date. Your guidance implies only modest loan growth, though the pipeline sounds like it's still pretty strong. Just - I think John has said a little bit about seasonality here for the current quarter. And I know you've talked about pull-through in the past. Just kind of curious, it feels a little bit maybe conservative on loan growth just given the pipeline.
Well, potentially. It's hard to predict in this environment. I have to admit Q2 was better than we expected. We expected to see more things slowdown in the pipeline. As I clearly stated, the second quarter is traditionally seasonally strong, second only to Q4. Q3 is typically one of the slowest quarters and that's for an obvious reason, people go on vacation and things get deferred.
So what's happening in Q3, just to set expectations, clearly, one, we - actually three things. One, it is traditionally one of our slower quarters, business slows down and so many of our clients go on vacation and that's part of what happens in Q4, traditionally, things kind of get pushed into Q4, and then they're motivated to get things done before year-end. But we're looking at a seasonally slow Q3.
Two, we'll now have a full quarter of runoff and this indirect auto loan portfolio that we discontinued at the end of May. We still had some things that were closing, so to speak, as June began. But it seems like we've got - yes, let's call it, $18 million a month, Rob, maybe closer to $20 million.
Yes. I would say it's $200 million annually.
So $200 million a year, so a quarter of that is going to come down. So that will offset growth in Q3. And that's a good move because it's lower yielding, it's not strategic and we can recycle that capital and that liquidity. And third thing is we do have known payoffs, clients who've informed us. We've got a couple of things going on, mostly in the C&I space, this is interesting. We have a couple of larger clients we deal with one has a pretty major asset sale. Another company is being sold.
And so we have advanced knowledge of some fairly material paydowns, and it's more than a couple so these are all things that we think will somewhat offset. But we are, in fact, sitting on a good loan pipeline better than I would have expected right now. We'll see how it plays out, Steve. But I do not see us having a double-digit loan growth year.
Is it possible we could do better than high single digits, which is 4% to 6%? That is possible, it could tip a little higher. We're just a little leery of forecasting that, frankly, because it's hard to do. So moderate growth mode, whether it's 6% or 7% or - but I don't think we're talking about teams. I actually don't want to see that right now.
Got it. And then on credit here, I saw there was one past due non-owner occupied commercial real estate loan, that's 90 days plus. Just kind of curious on any color and just set any expectations around that credit.
Past dues looks good. Past dues are as low as they've been in a long time.
Curious, we talked about the memory care that's restructured as a reengagement. Is that what you're referring to?
Could be we had held for sale last quarter, and we moved it back to held for investment.
Yes. Past dues are down. I'm looking by line item, that's a good story on past dues. You could be looking at the increase in nonperformers, and that was that credit note was not in a nonperforming loan at [indiscernible]. Yes, so we moved it back to held for investment, it looks like a new nonperformer, but it's not.
Is that what it was?
Yes, that's - credit is very clean right now.
Right. Okay. That's helpful. And then in terms of just maybe going back to the deal here with the North Carolina franchise that you acquired for American National kind of curious if you could give us an outline for how you're thinking about the North Carolina expansion in the future here a little further. Will we primarily be focused in the Greensboro or Raleigh area, obviously, you have an LPO down in Charlotte, just kind of --
Well, I think this was - broadly speaking, I would say this is going to be a to-be-determined and the leader of the North Carolina market for American National Bank, who will lead it for us. She and we will work together, David Ring, who leads what we refer to as wholesale banking, which will be all commercial banks will work out the plan exactly. But here's my perspective, my perspective is they have a good footing in the Piedmont Triad. And for those who don't know it, that means Winston-Salem and Greensboro and it's a little broader Burlington, is an important market for them. So they're sitting there on the I-40 corridor, they do have a Raleigh office, which we are thrilled about.
We have a Charlotte LPO, it's not quite the same thing, that's a commercial real estate play. We have four branches in Eastern North Carolina. And so in general terms, we see this as an infill. And it would be great. I think it will also give us opportunity in Charlotte because when you have an LPO and no other meaningful presence in event bankers, with some of the bankers on the ground, you execute what we've done and we've done it well in Charlotte, which is sort of a specialty play, and this is going to be a little broader. So think of this as an infill strategy over time. And I think this is going to create opportunity for us.
Bear in mind, for those who don't know this area, Greensboro, North Carolina is closer to Danville, Virginia than is Roanoke. Greensboro is only an hour away. So if you're in Martinsville, Danville, et cetera, kind of your closest metro area is, in fact, is Piedmont Triad it's contiguous. It's right across the line. So Dave, anything they bring us here, anything you wish to say about North Carolina expansion plans?
I think we'll work together with the management team in North Carolina to develop the strategy. We'll take our time and we'll plot it out so we can be successful.
It's right. I think they've done a good job. We bring additional capabilities to the table. We looked very much like American National not that long ago. We've worked very, very hard over the last 6.5, 7 years to transform this company. We have very good commercial and industrial banking capabilities, treasury management services, capital market services, specialty lending capabilities such as asset-based lending, equipment finance, government contractor finance, things that you wouldn't typically see a bank of our size doing that are actually playing vanilla in our minds.
So we bring all this to the table. This will be a big acceleration play, we believe. So we're excited having spent time with the leadership of these markets they are the ones who will really drive this, they will be at the table and we work with them. So that's more to follow on this with passage of time. I don't want to get the cart before the horse.
Thanks, Steve. And Justin, we're running a little bit long. So we have time for one more caller, please.
Thank you, sir. And one moment for our next question. And our next question comes from David Bishop from Hovde Group. Your line is now open.
David, good morning.
Hi, good morning, gentlemen. I'll keep it quick. John, maybe on a long-term basis, do you think this accelerates or improves the long-term loan growth prospects for Atlantic Union as you expand into these markets and obviously, you have experience consider yourself sort of a legacy North Carolina banker.
David, I'm so sorry, may I ask you to repeat that? We're having difficulty hearing you.
I'm sorry. Yes. Just curious if you think this accelerates the prospects for long term. Loan growth as a combined company and especially --
Absolutely, it does. So what's happening is that it absolutely accelerates prospects, not just for loan growth over time, but I just think growth for the company because now we'll have a physical presence in some very attractive growth markets in North Carolina. As I called out - if you look at the south side of Virginia, in particular, this is one of the better industrial markets of the state. We have clients there, even though we don't have a physical presence.
So I think when we couple the historic presence and relationships and knowledge of these markets that the American National team has with additional capabilities and a bigger balance sheet to be clear. I think that - and our treasury management services, this is going to be a formal combination.
So in summary, presence for us in these very attractive North Carolina markets, Piedmont Triad, in particular, the Raleigh office coupled with Charlotte, then the additional capabilities that we bring to the table that allows the American National Bank team to do new things that they're not currently doing. This is going to be a really good combination. And so we're excited. We think this is great.
And of course, the Roanoke Valley is - we are there. And I think that we're a bit undersized that when you couple American National with us and you combine our strength in the New River Valley, just to the west, where we're essentially tied for number one the way I think about it, this is a formidable Western Virginia franchise and we are excited about it.
Got it. And then, John, maybe - I'm just curious, obviously, strong growth in pure C&I this quarter. Just curious any color in terms of what drove the strong quarter just in sort of the pure C&I category this quarter?
In terms of where growth came from in terms of C&I during the quarter? Dave, do you have any perspective on that? So pretty good strength across the board.
Every market grew, except for the Western Virginia market, which we're, I think, now adding firepower to --
Isn't that interesting?
So all the specialty groups grew quarter-over-quarter, all the markets grew quarter-over-quarter, except for that one.
So pretty well distributed. And again, we just - we need more resources in Southwest Virginia, and now we have them. This is a hand-in-glove fit. I can't emphasize that enough. This is - if you were to go back and listen to our comments through the years, I've been describing this for years, it should be plainly evident if you understood what we were talking about, this is a good fit for us.
Got it. And then maybe just a housekeeping item. For Rob, the 40% cost saves off American National, that - should we assume a second quarter annualized or 2022? Just curious what's the best base to use in terms of forecasting those expense saves?
Yes. We're talking about $27 million of cost saves which we're modeling 75% in '24, depending on the close date and then 100% thereafter.
Got it. Appreciate the time.
And thank you.
Thanks, David, and thanks, Justin, and thanks, everyone, for joining us today. John, do you have anything --
Yes. I realize this has been a long call, but obviously, we had a lot to go over. I think that Jeff Haley's commentary, where he described the strategic rationale for the combination from his perspective is a master class of how a publicly held bank CEO and Board should think about their responsibilities. We absolutely agree with them out the Virginia Bankers Association, banker school take this transcript and teach that as a case study. So Jeff, to you and to the team at American National Bank, we couldn't be more excited. We look forward to consummating this and this is going to be great. So thank you all very much for your time today.
Thank you, and have a good day.
This concludes today's conference call. Thank you for participating. You may now disconnect.