Atlantic Union Bankshares Corporation
Q1 2017 Earnings Call Transcript

Published: 19 Jul 2017

[Operator:]

Good morning. My name is Christa and I will be your conference operator today. At this time, I would like to welcome everyone to the Union Bankshares and Trust Second Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. I would now like to turn the call over to Bill Cimino, Director of Corporate Communications. You may begin.

[Bill Cimino:]

Thank you, Christa and good morning everyone. I have Union Bankshares President and CEO, John Asbury; and Executive Vice President and CFO, Rob Gorman with me today. We also have other members of our executive management team with us for the question-and-answer period. Please note that today's earnings release is available to download on our Investor website, investors.bankatunion.com. During the all today, we will commentary about our financial performance using both GAAP and non-GAAP operating metrics. Operating metrics exclude the merger-related expenses for the pending Xenith acquisition, which should provide better perspective and better historical comparability to the operating performance of the company. Important information about these non-GAAP operating metrics including a reconciliation to comparable GAAP measures is included in our earnings release for the second quarter of 2017. Before I turn the call over to John, I would like to remind everyone that we will make forward-looking statements on today's call which are not statements of historical facts 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. A full discussion of the Company's risk factors, important information regarding our forward-looking statements and the pending Xenith acquisition are included in our earnings release for the second quarter and our other SEC filings. At the end of the call, we will take questions from the research analyst community. And with that, I will turn the call over to John Asbury.

[John Asbury:]

Thank you, Bill and thank you all for joining us today. Union delivered a fifth consecutive quarter of double-digit loan growth on an annualized basis, strong deposit growth and saw continued year-over-year improvements to our profitability metrics on an operating basis. So in short, it was another solid quarter for Union. Before I dig into the quarter, I’d like to provide an update on the Xenith acquisition. As a reminder, we announced the deal on May 22 and we noted how it checked off every one of our four strategic priorities of diversification, core deposit funding, efficiency and effectively crossing $10 billion in assets. Immediately following our announcement, we began a series of meetings and communications with the Xenith team. We wanted to improve upon our past experiences and get things started quickly that just as important we wanted to set the right tone from the beginning and provide a glimpse of our operating culture to the Xenith team. We have started the planning work to ensure our merger integration efforts are successful by following a detailed integration playbook to guide the effort. Integration teams are working together. The process is moving along quickly and smoothly while the majority of the integration work is yet to come, I am very pleased with how things have gone so far and the warm welcome we’ve received from the Xenith team. We remain on track to consummate the transaction in early January and we continue to be very enthusiastic about joining forces with the Xenith and what that means for the combined company on a go forward basis. Finally, I’d like to add that I have been able to get out and meet with a number of our commercial clients following the announcement and I am very enthusiastic about the feedback and the possibilities for Union going forward. Rob will provide more detail on the quarter. So I do want to speak about the first half which saw Union deliver year-over-year improvements of approximately 9% in net operating income, operating net income, 10% in operating earnings per share, 14% in loan growth and 11% in deposit growth. While operating return on assets was relatively flat, Union saw a year-over-year gain in within our operating return on tangible common equity which was up 48 basis points from the first half of 2016 and a first half improvement of 56 basis points in the company’s operating efficiency ratio. We did continue to see some lumpiness in credit quality in the second quarter as net charge-offs increased during the quarter. In addition, we saw a slight increase in non-accruals due to two unrelated credits, one of which was related to a relationship that was mentioned in the first quarter and are they are not indicative of any portfolio trend. The Virginia economy remains steady and our state government ended the fiscal year with a $132 million budget surplus. We are not seeing any weakening in the macroeconomic environment. Other leading indicators of credit quality within Union remain benign. With non-accruals being so low, any individual issues among commercial borrowers will certainly be noticeable while I do believe that problem asset levels at Union and across the industry are below the long-term trend line, we still have no early indicators of a downturn in portfolio level credit quality at this time. Turning to the bigger picture, as I mentioned above and stated in the last two calls, there are four areas that we are very focused on in 2017. They are diversification, core deposit funding, efficiency and preparing to cross the $10 billion asset threshold. And let me provide an update on each. First, diversification, Union has a great opportunity to further diversify our loan portfolio and income streams. Diversifying income streams and the loan book builds a stronger bank over the long run since Union is in a position where we can deliver many products and services better than a national big bank or the large regional banks, we believe we have a unique opportunity. Assets under management have grown by $141 million or about 6.3% from the prior year to $2.41 billion as of June 30. I believe the solid year-over-year growth shows that the wealth team is gaining traction in the market. As a reminder, we acquired Old Dominion Capital Management in Charlottesville in the second quarter of 2016, and that acquisition has gone well for both sides. We continue to actively explore opportunities to acquire other registered investment advisors and believe that that has the potential to further ramp up our fee-based income growth. On our loan growth, we saw broad based growth across virtually all markets and categories and feel comfortable with our loan growth momentum. We did experience some seasonality in our C&I category as we saw lower line utilization levels for our revolvers lines of credits. Our C&I practice which will be significantly enhanced with the Xenith acquisition did see an increase in commitments in overall lines of credit for Q2 though. Point two is, core deposit funding. We want to broaden our deposit base to manage our loan-to-deposit ratio to our targeted 95% level over time. We are intensely focused on improving our retail banking depository offerings, increasing our deposit-intensive small and medium size business relationships and enhancing our treasury management capabilities where we believe we can offer a superior treasury solution with better and in person support. Deposit growth trailed our loan growth rate during the second quarter. But deposits certainly grew a respectable 9% annualized. Deposit growth was broad base across all deposit categories with the exception of savings. The highest percentage growth rate by deposit products and tight backing from now accounts followed by jumbo CDs. We grew core deposit households by 3% annualized rate of increase in the quarter building upon our already large and strong retail deposit base. 50% of all of Union’s deposit base comes from transactional accounts. I still think we have a great deal of room to run and building out our deposit base with small and mid-sized businesses and that comes with an additional focus. Deposit and household growth were aided by a new marketing branding campaign designed to highlight our consumer free checking account product that Union provides. This product is a differentiator relative to some of our larger competitors in our markets. Point three is efficiency, improving our efficiency ratio takes time and dedication to doing it in a right way. In the second quarter, the operating efficiency ratio declined 56 basis points from the prior year on a consolidated FTE basis. Further efficiency improvement remains a significantly opportunity for the company and will of course move down meaningfully as efficiencies are captured through the Xenith merger. During the quarter, we completed our peer group benchmarking and in end-to-end process and procedure review that we launched last year. The benchmark was also done for a greater than $10 billion asset peer group, given the pending Xenith acquisition, we have a two track process to take advantage of opportunities that exist. First is act on act on immediate opportunities to improve and streamline processes and procedures that don’t directly overlap with our merger integration efforts and then, secondly, identify opportunities to improve the scalability of our operating platform as well as the overall efficiency of the organization next year when we cross the $10 billion assets mark and implement the recommendations following a successful integration with Xenith. And the last point is, preparing to cross $10 billion in assets. We made steady progress on this important objective and remain on track to be operationally ready to cross by the end of the year. We completed our first DFAST test run in the second quarter and tend to conduct another test run next year to include Xenith with the expected January close of the Xenith merger, we do not expect to be required to submit our DFAST results to the regulators until 2019 and that gives us about 18 months to continue to refine our DFAST process. The work undertaken to cross $10 billion has been a multiyear process at Union and I feel very confident in the work the team has put in since 2014 on this issue as we finish our preparations to cross next year. So, to summarize Union had a solid second quarter and a great first half with double-digit growth in loans, deposits, operating earnings per share, and operating net income, and we made significant process - progress on our four focus areas seeing meaningful improvement. The Xenith acquisition itself was the most important event of the quarter. It’s off on the right foot and it remains on track to close in early January. I'll now turn the call over to Rob to cover the financial results for the quarter. Rob?

[Rob Gorman:]

Well, thank you, John and good morning everyone. Thanks for joining today. I’d now like to take a few minutes to walk you through some of the details of our financial results for the second quarter. On an operating basis, which excludes $2.4 million in after-tax expenses related to the pending Xenith acquisition, consolidated earnings for the second quarter were $20.3 million or $0.46 per share, which is 5% higher than the first quarter and also 5% higher of last year’s second quarter earnings per share of $0.44. The Community Bank segment’s operating results were $19.8 million or $0.45 per share, while the Mortgage segment contributed $551,000 of earnings or $0.01 per share in the quarter. Now, turning to the major components of the income statement, tax-equivalent net interest income was $71.6 million, which is up $2.5 million from the first quarter and up $3.4 million from the prior year’s second quarter primarily driven by increased levels of earning asset balances during that period. The current quarter’s reported net interest margin was 3.62%, that’s a decline of four basis points from the previous quarter and is down 22 basis points from the prior year levels. Accretion and purchase accounting adjustments for loans and borrowings added eight basis points to the net interest margin in the second quarter which is consistent with the first quarter results. The core net interest margin which excludes the impact of acquisition accounting accretion was 3.54% in the second quarter also four basis points lower than the first quarter level. The decrease in the core tax-equivalent net interest margin was principally due to the eight basis point increase in the core cost of funds which was partially offset by the four basis point increase in core yield on earning assets. The quarterly 8 basis increase in the core cost of funds to 62 basis points was driven equally by higher core cost of deposits and wholesale funding costs. The cost of deposit was 37 basis points for the quarter which was up five basis points from the first quarter, primarily due to changes in deposit mix and increases in money market investments sweep interest checking and time deposits average rates paid. The increase in both year funding cost was primarily driven by higher federal home loan bank average borrowing rates paid resulting from the increase in short-term market rates during the quarter. The four basis point increase in earning asset yields was primarily driven by higher core loan portfolio yields which improved by seven basis points to 4.33% during the quarter. The increase in the loan portfolio yields from the prior quarter was driven by the impact of increased short-term interest rates on our variable loan rate – variable rate loans portfolio yields. The improvement in loan yields is partially offset by lower investment portfolio yields which declined due to lower reinvestment rates day count and the slight change in the portfolio’s taxable and non-taxable mix during the quarter. Looking forward, our baseline net interest margin outlook assumes that the current flattening yield curve conditions persists over the medium-term and if the Fed raises the Fed funds rate by 25 basis points one more time in December of 2017. Under these circumstances, we project that our quarterly core net interest margin will be flattish from current levels with a downward bias of 1 to two basis points per quarter for the balance of 2017. On the other hand, if we were instead to see a steepening yield curve over that period, as our previous NIM guidance assumes, we would expect to see a flat to expanding core margin in a range of one to two basis points per quarter from the current level. The provision for loan losses for the second quarter of 2017 was $2.2 million, that’s an increase of approximately $300,000 compared to the previous quarter and consistent with the same quarter in 2016. The increase in the provision for loan losses were primarily driven by loan balance growth and increases in specific reserves related to non-accrual loans additions. For second quarter of 2017, net charge-offs were $2.5 million or 15 basis points on an annualized basis compared to $788,000 or five basis points for the prior quarter and $1.6 million or 11 basis points for the same quarter last year. Of the net charge-offs in the second quarter of 2017, approximately half were specifically reserved for in the prior quarter. On a year-to-date basis, net charge-offs were $3.3 million or 10 basis points on an annualized basis, which compares to $3.8 million or $13 basis points for the same period in the prior year. Second quarter non-interest income declined by approximately $800,000 to $18.1 million from the prior quarter, primarily driven by lower bank-owned life insurance income due to proceeds from death benefits received in the first quarter, lower gains on sales of securities, and declines in insurance-related income which is typically seasonally higher in the first quarter. Mortgage Banking income increased $768,000 or 37.9% to $2.8 million in the second quarter, compared to $2.2 million in the prior quarter primarily related to increased mortgage loan originations during the quarter. Mortgage loan originations increased by $36 million or 36% in the second quarter to $137 million from $100 million in the first quarter. Purchase money mortgage volumes drove that increase for the second quarter. Excluding Xenith merger-related cost of $2.7 million reported in the second quarter, operating non-interest expense declined $200,000 to $57.2 million for the second quarter from $57.4 million in the first quarter. Salaries and benefits expenses declined by $1.6 million, primarily related to declines in payroll taxes which are seasonally higher in the first quarter as well as lower group insurance costs and lower unemployment taxes. This decrease was partially offset by increases in our marketing expenses of $539,000, increases in professional fees driven by higher consulting fees of $400,000 and printing and postage cost of approximately $256,000 related to annual privacy notice mailings. In addition second quarter expenses included approximately $150,000 in branch closing costs which related to two in-store branch closures which were consolidated into a new location in June of this year. Now turning to the balance sheet, total assets stood at just under $9 billion at $8.9 billion as of June 30, which is an increase of $815 million from our prior year level June 30th level and $245 million from the first quarter of this year. The increase in assets was driven primarily by net loan growth during these periods. At quarter end, loans held for investment were at $6.8 billion, that's an increase of $270 million or 13.3% annualized from the prior quarter. Loans held for investment increased $830 million or 14% from June 30, 2016 level, while quarterly average loans increased $765 million or 13% from the prior year. The quarterly loan growth was strong across all commercial and consumer loan categories except for C&I loans due to normal seasonal line usage activity as John noted earlier. Looking forward, we continue to expect lower double-digit loan growth for the full year. At June 30, total deposits came in at $6.8 billion, which is an increase of $150 million or 9.1% annualized from the prior quarter. Deposit balances were up $670 million or 11% from June 30, 2016 levels. All deposit categories experienced balance growth during the quarter with the exception of savings accounts balances. Looking at credit quality, non-performing assets increased $2.1 million to $34.1 million during the quarter which is comprised of $24.6 million in non-accruing loans and $9.5 million in OREO balances which also includes $2.7 of former bank locations. As John mentioned, the increase in non-accruals was primarily driven by one large credit relationship and the continuing work out of a credit with unique circumstances we discussed in the first quarter and is not indicative of pervasive credit quality issues in our markets. The allowance for loan losses decreased by $200,000 to $38.2 million at June 30, primarily due to the continued decline in historical loss ratios rates. The allowance as a percentage of the total loan portfolio was 56 basis points at quarter end, which is down slightly from March 31 levels as a result of the benign asset quality environment and lower historical loss rates. So in summary, Union's second quarter financial results demonstrated good progress toward our strategic growth objectives as we generated solid loan and deposit growth again this quarter and improve profitability metrics on an operating basis. In addition, during the quarter we announced the signing of a definitive merger agreement to acquire Xenith Bankshares and have initiated the merger integration planning process to ensure the achievement of the strategic and financial benefits of the consummation. As always, we remain focused on leveraging the Union franchise to generate sustainable profitable growth and are committed to achieving top-tier financial performance and building long-term value for our shareholders. And with that let me turn it back over to Bill Cimino to open it for questions.

[Bill Cimino:]

Thanks, Rob. Christa, we’re now ready for some callers from our analysts.

[Operator:]

[Operator Instructions] Your first question comes from the line of Austin Nicholas from Stephens. Please go ahead. Your line is open.

[Austin Nicholas:]

Hi, okay, guys good morning.

[John Asbury:]

Good morning.

[Rob Gorman:]

Good morning.

[Austin Nicholas:]

So, maybe, if you could just give a little more color on the loan growth and if you are seeing any increased activity in Northern Virginia or Richmond and just maybe some kind of geographic color on where that came from?

[John Asbury:]

Sure, Austin. I’d be happy to do that. As is usually the case, Richmond being our largest market, as always a some portion as a contributor to the overall loan growth. I would say overall, it’s fairly well balanced. We saw on a percentage basis, we saw outside performance in Hampton Roads which is good news, that’s one of the reasons why we are so enthusiastic about Hampton Roads. We did see a high single percentage increase in the Northern Virginia area as well, which obviously, from our perspective is off a fairly small base and then Richmond was strong. Southwest Virginia to include our Charlotte operation was strong as well. So, other than the northern neck which is a pretty modest commercial economy, we saw pretty good results across the franchise, across a very small picture.

[Austin Nicholas:]

Okay, that’s helpful. And then, maybe just as you think about your branch network, it’s large and how do you balance, thinking about that branch network, improving efficiency by potentially consolidating or rationalizing the branch network but also managing funding costs and attracting deposits as you look out maybe over the next year?

[John Asbury:]

Yes, I would say that, on the one hand, the branch – the retail deposit base of Union, I always stay as the crown jewel of Union Bank. That’s why half our deposits are in fact transaction accounts. That wouldn’t be the case where we have not done the branch network. Having said that, if you look at the facts, we’ve continued to tighten the branch network. We’ve continued to rationalize it. We are always thinking about that. I think that the future of the branch network in general is going to be fewer and smaller and we want to continue to leverage technology, but we do believe an Omni channel delivery. We do believe that probably for the remainder of my time here, which I hope is a long time, we are going to have a meaningful branch network and we view that as an important channel for certain clients but it has to be done in an efficient manner. It has to be rationalized. So where we have our opportunities to consolidate the branch network, we will do that as leases expire and we have the ability to reposition or move toward a smaller footprint with a more modern design we are certainly doing that. Elizabeth Bentley is here with me, Head of Retail, would you have anything else you would add to that?

[Elizabeth Bentley:]

No I think the other thing that I’d say, John, is that, to your point about Omni channel, we are very focused on digital space and making sure our customers can bank kind of when, where, how they want. So, as that matures, and grows and customers are that close, you will see that we will continue to rationalize the network since just that we’ve done before. We’ve got a net changed environment branch coming in August as we finish our exit from the Martin’s in-store grocery stores. So, that will sort of pin in that entire project for us and then we look forward to working with Xenith and leveraging that platform.

[Austin Nicholas:]

Okay, thank you. That’s helpful. And then maybe just one last question on expenses. They came down quarter-over-quarter excluding the acquisition costs. If we look out to the second half of the year, is there anymore expense build that we are going to see in expenses or is this kind of 57 runrate the right way to think about?

[Rob Gorman:]

Yes, this is Rob. Yes, I would say, the 57 to 57.5 guidance that we’ve provided earlier in the year still holds. You won’t see any really outsized increases in that and do some seasonality may see some declines and some increases over the next quarter, but on average, I’ll say $57 million runrate is pretty good.

[Austin Nicholas:]

Got it. Okay, well, thanks everyone. I appreciate it.

[Rob Gorman:]

Thank you.

[Bill Cimino:]

Thanks, Austin and Christa we are ready for our next caller please.

[Operator:]

Your next question comes from the line of Catherine Mealor from KBW. Please go ahead. Your line is open.

[Catherine Mealor:]

Thanks. Good morning everyone.

[John Asbury:]

Good morning, Catherine.

[Rob Gorman:]

Good morning, Catherine.

[Catherine Mealor:]

I would ask a couple questions on the margin, on the loan yields. Did you see an increase or an increase in commercial swap income back again this quarter or was the increase in your loan yield is more to fund the increase in the short end of the curve?

[Rob Gorman:]

Yes, Catherine. The increase was primarily due to the repricing due to variable rate loan. So, probably we have HELOCs et cetera in other commercial variable rate loans. Not much in increasing in the swap income level.

[Catherine Mealor:]

Okay, so then would your guidance assume that you get a rebound in that commercial swap income in the back half of the year or that’s crazy to your NIM outlook?

[Rob Gorman:]

That would probably be of an upside to forecast that we mentioned.

[Catherine Mealor:]

Okay. And then, on the deposit side, can you couple with how you are thinking about your betas in your market? Is anything then surprising to the positive and the negatives of how your deposit cost could trend in this quarter and your outlook for how you should see kind of quarterly increase in your interest-bearing deposits?

[Rob Gorman:]

Yes, I would say that from the deposit data perspective it was a bit higher this quarter that we had originally estimated and projected in our NIM guidance last quarter primarily due to some movements going into the money market portfolio and we are also seeing more funds flowing into – in CDs. So we’ve got some special rewarding on the CD book and we see some nice uptick in that area as well. So, I think the money market betas are a bit higher and we probably will expect to see that continue at a higher level than we had originally projected.

[John Asbury:]

And Catherine, this is John, as you know, we are running our loan growth rate at a pretty nice cliff at this point. Certainly it was higher than we guided during Q2. As you know, we do have a strategy of wanting to pace loan growth with deposit growth. Loan growth is running ahead of deposit growth. We certainly don’t feel badly about 9% deposit growth. We are experimenting at that. As a marketing strategy, we are testing our markets. We are testing some different product types. So, more so than we’ve really done in the past, we are trying some things out. So we are looking at rate sensitivities. We are checking elasticity. Some of this is just the evolution of our marketing where we are lot more sophisticated between number of new individuals who’ve joined. So this is a different strategy. As Rob said, we have run a few specials on the money markets that feels different from what we’ve done before. We’ve tested a few specials on CDs. We do have a select number of larger commercial borrowers that tend to be a bit more rate-sensitive. So, we never really pulled the rate lever that hard because we haven’t had to. So, you will see us be kind of cautious but you will also see us be unafraid to test and that’s kind of what we are working our way through right now.

[Catherine Mealor:]

Okay. That makes sense. One follow-up question on the margin. How do you think about the pro forma margin with the units layered up - layered in?

[Rob Gorman:]

Yes, I think if you look at our guidance, depending on how the curves – whether curves steepens or not flat margins with a steepening curve we are just kind of flattish without it. We think there will be some positives from the combination with Xenith regarding some deposit cost although, they’ve got some higher deposit rates than we have today. So I don’t think they will need to adjust those levels as market rates go up as much as we may be coming towards them and then, the earning asset yield should offset that. So, I would say, not a huge material change from what we are seeing in the legacy Union book from a margin.

[Catherine Mealor:]

Great, thank you.

[Rob Gorman:]

That’s not including the accretion of course, Catherine.

[Catherine Mealor:]

Right, okay.

[Operator:]

And your next question comes from the line of William Wallace from Raymond James. Please go ahead. Your line is open.

[William Wallace:]

Thank you. Good morning guys.

[Rob Gorman:]

Hey, Wallace.

[John Asbury:]

Hey, Wallace.

[William Wallace:]

Maybe just continuing the line of Catherine’s questions on the funding side, John, you mentioned in your prepared remarks the 95% target loan to deposit ratio. Where do you start to get uncomfortable running loans to deposits?

[John Asbury:]

Well, I think that we are at a 100% right now. And so, that’s not a position we want to stay in. So I think it begs the question, can Union Bank have a loan to deposit ratio over a 100%? The answer is, yes, we can. Do we like that as a long-term strategy? No, we do not. But we are not at a point where I would say that sort of a constraining factor on our ability to continue to fund loan growth as we have mainly for the reason I pointed out. We still have some levers available to us that we are testing. We could do things to increase the pace of deposit growth with higher rate strategies and so we are kind of experimenting a bit there. But as a strategy, we still think it be proper positioning for the Bank over time would be something more in the mid 90s. The Xenith combination with help that. So, on the other side of that, that will reduce the loan-to-deposit ratio. We don’t want to do anything based on what we see right now to purposely throttle the loan growth that’s available to us. So I hope that – would you…

[Rob Gorman:]

Yes, I agree with that, John. There is opportunities beyond what we are seeing on the commercial side more than side.

[John Asbury:]

I think we are still early on.

[Rob Gorman:]

We can run higher.

[John Asbury:]

Yes, and in terms of just a dedicated focus, disciplined focus on deposit-intensive commercial businesses, we are in the very early innings of that. We have never truly focused. We are going after that. That is an avenue that we will open up.

[William Wallace:]

I mean, I’d love, maybe if you could provide some commentary as to what you are doing or going to do to open that up? I mean, do you haven’t had made any?

[John Asbury:]

Yes, I think we have, yes, I think we have. If you look at a number of things on the small business front, the product set, I think that the incentive plan adjustments that we’ve made across the Commercial segment, the Investment and Treasury Management, our new Head of Treasury Management has been here for about a year. We are in the process of upgrading the Treasury Management platform to make us competitive with really the best of the large regional and national banks to the small to mid size businesses that we serve. So, it’s focused, it’s filling a gap that we’ve had to some extent on the TM platform and making sure that the commercial bankers are accountable and small business bankers not just for growing lending but delivering the total relationship and also increasingly, you are going to see more of a focused strategy on deposit-intensive businesses that really typically don’t borrow at all. Think about things like over time with the acquisition of Xenith, Xenith is doing this now. They’ve had to the legacy Xenith because they were a business bank, branch wide. There is a world of opportunity in Northern Virginia in particular as it relates to non-profits. So there are a lots of things that are on our mind. That doesn’t happen overnight. But I do think that we will be able to share progress over time.

[William Wallace:]

Does the addition of Xenith franchise – does that improve your Treasury Management capabilities and do you need to upgrade the platform or do they have a platform in place where you could hold off of it?

[John Asbury:]

No, I would say, it’s a good question. It’s complementary. I think that they have a few gaps. We have a few gaps. We are currently evaluating what is the right solution for the combined company in terms of the TM platform. So I think that we bring obviously more scale to the table built at the same time, they have some – they have a few competencies it will be complementary to us. We are, right now, trying to make a decision, not trying, we are in the process of making a decision of what is going to be the next generation TM platform. We have been frustrated with the vendor that we had selected. I won’t name their name who was behind schedules in terms of the platform that we intended to upgrade to and we have reopened that assessment and make it with a different route.

[William Wallace:]

Okay. And then, if you look at your retail deposit base, what you call your crown jewel, are you seeing them come to you as you advertise special rates in markets? Are they paying attention and coming to you asking for those same rates? Or are you having to increase price on deposits across your retail customer base? Or is it only on new customers that are coming in?

[John Asbury:]

Well, two things. The money market specials are really relationship-oriented. And so, the way that works is you have to bring new money to the bank in order to qualify. So we have a sort of series of different product offerings. We are doing experimentation in direct marketing with the free checking account for example. We had a lot of conversation in this company certainly since I’ve been here about do we or do we not want to offer free checking and the answer is, yes, we do, because we can demonstrate quantitatively that that is a gateway product that attracts new relationships that we can build from and we think that is a good strategy for us. And so, we have been very pleased with some of the testing that we’ve been doing on new deposit checking and we’ve seen some pretty significant uptick in terms of the – I won’t give the number, but the percentage of new relationships coming into Union Bank and when I talk about these products, from a checking standpoint, that presumes that they have things like direct deposit et cetera. It’s not somewhat opens up a small dollar balance and then closes it later to get some sort of reward. So, I think this is a good example of which resulted from having a fresh set of eyes in the marketing team and a skill set that we have not really had in before where we are willing to test, try things, if it works, scale it up quickly, if it doesn’t work, stop it and try something different.

[William Wallace:]

Okay. So, if I look at your cost on your average earning assets, the average balance sheet, the cost of your transaction in money market accounts was 33 basis points up, eight basis points from the first quarter at 25 basis points. So, is that increase – I know some of that’s going to be a shift, but, would you characterize that increase is being driven by promotions you are running to bring new customers on? Or is it being driven by increasing the costs for the rates that you are paying your existing base? I am just trying to get a sense as to how…

[Rob Gorman:]

Yes, well, it’s really attracting new money, the rates – we bringing in new money or hiring that repricing the whole money market book for example. So we will have different tiers from a pricing point of view.

[William Wallace:]

Okay.

[Rob Gorman:]

With the relationship money market account, as John mentioned, is new money coming in and paying a little higher rates on that.

[William Wallace:]

Okay, okay. Thank you. I appreciate that. And then, one last question, I’ll step out, but, John, I am wondering if you could maybe just kind of update us on your thoughts around mortgage? I think your earnings contribution year-to-date is a penny and it was a penny this quarter. What do you say an acceptable earnings contribution from the mortgage segment? I’ll hop out, thanks.

[John Asbury:]

Higher than where we are, and so, I think that the ultimate question is really what is our mortgage company capable of doing in this down refinance environment. Let’s face it given where rates are, I think that we have seen the high watermark of refinances and questionably, now you are seeing a pretty nice increase in the purchase money mortgage originations that are being going on in the system. And so, I think that, we are demonstrating that we are able to make money in this business in a down refinance market. We are demonstrating that we are able to grow meaningfully our purchase money originations, but let’s face it. We have not yet demonstrated what we are capable of doing in terms of giving an adequate return on capital. That is one of the big question marks candidly. What are we capable of doing in terms of return on capital? I feel good about the leadership for the Mortgage Group. I feel good about the direction, but this is a question that’s still very much in play. It’s probably the best answer I can give at this point.

[William Wallace:]

Thank you.

[Bill Cimino:]

Thanks, Wally. And Christa, we are ready for our next caller please.

[Operator:]

Your next question comes from the line of Laurie Hunsicker from Compass Group. Please go ahead. Your line is open.

[John Asbury:]

Good morning, Laurie.

[Laurie Hunsicker:]

Yes, thanks. Good morning gentlemen. I just wanted to go back to – you were talking about the branch network. So you closed one branch in the quarter? Is that correct?

[John Asbury:]

That’s correct, yes.

[Laurie Hunsicker:]

Okay, and was that an in-store?

[John Asbury:]

Yes, we actually consolidated two in-store branches into a standalone location.

[Laurie Hunsicker:]

Okay, okay. And then, were there any one-time cost associated with that?

[Rob Gorman:]

Yes, I mentioned in the prepared remarks.

[Laurie Hunsicker:]

I know, so you’ve broke out during the prepared remarks, right, when you are talking about that. So I was having trouble with hearing. I am sorry.

[Rob Gorman:]

About $150,000 was incurred this quarter related to closing costs.

[Laurie Hunsicker:]

Okay, and was that in the other expense line that 1.50 million, is all that’s there?

[Rob Gorman:]

Yes, it would be in the earnings release, yes, it would be there.

[Laurie Hunsicker:]

Okay, okay. Great and, okay, so that takes your total in-stores now down to four?

[John Asbury:]

Maybe we will have two.

[Rob Gorman:]

Yes, so I guess we – yes, two – two closing or two consolidating in…

[Elizabeth Bentley:]

Into one.

[Rob Gorman:]

Into one. But would that won’t be an in-store, so?

[John Asbury:]

Yes. That’s right.

[Elizabeth Bentley:]

We won’t have any left inside of the grocery stores come the end of August?

[Laurie Hunsicker:]

End of August, okay.

[Elizabeth Bentley:]

But, we will have, we have a branch in a convenient store in a different market and we have one in a Wal-Mart in our northern neck. So, that will be the last of our, sort of co-located branches.

[Laurie Hunsicker:]

Okay, all right. That’s helpful. Okay, and then, obviously you talked about the Xenith acquisition, that’s going as planned. The one-time charges that you had estimated of $33 million or so pre-tax, are you still tracking in that range as well?

[Rob Gorman:]

Yes, Laurie, we are still on track with that.

[Laurie Hunsicker:]

Okay. And then, this quarter, your tax rate of 20% was higher – I mean, higher than 26% last quarter higher than 26% last year. So outside of whatever changes happen in Washington, I thought your tax rate was closer to the 26%, 26.5% which weathers …

[Rob Gorman:]

Right, yes.

[Laurie Hunsicker:]

A penny on earnings, was there something unusual this quarter or should we be thinking about a higher tax rate?

[Rob Gorman:]

No, the core tax rate we are excluding the merger-related cost was 26.5% this quarter. What you need to understand in terms of the merger cost is, the majority of those merger costs are not tax deductable. So, the tax effect of the $2.7 million on the merge cost, the tax deduction is – or the calculation on that from a benefits point of view is only $386,000.

[Laurie Hunsicker:]

Right, 50% is that okay?

[Rob Gorman:]

That out and then you get actually the 26.5%, 26.6% tax rate.

[Laurie Hunsicker:]

Okay, okay. And then, maybe just jumping over to credit, can you give us a little bit more color around your uptick in commercial real estate both the jump in actual non-performers and the jump in past due? I mean, I heard your comments that there is not some major turn the revenue. Can you just help us about that?

[John Asbury:]

Right. Sure, if you look at the actual data, so we saw it increase in commercial real estate non-owner occupied of, call it, $2 million quarter-over-quarter in terms of non-accruals. What happened is, we actually had a $2.6 million non and upside real estate credit go into that non-accrual category and the past due category during that period of time. And that is linked – it’s related to a relationship that we mentioned in Q1 that was the single largest component of the uptick in non-accruals we saw in Q1. It is a separate entity, that’s actually an operating business. However, the principal of the business does also have a commercial real estate non-owner occupied entity and that had been performing. This was pulled into, what I would call an overall forbearance agreement as a part of the workout strategy. They have been challenged in keeping up their end of that work, therefore it went non-accrual. So, that’s – and that’s the end of that. The total relationship is everything that’s related to at this point is now non-accrual and going to the workout stage. So that’s really – that explains both of those items.

[Laurie Hunsicker:]

Okay, and so, what is the actual total dollar size now combined of that entire relationship?

[John Asbury:]

That relationship, approximately $6 million.

[Laurie Hunsicker:]

$6 million. Okay, and then do you have an update on the King George?

[John Asbury:]

We continue to acquire…

[Laurie Hunsicker:]

When acquired it was around $2 million.

[John Asbury:]

Sure.

[Rob Gorman:]

Just that’s - Laurie look hey, it is in the balance sheet.

[John Asbury:]

Yes, just we continue to evaluate what our options are for King George.

[Rob Gorman:]

So, $2 million.

[John Asbury:]

You know the history that’s OREO.

[Laurie Hunsicker:]

Okay, perfect. And just also under OREO, the real estate investment, i.e. your shutted branches of about $2.7 million. Any thoughts on movement there?

[Rob Gorman:]

Yes, we continue to work that – we kind of made a lot of progress in that area, but we’ve got some stubborn properties at this point in terms of the market and the demand for space in those markets. We do have – one of the – part of that is an – centered it. We’ve got to lift it for sale. We do have a tenant in there now which hopefully will make that an easier sale from an investor point of view. But really not much movement on that at this point of time. I don’t think we have a prognosis that those are going to move any time quickly.

[John Asbury:]

Laurie, this is John. I want to correct one thing. I just realized, you would ask me what is the totality of the relationship you are discussing with the non-owner occupied real estate went non-accrual. I said, that was six before we added. So it’s just under non in total, all of which is non-accrual at this point.

[Laurie Hunsicker:]

Okay, okay, thanks. And then, just on the credit piece, just to switch to Xenith which obviously when you announced and they gave a lot of detail, but there was one book that kind of I guess, flagged attention for me, the consumer piece that was marine around – plan and at the time you announced this in May, you want to show what you were doing with that. Is there any update around that book? Any thought about what you are doing with that book? How you are approaching it? How you think about from a credit standpoint?

[John Asbury:]

Sure, we are still learning about it. What I would say is we do feel very good about the creditworthiness based on our due diligence. I was actually in Hampton Roads Monday and Tuesday of this week meeting with the Xenith team. I did meet with the marine finance team and that was helpful from my standpoint just to understand more of the overall business model, the characteristics of the business, so on and so forth. So, based on everything I have seen and heard and we understand at this point in time, we look at this as something that has been a good earning asset for Xenith. We think it will be a good earning asset for us and we do have some competency and experience in marine finance within Union Bank. And that is along the Chesapeake Bay area where we have done ships mortgages for larger boats. That’s what’s these guys are financing. They have to understand marine finance means two things. Most of this is where they are financing boats, they would call it third-party whereby you might think of it as indirect paper. It was explained to me that that would be the correct incorrect characterization, but it’s conceptually the same thing. That’s what the majority of its exposure is. They have a smaller component which would be fore-planning of certain marine dealers and that is a smaller piece of the operation. So we are just learning more about both. I felt pretty good, very good actually about the experience model of that team. So that’s where we stand right now.

[Laurie Hunsicker:]

Okay, great. Thanks, I leave with that.

[Bill Cimino:]

Great. Thanks, everyone for dialing in today. As a reminder, we’ll post a reply of this conference call on our investor website at investors.bankatunion.com. Thanks for joining us. Good bye.

[Operator:]

And this concludes today's conference call. You may now disconnect.