Atlantic Union Bankshares Corp
NYSE:AUB
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Good morning. My name is Jennifer, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Union Bankshares’ Fourth Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator instructions] Thank you. I’ll now turn the conference over to Mr. Bill Cimino. Please go ahead, sir.
Thank you, Jennifer, and good morning, everyone. I have Union Bankshares' President and CEO, John Asbury and Executive Vice President and CFO, Rob Gorman with me today. We also have other members of our executive management team with us for the question-and-answer period.
Please note that today's earnings release is available to download on our Investor investors.bankatunion.com.
During the call today, we will comment on our financial performance using both GAAP metrics and non-GAAP operating metrics. Operating metrics exclude the after-tax merger-related expenses for the Xenith acquisition both the impact of the Tax Cut and Jobs Act. Important information about these non-GAAP operating metrics, including reconciliation to comparable GAAP measures, is included in our earnings release for the fourth quarter and full year of 2017.
Before I turn the call over to John, I would like to remind everyone that on today's call we will make forward-looking statements, which are not statements of historical fact and are subject to risks and uncertainties. There can be no assurance that actual performance will not differ materially from any future results expressed or implied by these forward-looking statements. Please refer to our earnings release for the fourth quarter of 2017 and our other SEC filings for further discussion of the Company's risk factors, important information regarding our forward-looking statements including factors that could cause actual results to differ. At the end of the call, we will take questions from the research analyst community.
And now I'll turn the call over to John Asbury.
Thank you, Bill. And thank you all for joining us today. Before I get into the fourth quarter of 2017, I'd like to provide an update on the Xenith acquisition which closed on January 1st. We announced the acquisition on May 22nd of last year and noted how it checked off everyone of four strategic priorities of diversification, core deposit funding, efficiency and crossing $10 billion in assets. With the acquisition closed, we created a Virginia based regional bank for the first time in 20 year, something that is uniquely valuable to our teammates, customers, communities and shareholders. We passed our first half while having smooth legal day one with the initial integration going well. I am proud of the work our teammates have put in to ensure a seamless transition for our customers. There is much more ahead as we focus -- as our focus shifts to the core systems conversion scheduled for Memorial Day weekend. I am confident in our playbook and together we can make the transition as seamless as possible for new customers and as easy as possible for every teammate.
With our differentiated competitive positioning and expanded capabilities in market, we continue to believe we are capable to going head-to-head without a state based super regional and national banks that dominates market share in Virginia. I continue to say our clients, prospective clients, business community and recruits, at Union that no one calls from Charlotte, Atlanta, Winston-Salem, San Francisco or anywhere else to tell us what we can't and can't do to serve our markets. We decide any client has any opportunity to meet the decision makers. I say this because it resonates and I say it because it's true.
Turning to earnings report, Union delivered another quarter of strong loan and deposit growth and improvements to our profitability metrics on an operating basis particularly in return on tangible common equity. Rob will provide more financial details in his section so I'll speak to some key achievements both during the quarter and for 2017. On a linked quarter basis, Union achieved improvements of 7% in operation net income and 6.1% in operating earnings per share. On a full year 2017 over 2016 basis, Union achieved improvements of 7.9% in operating net income and 7.9% in the operating earnings per share. Union also saw outstanding annualized quarter and balance sheet growth of 14.1% in loan growth and 6.4% in deposit growth. And for the year as compared to December 31, 2016 we had 13.2% increase in loans and 9.6% increase in deposits.
Looking at fourth quarter profitability metrics compared to the third quarter, operating return on assets improved by 6 basis points, operating return on tangible common equity increased 62 basis points and the operating efficiency remains steady at 62.1%. Overall, credit quality improved in the fourth quarter due to a number of sales of OREO both in foreclosed properties and former bank premises and past due loans levels declined. We took valuation adjustment for the King Carter OREO property during the quarter as it's now under contract for sales and is expected to close during the first quarter.
As we saw during 2017 the economy in our footprint remains steady and the leading indicators of credit quality within Union remain benign. As I've said before, I continue to believe that problem asset levels in Union and across the industry remain below the long-term trend line but we see no early indications of downturn in portfolio level credit quality at this time. It's too early to say what economic impact of tax reforms will be in our footprint, but we believe it will be positive catalyst over the long term. We were pleased to see Xenith had a strong fourth quarter. I want to compliment CEO, Gaylon Layfield and his team for remaining focused on serving their clients leading up to the merger closing. And their performance shows the enthusiasm among our new teammates from Xenith and their clients for joining with us to form the new Union. Xenith saw operating earnings increased by $19.7 million in 2016 to $28.7 million in 2017. Loan balances increased 13.5% annualized from the third quarter and for the year, loan increased by 1.7%.
Deposits declined by 9.1% annualized from the third quarter and 1% for the year primarily due to repricing strategies on high cost accounts, a number on which we are single service customer.
Core demand deposit accounts at Xenith averaged up 7% for the year demonstrating that the Xenith team did well and growing their most important deposit to a relationship.
Turning to the bigger picture. 2017 was year of changing growth for Union. We began the year with a well-planned and well-executed CEO transition, added strength and depth to our executive leadership over the course of the year and finished by transformation Union to Virginia's regional bank through Xenith acquisition. At the risk of understatement, 2017 was an eventful year at Union. Throughout 2017, I updated you on our four focus areas. Diversification, core deposit funding, efficiency and preparing to cross the $10 billion asset threshold.
Let me provide a final update on each then I'll turn to our 2018 priorities. Diversification. I remained confident in our ability to further diversify our loan portfolio and income streams. On the loan portfolio diversification, we gained momentum and saw impressive growth in our commercial lending categories of C&I and owner occupied real estate. The Xenith acquisition and changes to the executive ranks will accelerate our progress on this in 2018. Outstandings for our C&I loan type increased by 10% linked quarter. In my experience I would expect the fourth quarter to be seasonally strong for C&I. And while we had some of that, our growth largely resulted from the progress our team has made in building new commercial relationship this year. Importantly, commitments grew by 40% annualized linked quarter and is bodes very well for future balance growth. To this point, C&I line utilization increased to about 38%, up from 30% in the third quarter. Owner occupied real estate outstandings grew by an impressive 17% annualized for the quarter and that remains a key commercial banking product type for small and mid sized businesses.
We continue to believe there is significant upside in commercial loan categories as more small and medium sized and lower middle market companies are becoming aware of our expanded capabilities at Union and new relationships are developing. This will ultimately fuel growth in the commercial banking loan categories of C&I and owner occupied real estate. And just as important, in core deposit and treasury management fee income. I continue to expect this will eventually be the largest drivers of future growth at Union as the effort matures, the Xenith team is fully integrate and we expand in our markets that we acquired with Xenith.
On the fee based revenue initiative, I believe the wealth team is making steady progress towards their objectives. In 2017, we added depth to the team with some high profile hires. We continue to actively explore opportunities to acquire registered investment advisors. And believe that will be the fastest path to meaningfully increase our fee income stream but not the only path.
Second priority, core deposit funding. We want to grow our core deposit base to manage our loan to deposit ratio to our targeted 95% level over time. We are focused on improving our retail banking depository offerings, increasing our deposit intensive small and medium sized business relationships and enhancing our treasury management capabilities where we believe we can offer a superior treasury solution with better and in person support. I'll also point that we recently realigned our business banking teams to our commercial channel under the leadership of David Ring from retail and that should foster better cooperation with the commercial bankers and better results.
Deposit growth did trail loan growth during the fourth quarter with deposits increasing 6.4% annualized, with average deposits increasing a very respectable 9.3% annualized. Union traditionally does see some seasonal deposit reduction and transaction accounts in December, so that is not unusual. Deposit growth was driven by interest growing -- money market and planned deposits.
As a reminder, 49% of our deposit base comes from transaction accounts, an unusually good profile. I'll say again. We had a great opportunity to build our deposit base with deposit intensive commercial business. This is not traditionally been a primary focus at Union but is certainly now.
Third objective, efficiency. We are making headway on the efficiency ratio organically at Union which currently stands at 62.1%. In the fourth quarter, the operating efficiency ratio declined 72 basis points from the prior year's fourth quarter on a consolidated FTE basis and for the full year it declined by 103 basis points. Further efficiency improvements remain a significant opportunity for the company and will move down meaningfully as efficiencies are captured post core system conversion with Xenith. Xenith aside, numerous opportunities for efficiency improvement remain at Union and were identified through our peer benchmarking work done last year and are being executed on a path independent from the integration work.
And last preparing to cross $10 billion in assets. We completed our multiyear preparations for the $10 billion in crossing which is now occurred with Xenith acquisition. I am very proud of team made this happen and thankful for the foresight of our predecessor, Billy Beale, and our Board of Directors for undertaking this year's before my arrival and years before we knew we are partnering with Xenith.
As I hope our investors have noticed, at Union it's important for us to set goals, communicate them and track back to them. With disciplined management team and as you can see Union made good progress on our first three focus areas and completed the fourth one.
Now let's shift to 2018 priorities, three continue from last year and three are now new and logical next steps for us. Continuing into 2018, a diversifying our loan portfolio and revenue streams. We define that as increase in commercial lending growth which includes both commercial and industrial and owner occupied real estate in order to better balance the total loan portfolio over time. And growing fee based products and services to become less reliant on spread income.
Second priority. Grow core funding to find us funding loan growth with deposit growth and attaining a 95% loan to deposit ratio over time and growth core deposits with the particular focus on increasing commercial and small business operating accounts. Third, improved efficiency is measured by efficiency ratio and do so by leveraging technology to lower cost. Improve quality and support growth and build scaleable, replicable processes. And new for 2018 is the fourth, manage the higher levels of performance by achieving and sustaining top tier financial performance and investing in talent, developing people and aligning compensation and incentives with corporate goals and objectives.
Fifth, create a more enduring and distinctive brand by creating differentiated client experiences that make banking easier and continuing to build our brand in existing and new geographies and last, integrate Xenith to include leveraging commercial expertise at Xenith and new market opportunities. And achieve our cost save target and a successful conversion. Our 2018 priorities are the way forward for Union as Virginia's regional bank that also serves Maryland and North Carolina. Our geography offers a competitive advantage and getting us a powerful franchise that we believe cannot be replicated in our home state of Virginia. With options to grow the franchise organically in metro DC Maryland and North Carolina.
As a secondary strategy, it is likely we'll eventually have further M&A opportunities should it make strategic and financial sense to pursue them, both in these new markets and as infills to our existing markets.
Finally, I'd like to talk about the leadership team. As you may recall, we made some high profile and key hires at the last five months starting with John Stallings as President and David Ring as a Head of Commercial shortly thereafter. We just announced on Friday that Sara Rountree has joined as Head of Digital Strategy and we are thrilled to have her around our team. Sara has followed the similar career path as our other key hires and that they all had experienced at a larger financial institution before coming to Union. We have one last key role to fill and that's our Head of Retail Banking. We are in the final stages of that search and like the others this generated enormous amount of interest among our large and very qualified candidate pool.
I had mentioned this before but in addition to our unusually dense and compact franchise, one of the differentiators for Union over other banks of our size is the experience of our leadership team. All are new to Union within a last six years. All are accustomed to dealing with the greater complexities of a larger institution. They are not trying to figure this out for the first time at Union and are able to develop, teach, and coach teammates on the skills they need in a small regional bank that are scaling up. This is in energetic team with a positive can do attitude at the top. And nothing is off the table when it comes to achieving the priorities we've laid out. I am highly confident we have the right talents in place to lead Union forward.
To summarize, Union had a strong fourth quarter and full year 2017 performance with solid growth in loans, deposits, operating earnings per share and operating income. We made meaningful progress on our focus areas while efficiently crossing the $10 billion asset threshold with the Xenith acquisition. The integration is going well. And core data systems conversion is scheduled for Memorial Day weekend. I feel comfortable with our loan growth momentum. Our lending pipeline looks strong heading into the first quarter and beyond. And I can feel the energy within our team. I remain highly confident in what the future holds for Union and the potential we have to deliver long-term, sustainable performance for our customers, communities, teammates and shareholders. As we enter 2018, Union is well positioned as a growth platform in Virginia, Maryland and North Carolina. We believe we have a story unlike any other in our region having assembled the right scale with the right markets and the right team to deliver high performance. You won't always hear such lengthy comments from me on these calls but those who know that new Union story, a lot of good things happened at our company in 2017 and I want to share them with you.
Last week the Board of Directors held our winter planning retreat in Norfolk to celebrate our expansion into the important Hampton Roads market. We had the opportunity to meet the large number of our new teammates from the Hampton Roads area at the event and the mood was electric. As the New Year begins I can say with confidence that there is never been a better time to be at Union and I cannot wait to prove out the logic of strategy and combination with Xenith.
I'll now turn the call over to Rob to cover the financial results for the quarter.
Well, thank you, John. And good morning, everyone. Thanks for joining us today. I'd now like to take a few minutes to provide you with some details of Union's financial results for the fourth quarter and for the full year of 2017. Please note that for the most part my commentary relates to Union's financial results and do not include the financial results of Xenith since the transaction closed on January 1st, 2018. I'll, however, briefly touch on Xenith's result at the end of prepared remarks.
Reported net income was $15.2 million and earnings per share were $0.35 in the fourth quarter. On an operating basis, which excludes $1.4 million in after-tax merger related cost and $6.3 million in nonrecurring tax expenses related to the Tax Act. Consolidated net earnings for the fourth quarter were $22.8 million, or $0.52 per share. On an operating basis, return on assets was 1%, return on tangible common equity was 12.3% and the efficiency ratio was 62.1% in the fourth quarter.
On a full year basis 2017 net operating earnings were $83.6 million, and operating earnings per share were $1.91. These operating results exclude $4.4 million in after-tax merger related cost and the $6.3 million in nonrecurring tax expenses related to the Tax Act.
Turning to the major components of the income statement; tax-equivalent net interest income was $76.2 million, up $2.3 million from third quarter and up $4.7 million from the prior year's fourth quarter driven by increased levels of earning asset balances. For the year, net interest income was $290.8 million, up $15.4 million, or 5.6% from 2016.
The current quarter's tax-equivalent net interest margin was 3.64%., an increase of five basis points from the previous quarter.
Accretion of purchase accounting adjustments for loans and borrowings added 10 basis points to the net interest margin in the quarter, up two basis point from the third quarter. The five basis points net interest margin increase from the third quarter was due to the seven basis points increase in tax equivalent yields on earnings assets, partially offset by two basis points increase in the cost of loans.
The quarterly net increase in earning asset yield was primarily driven by higher loan portfolio yields, which improved by six basis points during the quarter due to impact of increased short-term interest rates on variable rate loan yields, higher accretion income and higher loan fees. The quarterly two basis points increase in the cost of funds to 68 basis points was driven by higher deposit cost which increased two basis points as well from the third quarter to 44 basis points.
The provision for loan losses for the third quarter of 2017 was $3.7 million, an increase of $661,000 compared to the previous quarter and an increase of $2.2 million from the same quarter of 2016. The increase in provision for loan losses was primarily driven by loan balance growth during the quarter.
For the fourth quarter of 2017, net charge-offs were $2.7 million or 15 basis points on an annualized basis as compared to $4.1 million or 24 basis point for the prior quarter and $824,000 or five basis points for the same quarter last year.
For the year, net charge-offs were $10.1 million or 15 basis points compared to $5.5 million or nine basis in 2016.
Noninterest income declined by $293,000 or 1.7% to $17.2 million in the fourth quarter from $17.5 million in the prior quarter, primarily driven by lower mortgage banking revenue of $187,000, seasonally lower insurance related income of $127,000 and reduced levels of security gains of $166,000 partially offset by increases in customer related fee income of $214,000 and wealth management fees of $139,000. We also recorded a loss of $65,000 in the quarter related to the sale of our 51% interest in Johnson Mortgage Company.
Mortgage banking income declined approximately $187,000, or 8.1% to $2.1 million in the fourth quarter compared to $2.3 million in the third quarter. And that related to seasonally lower mortgage loan originations as well as fair value adjustments associated with the interest rate lock derivative. The fair value of each interest rate lock derivative declined $209,000 in the current quarter as a result of seasonally lower levels of locked mortgage balances at yearend. Mortgage loan originations increased by $5.4 million, or 4.3% in a current quarter to $121.9 million.
Excluding Xenith merger-related costs of $1.9 million recorded in the fourth quarter, and $732,000 recorded in the third quarter , operating noninterest expense increased $1.3 million from the prior quarter to $58 million in the fourth quarter. The quarterly expense increase was driven by higher incentive compensation and profit sharing expenses of $420,000 as well as increased OREO and credit related expenses due to higher valuation adjustments and higher foreclosed property legal cost.
During the quarter, the Company entered into a contract to sell its long held King Carter OREO property, and as a result recorded a OREO valuation adjustment of $980,000. This sale is expected to close in the first quarter of 2018.
In addition, on the expense front, professional fees increased $205,000 related to higher consulting and legal fees and also technology cost increased $194,000 due to higher data processing charges.
As noted during the fourth quarter of 2017, the company recorded $6.3 in additional tax expenses based on the company's preliminary analysis of the impact of the Tax Act. The company also recognized tax benefits of approximately $2.5 million during the quarter primarily related to the reversal of the company's state tax net operating loss valuation reserve as a result of state tax planning strategies implemented in the fourth quarter.
Of the $2.5 million benefit, $2 million related to state tax state net operating losses which were reserved toward prior years and approximately $500,000 related to state net operating losses incurred in 2017.
Now turning to the balance sheet. Total assets stood at $9.3 billion at December 31, that's an increase of $888 million from December 31 of the prior year. The increase in assets was driven primarily by net loan growth.
At quarter end, loans held for investment were $7.1 billion, an increase of $243 million or 14% on an annualized basis from the prior quarter. Loans held for investment increased $834 million or 13.2% from the prior year level, while the full year average loan balance is increased $745 million or 12.5% from the prior year.
The quarterly loan growth was broad-based across commercial and consumer loan categories with the exception multifamily and non-owner occupied loan balances.
Looking forward, we are projecting upper single digit loan growth for 2018. At December 31st, first deposits were $7 billion, an increase of $110 million or 6.4% annualized from September 30th level. Deposit balances were up $612 million or 9.6% from December 31st, 2016 level driven by strong year-over-year growth in checking money market and time deposits.
On a full year basis, average deposit balance is increased by $591 million, or 9.7% from the prior year.
Turning to credit quality, nonperforming assets decreased approximately $500,000 to $28.4 million during the quarter, comprised of $21.7 million of non-accruing loans and $6.6 million in OREO balances, which includes $1.4 million of former bank locations.
The allowance for loan losses increased by $1 million to $38.2 million at December 31, driven by loan growth in the quarter. The allowance as a percentage of the total, the loan portfolio will be steady at 54 basis points at quarter end.
Now let me provide a brief update on Xenith Financials results for the quarter. Xenith recorded a net loss of $55.8 million in the fourth quarter due to the impact of the after-tax merger related cost of $5.5 million, and nonrecurring tax expenses related to the Tax Act of $57.2 million. Excluding these items, Xenith's net operating earnings were $6.9 million for the fourth quarter of 2017, a decrease of $1.2 million compared to $8.1 million in operating income in the third quarter. The decline in net operating earnings from the prior quarter is primarily driven by higher provision for credit losses of $865,000 which resulted from loan growth during the quarter and lower security gains in the fourth quarter as compared to the third quarter. The current quarter's tax equivalent net interest margin was 3.53%, that's an increase of two basis points from the previous quarter, driven by higher earnings assets yields of four basis points, offset by a two basis points increase in the cost of funds.
As John mentioned we were pleased to see the Xenith's loss balances grew by $82.4 million, or 13.5% on annualized basis from September 30th level to $2.5 billion at yearend, which coupled with Union's strong loan growth suggest that we have strong momentum going into 2018 as the companies come together as the new Union.
So in conclusion, Union's fourth quarter and 2017 financials results demonstrated continued progress towards our strategic growth objective as we generated solid loan and deposit growth and the company's operating profitability metrics improved. The Xenith transaction closed at January 1st, and the integration work is going well. We remained confident that we will achieve the financial benefits of the combination once the cost savings are fully realized starting in the fourth quarter of 2018.
As always, we remained focused on leveraging the Union franchise to generate sustainable, profitable growth and remained committed to achieve top tier financial performance and building long-term value for our shareholders.
And with that I'll turn it back over to Bill to open it up for questions from our analysts community.
Thanks Rob. And I am looking at the clock so we are trying to get through as many as questions as we can today. Jennifer, we are ready for our first caller please.
Your first question comes from Austin Nicholas with Stephens Inc.
Good morning, guys. Yes so maybe just nice loan growth in the quarter and stronger in a period end basis and the outlook for upper single digit loan growth for 2018. Just to confirm that on a standalone basis for Union that's not -- that the pro forma company I guess or any assumptions in Xenith that.
That would be off -- so we are suggesting that on a combined basis with Xenith.
Understood, okay.
I am talking about 2018, we'll keep reminding you we are not talking about the new Union which --
Sure. Okay, great. And then maybe just on the expense side of things. Could you maybe get some clarity on the expense call it core expense growth going into the first quarter? And maybe just specifically on the OREO line. I assume that should normalize down closer to that $1 million or lower as you have some lower balances and those properties kind of move out of the bank.
Yes, that's right, Austin. The expenses during the quarter were impacted by the OREO valuation adjustment for King Carter, the sale that we announced. You'll see that come down quite a bit. Obviously, we are not left with much OREO at least from the Union side; I think we are about $6 -- little over $6 million at quarter end. From that point of view we got a couple of properties that are under contract that we will close in 2018, so you will see that number coming down even further. From that point of view you wouldn't see any valuation adjustments since based on the sales contract. We were taken a bit or we've already recorded that or we expect that proceeds will equal what our book value is. So you will see that come down quite a bit for sure next quarter. Now the other aspect of that and I should point this out from an order perspective is King Cart was costing us about $800,000 on an annualized basis to operate. So that -- those numbers or that expense goes down from an OREO expense perspective. So you think about the trade-off there, Union is actually pretty good on that.
Interesting, okay, that's helpful, Thanks Rob. And then maybe just on the margin looks like if on a core basis the margin was up pretty nice quarter-over-quarter to call it three basis points on a core basis. Maybe as we look out to the first quarter, could you maybe give some guidance on where the core -- we could expect the core margin to be both maybe on a standalone basis and then when you layer in Xenith?
Yes. So as we said in the past and I kind of at this point stick into what we've mentioned in the past week. We expect the core to hover on legacy Union side in the 350 to 353 or so range is what we've been talking about. Combined with Xenith it's kind of in that range going forward. I'll point though that that's kind of related to what we said in the past assume to 35% tax rate, as we go forward now with the 21% tax rate we are going to from an FTE, fully tax of equivalent basis, we are going to have to take haircut related to our tax exempt income in the Union work or/and our loan municipal tax exempt loan book. And that's going to cost us about six basis points we estimate. So all things being equal we are at 350 to 353 prior will be in 340, 60, 47 range on a core basis. With -- and that would be on a combined basis as well. Obviously, we are going to get accretion income. We think that's 12 to 13 basis points on top of those core numbers that I mentioned.
Okay, great. And then maybe just one quick last one. Are there any changes to the initial Xenith creditor or interest rate marks that you could share with us?
Yes. We don't have anything that we can share publicly at this point. We have been evaluating the original mark we said as we announced the acquisition. Obviously, interest rates have been changing. We will be in a better position obviously coming out of the first quarter to be able to provide more clarity on that. At this point, we are not in a position to be --
I'll state you didn't ask us but to reiterate something Rob said in his comments we would reaffirm the cost save estimate. We have clear line of sight to the cost save estimate and we will do that.
Right. Our next question is from Catherine Mealor with KBW.
Thanks. Hey, good morning. John, you talked in the past about profitability target. I think you said in the past you have a goal of getting to 2.12% ROA 14%, ROTCE and then mid 50 efficiency ratio by the end of this year. How do we think about these targets when we layer on lower tax rate?
The lower tax rate have lifted our boat to the right tide of lower tax rate -- in both, Rob, you want to answer it?
Yes. Well, Catherine, we are obviously looking to be in the top quartile of our peer group obviously with a new tax, the impact of new tax rate we don't know what those levels are but in terms of internal modeling, as we mentioned if you -- our ROA we say coming out of a year would be at 1.20% ROA, we think is probably leakage about 15 to 20 base points on top of that we have a tax rate change. ROTCE, we said we come out of the year with a 40%, we think there is 2% to 2.5% comp of that when you bake in the impact of the tax, the lower tax rate going forward. So that's how we think about it, of course, we will continue to evaluate what our peer groups looks like and that we probably won't be able to do until first quarter results are reported.
So said Catherine we are not going to declare victory on our old targets due to the lower tax rate. We are going to raise our targets.
Great. Understood. And what is -- Rob, what is the expected tax rate for next year?
Yes. So expected tax rate we -- it's going-- we are still evaluating, it could move a bit, I would say it's not going to move much but we are talking about an 18% effective tax rate next year combined.
Casey Whitman with Sandler O'Neill.
Hi, good morning. Just digging more into the loan growth you guys put up this quarter. Just wondering could you maybe talk about the increase in consumer loan specifically saw this quarter and what drove that?
Yes. Consumer and other actually include and we are -- this is appropriate for the line item but embedded within consumer and other, we actually include strangely because this is the way it works institutional, university government type finance and we had about $50 million from several two universities, one small municipality that is embedded in that category. So that means we- the commercial banker like Mr. Stallings, I am looking at and I, we look at that and say that's commercial. So it actually -- we actually have another commercial story than you even think once you understand that. That was really one of the driver. Rob, do you have anything you would add from a consumer standpoint.
No. I think we did have a bit of growth in our third party alternative learning channels during the quarter but it wasn't really as much as what you were describing.
And we are working at; I'd like to give better strip that out so it's more clear and other versus consumer.
Okay. And just looking at your margin this quarter. Any specific loan categories driving the better yield this quarter? And then you mentioned higher loan fees contributing this quarter. Do you think that level is sustainable?
Yes. So, Casey, just on that point it was worth about a basis point to loan fee quarter-to-quarter. That can be a bit volatile quarter-to-quarter but we've been plus or minus one or two basis points are usually what we look at. The other question was in terms of --
Higher --
Higher yield, yes, it was -- it actually was pretty much across the board in terms of -- certainly our variable rate, commercial loans improved the pricing as market rates have raised over the last six months and also the quarter. We are seeing a pick up in our HELOC yield as well and some other consumer related loans. And so it's really picked up across the board.
Joe Gladue with Merion Capital Group.
I guess just wanted to I guess ask again about yes short of the windfall from the lower tax rate and what the plans are for it in terms of the -- whether it's capital return or from buyback or any other uses for that?
Joe, this is John, I'll start and I'll ask Rob to join me. In general, we would expect to use that additional profitability as growth capital. We certainly are growth story. And so that will fuel our growth story. We continue to have thoughtful discussion about and opportunity it presents to address some of the lower compensated roles within the bank and we will go about that in a thoughtful manner. I do want to point out that Union bank for years, Union is had a profit sharing plan that is rewards, our teammates who are not otherwise eligible for incentive and so that can be meaningful particularly the lower pay grade and also there is an employee stock option from whichever end participates in. So Union already has a vehicle in place to share the wealth and improve profitability among its teammates and that has the profit sharing again is designed for teammates who don't otherwise have incentive opportunity. So the mechanism is there. The more profitable we are, the more there is to share. So we already kind of have that built in. That's my immediate reaction. Rob, would you add to it?
Yes. I would agree. I think some investments in our teammates that we are going to be making as well as in the community that we are serving. So there are some other opportunities coming through the investment point.
Your next caller is William Wallace with Raymond James.
Hey, guys, good morning. I'd like to maybe dig in a little bit more on the loan growth. You are guiding high single digit, you grew -- your portfolio low teen this year, looks like Xenith low teens, I am just curious should we interpret your guidance as management conservatism or is they are in the prospect of some rejiggering of Xenith's loan portfolio that could slow the growth rate on a combined basis.
Your question, we will -- as we did last year, we began last year by guiding toward high single digit and then we concluded that we are able to see that and therefore we revised our guidance upward. We like to begin this year in the same fashion and we have lot of moving pieces here. I got to tell you Wally things are going very well in terms of the overall integration. So there is not any singularly large thing that we are looking at Xenith that we would say that's going to go away. So we like to be conservative and we will come back to next quarter and tell you what we are seeing and if we gain confidence that we can sustain a greater than that growth rate then we will tell you.
I was just going to say thank you but if you have more Rob go ahead.
No, we are good, thank you.
So if you were to kind of look at the fourth quarter's loan growth from Xenith and Union combined, where would -- where did you see on a dollar basis, how is the loan growth in Hampton Roads or Richmond market, Frederiksberg market, Northern Virginia and Baltimore and then kind of maybe rural Virginia.
Well, let's see, may what -- let me first speak to Union, if you look at it geographically not surprisingly Central Richmond is going to be the largest one, metro Richmond, this is one the strongest -- probably the strongest economy in Virginia right now. Metro Richmond and it's probably the place where we most rapidly gained traction since it's our home turf at Union. And the C&I story. Just in terms of Union itself did add C&I bankers to its team last year and we've always done that but I just feel like quite candidly we hit a tipping point after the Xenith acquisition was announced in terms of how we were regarded within the business community. Union story is playing very well and we saw a pick up and we were in some respect even bit surprises some of the larger businesses were interested in Union and that's helpful. So I would say Central Richmond we saw growth really in most of our markets from the Union franchise, Charlottesville, Frederiksberg et cetera usually follows we have market share, Hampton Roads, I'll point this out, Hampton Roads for Union was actually pretty good growth market, it really were more on the peninsula and in Charlotte LPO has done well. So it felt reasonably broad based out of the Union franchise with the largest performance coming out of Richmond area. Within Xenith and I'll speak mostly to the third quarter, within Xenith, where did the growth came from? The growth came out of their C&I efforts, their commercial efforts and in order of ranking it was metro -- what they call Greater Washington, what we call Greater Washington based in Northern Virginia that was one. Richmond was two, Hampton Roads was three. So that was a really good story and so Wally I feel like we hit the tipping point, we are a legitimate contender as a small commercial bank to go after those market and Xenith, our new teammates have come from Xenith now have balance sheet 4x their size. So we will continue to be very transparent in terms of how this is playing out. I don't want to overplay this point but I'll tell you one thing I'll go ahead and share. I am sitting here looking at our pipeline. Our pipeline and this is Union not Xenith. I am just looking at Union. The Union pipeline right now let's call it beginning at the year is about comparable in size to the same pipeline a year ago. But here is the difference. The year ago Union's loan pipeline was 73% commercial related, 27% probably commercial real estate related, 73%, 27% C&I related. This year it's 55% commercial real estate related 45% in round numbers C&I related. So you get the point. This is evidencing, it's a proof point that we are executing a diversification strategy. This is a good leading indicator of which you can expect. Now this won't be a straight line winning your growth story. It will have some degree of fluctuation but we are feeling very, very good about our ability to execute the diversification strategy.
Okay, thanks. Appreciate all that color. Then I have one follow up question on the noninterest expense line. I assume we are not going to get most of the cost cuts until the conversion and Rob you mentioned I think in your prepared remarks that fourth quarter we should probably see a good run rate. I am wondering if you would be willing to guide us towards what expense line should look like after cost saves.
You mean in terms of quarterly run rate perspective?
Yes.
Yes. It should be in the 75-ish range in that area plus or minus.
And you think fourth quarter were there if we hit your target.
That's correct, that's correct, Wallace.
Okay, great. Then my last question is the $2.5 million benefit form state net operating losses that had previously been booked. Can you talk a little bit about what exactly that was and is this something that you caught when you are looking at the tax strategy right, its tax reform or what?
Well, actually we have been looking at this for a bit of time. As you may know, Banks of Virginia don't pay a state income tax, they pay a franchise tax. So the only state income tax we pay relates to non bank subsidiaries, Virginia subsidiaries, so we have been generating and that -- the biggest piece of that is our parent company as well as our mortgage company. And we've been generating losses from the parent perspective that would offset the mortgage over the last several years. And we've been basically putting not allowing ourselves to take the tax benefit; we have been putting valuation zero against 1 for 1. But we've been evaluating tax planning strategies which could help unlock that -- the value of those evaluations reserves or state NOLs and we finally came up with the strategy that we want to pursue and we are able to do that basically what it means we will be putting income into non bank Virginia subsidiaries to allow us to utilize those going forward.
So this was a catch up from historical -- basically like evaluation reversal.
Yes. It is. About $0.5 million of that were 2017 operating losses that we incurred and about $2 million was prior to this year.
And, Rob, just to clarify so that means that in 2018 and going forward there is a lower run rate.
Yes. So we will continue to get a benefit call it $0.5 million until we can generate enough earnings in the subsidiaries, non bank subsidiaries to utilize and I guess and I should say --
And that's included in the 18%
Yes. That's tax rate, that's right, Wally. That's included for next year.
So if kind of back out the noise around tax reforms, this tax strategy is 26.5% is that kind of where you ended up in the fourth quarter on -- call the core basis?
Core basis we are about 27.1 or so 27.2.
Your next caller is Laurie Hunsicker with Compass Point.
Yes, hi. Hi, John and Rob and Bill, good morning. I just wanted to go back actually on Wally's question on expenses. And I just wondered if you could step us through. If we just start with the ROE the $1.74 million which I know is outsized, congratulation by the way getting King Carter sold and that was backing out their credit valuation and backing out you said King Carter was round about costing $300,000 a year. That number roughly comes down to $600,000 for the quarter. It included because I know you have outsized taxes so call that another $200,000 so I am down to $400,000 or so is what the our run rate.
Yes, that's correct, Laurie.
Is that right? Okay, and then I am backing out the merger charges I mean roughly even applying growth and even looking at Xenith and saying, okay, Xenith has been running round numbers $19.5 million a quarter and layering in your 40% or $20 million pre taxing your cost save. I am coming up with a noninterest expense number closer to $73.5 million a quarter fully baked and just wanted to know what the delta difference is. Is there some windfall, tax windfall reinvestment spend that you are doing? Is there still spend coming from the $10 billion cross? Obviously, you don't have your first DFAST submission until July of next year. Just help me think about what I am missing here.
If you are in the ballpark, we've got as John mentioned there will be some reinvestment of tax savings in our teammates and other things. So you could probably would add value to your numbers. And obviously merit increases and inflation that plays into that as well. So I am ballpark at that level. You are pretty close so where we think we will be.
Okay. And so basically your tax windfall reinvest if we think about, if we think about that in the expense line, that's the entire difference?
Let me think about that. It's --
Or maybe asked another way what is your dollar amount that you are projecting in the noninterest expense line from just infrastructure reinvestment, wage inflation, just to broad number.
In terms of the full year run rate it is about $4.5 million to $5 million all in.
$4.5 million to $5 million, okay, that's helpful. And then if we can just go back to OREO and your credit is pristine here. I just want to make sure I have got this so your old Stellar branches went from $2.3 to $1.4, how many are left in that?
Well, there are three properties in there. One of which is under contract, the biggest component, the biggest one is about $1 million which is under contract. We expect to close that. It is got long fuse on it so it may not be the first quarter but early in the second quarter is what we are thinking. So that will be about a $1 million. Yes, basically the other one is throughout, we are actively marketing, and we think there are some opportunities there so you could see that. It's possible to see that though way pretty much in the 2018, at the end by the end of 2018. Certainly in the first quarter and most of that-- close to first quarter
And then the other $1 million drop in OREO linked quarter that was $1 million to King Carter, so King Carter is now theoretically December 31, it's on your book for $1 million coming off.
That's right, that's right.
Okay, okay and then just in terms of -- where did your asset under management stand at December 31?
It's at $2.6 billion at the end of the year.
$2.6 billion, okay and you guys had record fees. How should we be thinking about line item?
Well, as we project core we are looking at solid growth in the fees coming off of that, obviously we had some pretty decent growth for the last half of the year so fees will be up year-over-year and above, and we are projecting like 7%, 8% growth in the fees line.
Yes, that's correct.
That's Bob Martin, Head of Wealth Management.
Yes, Bob. As we've said before as a strategy we continue to be interested in acquisition of smaller registered investment advisors and we may have opportunity this year along those lines.
Yes, that would include any large acquisition of RIAs
Yes, Lauries, John Stallings here, one other thing that's driving is terrific improved partnership between commercial banking and wealth. I think they're sure are an example of where we are teeing up wealth partners with commercial banking clients and finding opportunities. And the institutional capability, Bob, with the addition of some new talent there, we began, I think, upped our game and our reputation in terms of our capabilities.
Okay, great. And then just jumping back over to Xenith. The marine finance book, they have round numbers in $300 million. What you have all decided to do with that?
We don't really have any saying that any specific plan at this point that we are able to share, Laurie. This is -- as I said all along, we want to get our arms around that business and certainly by all accounts, it's well run business and we'll have more to say about that as we better come to understand it.
Okay. And then obviously they took some merger charges this quarter too. Can you just remind us Rob where we are in terms of one time merger charges that are still expected?
Yes. So we had an after tax basis we said that we had about $33 million of merger cost from day one through the conversion related cost. So we are probably more than half way there in terms of -- maybe think about investment banking fees we paid, legal fees, and other fees that are more successful transaction success fees. We've incurred those so I would say about it's probably a third to 40% left which would include severance expense, retention bonuses and any conversion related termination fees and that sort of things.
Okay, great and then obviously Xenith brought over three large PE investors so round number there at $30 million or 20%, what is the latest in terms of your interaction with them and how should we be thinking about their shares?
Well, we would say that both Union and the PE firms want to have an orderly exit of their stock and do it efficiently. We'll provide an update on that when we are in a position to do so. And that's all we have to say for now.
Your final question will come from Blair Brantley with Brean Capital.
Hey, guys. Just quickly have you seen any change in the size of the credit that you guys are put on the books now?
I would say that to some extent what's happening and I'll ask John Stallings and Dave Ring maybe to chime in, we do have an effort which we call corporate. The corporate us generally means lower middle market which I'll define is company with sales above $100 million. So we are seeing some additional opportunities in larger credit but to size it for you excluding the two university deals that we did the longest new funded balance we saw -- the largest new funded balances we saw last quarter and C&I was about $11 million. And then it dropped from there into 5, 7 range. So we are not out dropping on the books, $30 million and $50 million outstanding types of credit but as a strategy, as a $13 billion bank, we are able to do something that is not been done in Virginia since the days of Crestar who I used to compete against and Bob Martin worked for them. We are Virginia's regional bank. We can absolutely go head to head with the large players and John you can speak to this probably better than anyone because you ran the largest players. So you'll see us be active in small, mid sized into that lower middle market in Virginia.
Yes. Well, one thing, two thing I will say that one the vulnerabilities as we go up market of our competitor, we call them big four are such that we have a chance really to penetrate a quicker clip than ever before in terms of the call we are doing. One of the things that's been so obvious to me since joining up four five months ago is in collaborating with Xenith team there is really very much the whole is a greater than some of the parts as Dave works closely with the Xenith and Union teams. The new Xenith team is refining connectivity and overlapping calling efforts which allow us to put our best teams forward, both relationship managers and their prospecting efforts, the right partners to essentially put forward the better calling effort. I think the opportunities continue to be great and early stage pipeline I think even current pipeline John alluded to it earlier. I think both for us to continue to play bigger in the C&I space.
Yes. I would say six months ago John we are getting feedback even before you joined which I'll sort of paraphrase, feedback through competitors. People we know like what you are doing here. And they don't ask that any more. And so you come out of SunTrust, you ran SunTrust here in Virginia which is in fact the old -- that's what left of that old Crestar franchise. We got a lot of folks out of that organization.
Dave Ring as a reminder for those who we didn't know or don't recall, Dave Ring ran what was Wachovia commercial from Virginia to Massachusetts. Dave is actually known people knew him as the boss. So these bankers that have been around for a while. They will be at Wells Fargo today, some of the folks from Xenith I grew up with at Nation's Bank which became Bank of America. So we've got it circled in terms of the -- we have some folks out of BB&T. Our new Head of the Commercial Bank Operation, Andy Hodges, who joined us in Hampton Roads, grow at BB&T. So this is a really good assemblage of talent here that has a pretty clear view on this market.
Yes. And we have this. This is John again. We have strong talent already but it's really opening some opportunities where we are getting a lot of inbound calls whether it's straight up, do you have room for me or more subliminal or intermediaries connecting us with people they are interested in joining our team. Dave Ring any comments on the point about larger opportunities?
Yes. I mean we are going to -- our strategy is to continue to grow safely so to maintain a very granular portfolio. So I don't think we are going to pursue large chunky deals to grow. We are going to continue to just have aggressive calling effort and spread it out.
Also I want to make sure, Dave, sticking on materiality, even though it wasn't asked, we are not just a credit shop. We did not use the term lender. There are no lenders in Union bank. We discontinue that job code. So we only have bankers, relationship managers, talk about the treasury effort, and the depository strategy around commercial businesses as well. Yes. I mean part of our long-term strategy is to not only develop a new business, new lending business but to use our bankers to get a holistic relationship with clients. So we are not only looking at prioritizing prospects in the market to grow the loan business but those prospects must have other business that we want to go after such as deposits, we want to avail them to things we do which we don't do a lot of today like foreign exchange. We want to continue to grow using derivatives to protect risk against interest rate, rising interest for our clients and develop treasury management products that really target the 0 to 150 revenue size company. So we want to stay right in our sweet spot. We think that will help us grow very safely.
Correct. And other thing we will talk about later through our wonderful Northern Virginia operation that came to be part of us through Xenith. They are sitting there and the largest cluster of nonprofits in the country and so we do in fact have may sent nonprofit depository strategy, we've got some other sort of niche and specialty focus as well we'll talk about later on. So this is really getting well organized. So bottom line, when I look at Union, part of it what excites me more so than anything else is really this talent pool. We have people who have grown up here at Union and we have people who joined us from elsewhere. So a bit of melting pot but certainly a discernible culture and this is going to be great opportunity for our team and some special new teammates. That's my pitch.
Thanks Blair. Thanks everyone for joining us today. We look forward to talking with you next quarter. Have a good day.
Thank you, ladies and gentlemen. This does conclude today's conference call. You may now disconnect.