AUB: Reports Solid Quarter, But Profitability Targets Reduced Due to Interest Rate Environment; Reducing EPS Estimates but Reaffirming Target Price; Reiterating Outperform Rating.
Atlantic Union Bankshares Corporation (AUB – NASDAQ – Recent Price: $35.91)
Rating: Outperform / Buy Price: $35.00 / Target (Sell) Price: $40.00
4Q19 Results:
Atlantic Union Bankshares Corporation (Atlantic Union, AUB, or the Company) reported 4Q19 net income of $55.8 million, up 4.9% compared to the $53.2 million recorded in 3Q19. This translates to 4Q19 EPS of $0.69 compared to $0.65 in the prior quarter. Reported 4Q19 results include $1.8 million ($1.4 million after tax) or $0.02 per share in merger-related and rebranding costs, while 3Q19 results include $3.6 million ($2.8 million after tax) or $0.04 per share of such costs. Excluding these charges from both periods, adjusted 4Q19 EPS was $0.71 compared to adjusted 3Q19 EPS of $0.69. Adjusted 4Q19 results were $0.01 above our adjusted $0.70 estimate (our estimate was $0.69 including merger-related expenses), and in-line with the $0.71 median Street estimate. The 4Q19 results were characterized by a lower-than-expected loan loss provision and higher noninterest income, offset by higher-than-anticipated operating expenses, and lower net interest income. Highlights from the quarter include:
· Gross loans held-for-investment advanced $303.9 million or 2.5% sequentially. The main contributors to the growth were the non-owner occupied CRE, owner-occupied CRE, consumer, C&I, and construction segments, which advanced $87.5 million, $62.2 million, $73.8 million, $55.9 million, and $49.8 million, respectively. The multifamily and single-family mortgage segments declined $26.2 million and $19.6 million, respectively.
· Total deposits advanced $260.3 million or 2.0% sequentially. Noninterest bearing accounts declined 5.9% to $2.97 billion, falling to 22.3% of total deposits from 24.2% at September 30, 2019. Interest bearing deposits rose $445.3 million or 4.5% linked-quarter, with the interest bearing checking and money market categories contributing $390.0 million and $214.4 million, respectively, to the growth. Meanwhile, CDs fell $147.4 million or 5.1% LQ, dipping to 20.7% of total deposits from 22.2% at the prior quarter-end.
· Net interest income fell $1.5 million or 1.1% sequentially to $135.1 million. A 1.5% increase in average earning assets was countered by 9 bps of NIM compression to 3.55% (on a taxable equivalent basis). Yields on average earning assets declined 18 bps from the prior quarter. Purchase accounting accretion of $6.6 million boosted the NIM by 17 bps in 4Q19, up from the 13 bps impact in the prior quarter. This increase was offset by 17 bps of decline in average loan yields, as falling interest rates affected variable rate loans. The average cost of interest bearing liabilities declined 12 bps sequentially, driven by decreases of 8 bps in transaction and money markets deposits and 28 bps in other borrowings costs, offset partly by an increase of 1 bps in the cost of time deposits.
· Noninterest income fell $18.9 million or 39.3% sequentially. A $9.3 million recovery in the prior quarter on an acquired Xenith Bank loan was the biggest contributor, but a $6.7 million drop in securities gains also helped. Excluding these items, “core” noninterest income fell $2.9 million or 9.1% sequentially, as swap fees fell on lower transaction volumes and fees on mortgage operations declined due to lower seasonal activity.
· Noninterest expenses declined $17.4 million or 15.6% sequentially, but this also includes several nonrecurring items. The biggest was a $16.4 million loss in the prior quarter on debt extinguishment as part of a balance sheet restructuring. Expenses in 4Q19 also included $1.8 million of merger-related and rebranding costs, down $1.8 million from 3Q19. Lastly, the prior quarter included a $3.4 million credit for previously paid premiums, leading to a $0.9 million increase in FDIC expenses in 4Q19. Excluding these items, operating expenses were down roughly $2.5 million or 2.6% from the prior quarter, driven by lower employee compensation.
· AUB’s effective tax rate for 4Q19 was 16.7% compared to the 16.8% recorded in 3Q19. Management anticipates a full-year effective tax rate of 16.5% to 17.0% for 2020.
· Atlantic Union recorded a loan loss provision of $2.9 million in 4Q19, down 68.1% compared to the $9.1 million posted in 3Q19. The decrease reflected lower net charge-offs and growth in the loan portfolio.
· Asset quality improved in 4Q19. Nonaccrual loans fell $1.8 million or 6.0% linked-quarter, while performing TDRs edged up $0.5 million or 3.5%. OREO & other repossessed assets declined $1.7 million or 26.3%. The end result was a 5.7% drop in NPAs. Consequently, NPLs/Loans slipped to 0.35% compared to 0.37% at September 30, 2019, while NPAs/Assets dipped to 0.28% from 0.30%. Net charge-offs (NCOs) were $4.6 million in 4Q19, which translates to 0.15% of average loans compared to 0.25% in the prior quarter. The $3.1 million provision fell short of the $4.6 million in NCOs, leading to a 3.5% decrease in the loan loss reserve. Reserve coverage of total loans dropped to 0.33% from 0.35%, and reserve coverage of NPLs slipped to 96.30% from 96.97% three months earlier.
· Atlantic Union’s regulatory capital ratios decreased slightly in 4Q19. The total risk-based capital ratio fell 29 bps to 12.64% while the Tier 1 capital ratio dropped 24 bps to 10.24%. The leverage ratio declined 15 bps to 8.79%. The regulatory ratios all remain well above the minimum levels required to be considered well-capitalized.
· The tangible common equity ratio lost 15 bps LQ to 9.08%, Atlantic Union’s tangible book value per share increased from $18.69 at September 30, 2019 to $18.80 at December 31, 2019.
· Management lowered their targets for financial performance, which had been established during a time when interest rates were expected to be increasing. As this outlook has changed, the financial targets for 2020 have been reduced accordingly. Management is now targeting an ROA of 1.2%-1.4% (down from the prior 1.4%-1.6%), ROTCE of 15%-17% (down from 16%-18%), and an efficiency ratio of 53% or lower (up from 50% or lower).
Earnings Estimates: Atlantic Union’s 4Q19 results were largely in-line with our expectations. Loan and deposit growth were strong and asset quality improved further. However, the NIM contracted more than anticipated and operating expenses were higher as well. Given the change in the interest rate environment over the last six months, management has revised their guidance for profitability measures in 2020, as falling interest rates mean a lower NIM than had previously been assumed.
The biggest item we have adjusted following 4Q19 results is the NIM. We expect a few additional basis points of NIM compression in 1Q20, with the NIM stabilizing for much of the rest of the year. We also nudged our loan and deposit growth estimates down a bit, not because of anything in 4Q19 results, but rather because our prior projections were a bit above management guidance for 6%-8% growth for the year. We have reduced our estimates to fall within that range. We are boosting our estimate for noninterest expenses to reflect growth of approximately 4% from the “core” operating expense run rate of roughly $92.5 million per quarter posted in 4Q19, which is a higher base than our starting point in the prior model. Offsetting some of this increase is a reduction in our loan loss provision projection, which we decreased to $29.4 million in 2020 from $36.8 million. This still represents a 39.4% increase from the $21.1 million recorded in 2019, but we reduced the projection as a result of improved asset quality. We are still modeling an incremental jump of around $50.0 million in the loan loss reserve in 1Q20 as a result of implementing the CECL accounting standard. This incremental reserve will not affect the income statement, but it will reduce tangible book value and capital ratios.
After making these modifications, we are reducing our 2020 EPS estimate from $2.67 to $2.62 and our 2021 EPS estimate from $2.92 to $2.86.
Valuation: We believe Atlantic Union Bankshares continues to demonstrate progress on a number of fronts and that market consolidation in Virginia presents the bank with some good opportunities to add talent and gain market share. However, the interest rate environment has caused a reduction in some of the bank’s profitability targets that are bound to have some impact on valuation. Atlantic Union is currently trading at 15.3x LTM EPS and 195.8% of tangible book value. We are maintaining our price $40.00 price target based on the stock’s current 15.3x P/E multiple applied to the $2.62 EPS we are projecting over the next four quarters (1Q20-4Q20). Our target suggests a potential gain of roughly 11.4% over the next twelve months, and a 14.2% total return when including the stock’s 2.8% dividend yield. Consequently, we are reiterating our Outperform rating for shares of AUB.