Earnings Call Transcript - AUB Q3 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by and welcome to the Atlantic Union Bankshares Corporation Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. I would now like to hand the conference over to your speaker today, Bill Cimino, Investor Relations. Please go ahead, sir.

William Cimino, Investor Relations

Thank you, Josh and good morning everyone. I have Atlantic Union Bankshares President and CEO, John Asbury and Executive Vice President and CFO, Rob Gorman with me today. We also have other members of our executive management team with us virtually for the question and answer period. Please note that today's earnings release and accompanying slide presentation we are going through on this webcast are available to download on our investor website at investors.atlanticunionbank.com. There is also a download link on the website that you are on today. During the call, we will comment on our financial performance using both GAAP metrics and non-GAAP financial measures. Important information about these non-GAAP financial measures, including reconciliations to comparable GAAP measures is included in our earnings release for the third quarter of 2020. 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. We will take no obligation to publicly revise any forward-looking statements and please refer to our earnings release for the third quarter of 2020 and our other SEC filings providing further discussion of the company's risk factors and other important information regarding our forward-looking statements, including factors that could cause actual results to differ. All comments made during today's call are subject to the Safe Harbor statement. At the end of the call, we will take questions from the research analyst community. Now I'll turn the call over to John Asbury.

John Asbury, President and CEO

Thank you, Bill. Thanks to all for joining us today and I hope everyone listening is safe and well. As I've stated before, since early March we've been consistent in our commentary that we're managing through two significant and distinct challenges. First the COVID-19 pandemic and everything associated with it and second, a much lower than expected interest rate environment for years to come with all of its implications for the company's profitability. This quarter's results evidence the actions we've taken so far to address those two distinct challenges and are having a positive impact in positioning Atlantic Union for future success. We continue to believe that our strategic plan is the right one, and that we have a great opportunity before us to create something uniquely valuable for our shareholders and the communities we serve and we remain keenly focused on reaching the full potential of this powerful franchise despite the present challenges. We continue to operate under the mantra of soundness, profitability and growth in that order of priority. A sound bank is and will remain our highest priority. A prudent and conservative credit culture served the Company well during the Great Recession and it will serve us well during the economic challenges brought about by the pandemic. Our loan modifications have helped our clients weather the storm and we fortified capital with the preferred equity issuance in the second quarter. Our second priority is profitability and you can see the initial impact of our actions to align our expense run rate to the new revenue reality of the lower rate environment. As for growth, on the other side of the current economic challenges, we believe we have a long runway ahead of us to grow organically and through market share takeaway from our larger competitors that dominate market share in our home state of Virginia supplemented by our operations in Maryland and North Carolina. We also expect there will be potential future opportunities to continue to be a consolidator within our footprint. Let me first update you on our pandemic response. Our March 16 pivot to a new operating model with 90% of non-branch personnel working from home and having branch lobbies closed except for appointments has been effective. During September, we piloted reopening branch lobbies to customer walk-in traffic and on October 14, we fully reopened all branch lobbies. Corporate offices will remain closed to all but essential personnel for an indefinite period. Work from home is going fine. We're not going to rush bringing people back in given the safety and social distance challenges. I want to take you through the details of the Paycheck Protection Program again that we do continue to think PPP has been a brand builder for Atlantic Union and the numbers and our share of loans processed, particularly in Virginia support that statement. We have an organized process underway to convert the more than 3,000 new-to-bank PPP clients to full relationships. We think there's a great opportunity from the negative experiences many of them had with larger banks that caused them to come to us seeking help. We started to submit applications for PPP loan forgiveness on behalf of our clients to the SBA. We did not receive any approvals during the third quarter, but we did obtain the first approval from the SBA last week so it's good to finally see that this process begin. We remain hopeful that Congress will eventually pass the bipartisan proposal to automatically forgive PPP loans under $150,000. They represent 85% of all of our PPP loans by count. We are happy to see the streamlined forgiveness for PPP loans of $50,000 and below, which represents 58% of our PPP loans by count, but we think Congress can and should do more to help these businesses. Our customers have learned to bank differently. While branch lobbies are now open, we rolled out a digital appointment scheduling option to customers and have had more than 18,000 appointments set since June 1. We added mortgage options to the appointment schedule during the quarter as well. We've seen usage of our digital channels increase substantially from the prior year. For example, digital logins are up 21% since the start of the year, mobile check deposit utilization is up 18% this year, Zelle utilization is up 290% year-over-year and card control users are up about 100% since we launched that in April. Our call center volume has decreased from its peak and it's now about 10% higher than February. The average call wait time is now lower than before the crisis, all the while 90% of the call center personnel work from home. We updated our digital channel navigation to make self-service updates easier to find and added e-statement opt-in to online banking enrollment. We continue to work on new projects and improve the omnichannel customer experience with quarterly releases and upgrades to our product offerings. During the fourth quarter of the year, we expect to roll out a Zoom video chat option to our current branch appointment options, which are currently in pilot in 44 branches. We'll expand the pilot of having branch teammates take call center overflow calls during the busy parts of the day that improves both productivity and customer experience. We'll allow customers to select e-statements at the account level rather than the customer level, and that should improve e-statement penetration and reduce expenses. We'll also be able to notify customers when a new e-statement is ready. We continue to pilot our enhanced wealth CRM platform using real-time analytics and technology and continue our efforts to rightsize small business clients with the consumer online platform in order to ensure that they're not unnecessarily using a more complex commercial banking solution. All the while we continue to enhance our treasury management offerings and experience for our commercial client base. Turning to credit; as COVID-19 began we prepared expecting to be hit by the economic equivalent of a category 5 hurricane. While we still think there's a storm swirling on the horizon, we don't expect it will be as severe as we initially feared but anything could still happen. The resiliency and diverse nature of our markets coupled with government stimulus and an accommodative Federal Reserve is helping as we've seen the unemployment rate in our markets improve faster than expected. Here in our home state of Virginia, September unemployment came in at 6.2%. Our loan book also helps as we don't have any outsized exposure to the industries most directly impacted by the social distancing measures put in place such as hotels, restaurants and retail. By all indications and metrics, credit remains solid and we continue to try to help as many of our clients through this as possible while at the same time mitigating our risk of loss. As for payment deferrals, we had a number of loans roll off of modifications during the quarter and into the first part of October. The total modification balances as of Friday, October 16, were approximately 830 loans under modification with a balance of $523 million or 3.6% of our total portfolio. If you exclude the SBA-guaranteed PPP loans, then it would be approximately 4.1% of the total portfolio. This is down from $1.9 billion and 4,000 loans as of April 24, which was then approximately 16% of the portfolio. Our modifications peaked in May around 17%. Nearly all of the initial rounds of loan modifications will have matured in November. So far, of all the loans with an expired initial modification, only 40 commercial loans with an aggregate balance of approximately $90 million or 8% of the dollars have gone under a second modification. Of these, half the dollars were for nine hotel properties that were initially on a 90-day modification before we decided to make hotel modifications a standard 180 days. We noted in the middle of the third quarter that we had $302 million in modifications that we approved but subsequently deemed unnecessary as the clients informed us they no longer needed them so we removed those from our report. That was reflected in the mid-quarter deferral update we provided in September. The modifications run a range of options and are tailored for each borrower. The majority of our commercial modifications, about 70% of principal and interest deferrals, are mostly for 90 days with a balance of about $340 million as of last Friday and that's about 2.7% of the loan portfolio after adjusting out the PPP loans. Our exposures to the most in-focus industries are limited and they are outlined on slides numbered 7, 8 and 9 of our accompanying presentation. The amount of loans under modification in these segments decreased from 224 loans for $324 million on August 28, to 111 loans for $199 million as of October 16. As a reminder, our hotel portfolio was entirely within our footprint. It comprises $676 million or 5% of our total loan portfolio, excluding PPP loans as of September 30, and consists primarily of limited service non-resort hotels, mid-scale brand, that don't rely on conventions and conferences. The hotel portfolio's debt service coverage ratio and loan-to-value going into the crisis was the best among all of our commercial real estate property types. We saw that occupancy generally improved in August from July. Looking at September data, Northern Virginia, Charlottesville and Harrisonburg saw occupancy rates remain steady or improve from August, whereas the rest of the footprint saw some degree of decline. Whether that decline was seasonal in nature from the end of the summer or a reflection of a new trend remains to be seen. Our restaurant balance is $223 million or 1.7% of total loans excluding PPP as of September 30. It's granular and it's 85% secured by real estate collateral. Restaurants in Virginia have been open for indoor and outdoor dining since early June at 50% occupancy. Since July 1, we've capped at a 250 patron limit. About 10% of the segment was under modification as of October 16. Our retail trade exposure, which means loans to retail operators and single credit tenant leases, is 4.3% of total loan exposure excluding PPP as of quarter-end, but only about 2% of the segment was under modification as of October 16. A significant portion of this segment is the local convenience stores with gas and auto dealers. About 80% of the retail trade exposure is secured by real estate collateral with 21% in PPP. Our Healthcare segment is also granular, it's heavily secured by real estate and they've been open with social distancing and PPP rules since May. We only have about 3.6% of this segment still on a modification as of October 16. We have no meaningful exposure to passenger airlines, cruise lines or energy. As you may recall, our third-party consumer portfolio has been winding down for some time. The quarter-end balance for our Lending Club exposure was $66 million and continues to run off. Payment deferrals in the Lending Club portfolio declined by 71% to less than $1.7 million during the quarter as those accounts went off of modification and became current. With the unemployment rate in Virginia better than the June 30 Moody's forecast which informed our Q2 CECL reserve and with no negative changes in the outlook since then we have had a more normalized provision expense for the quarter and Rob will walk you through all of those details. Overall, we continue to proactively work through this event with our clients, while mitigating credit risk wherever we can. Moving on to our expense reduction actions we developed our initiatives to reduce the company's expense run rate to match the lower revenue expectations due to COVID-19 and the lower-for-longer interest rate environment back in March. We started to take action on them in the second quarter into the third quarter. These expense reduction efforts include the consolidation of 14 branches for about 10% of our branch network, which closed in mid-September. In addition to moving some projects to next year and eliminating others, we put a hiring freeze in place in March, except for critical positions. We eliminated a number of positions in June and including branch consolidation personnel we reduced total headcount by 6.4% by the end of the third quarter as compared to FTE levels at the end of March. In addition to these actions, we're executing on several other cost reduction initiatives such as tighter management to reduce overtime, contract labor and outside consultant spending, extracting price concessions from third-party vendors and renegotiating contracts including leases and improving teammate productivity through process reengineering and robotic process automation. Our goal remains to achieve and maintain top tier financial performance regardless of the operating environment. Our financial outlook will ultimately depend on the continued success against additional flare-ups of COVID-19 in our main operating areas, which will be one of the primary factors that determine the length and depth of the disruption in our markets. We continue to face great uncertainty at this point, mostly the duration of COVID-19. But as I mentioned before, we are in a better macroeconomic environment today than we thought we would be six months ago. There will probably be some depths along the way to a full recovery but we believe the overall trend should be upward. At this time, we simply don't know when we may return to pre-pandemic macroeconomic levels, but the evidence supports that we're seeing better economic performance in our footprint than is reflected in some national economic model projections. As we've said in the past, the Virginia economy is fairly unique with a broadly diverse set of regional economies and about 20% of it anchored in some fashion by the federal government. Federal government spending on Virginia is mainly for government agencies and Department of Defense, with only a small fraction going to income assistance programs, education and transportation. We expect to have full year loan growth in the low single digits, excluding PPP loans. Commercial loan categories of all types on a combined basis grew about 4% annualized during the quarter, substantially offset by declines in consumer categories such as third-party lending and residential mortgages held on balance sheet. We continue to see the trend of increased line of credit pay downs with utilization down to about 24%, well below our normal utilization of around 40%. Clearly, we've had a sea change in the economy, brought on by the pandemic, resulting in a systemic downturn that we're climbing out of now. Credit losses were minimal during Q2 and Q3, but of course, the real impact is yet to be seen. We continue to expect an eventual rise in credit losses and we thought Q3 would have begun to transition toward that, but obviously, it didn't happen. Although we cannot predict with certainty, our current best estimate is that credit losses may materialize in the first half of 2021. We expect normalized levels of credit losses after the impact of the pandemic works its way through the economy. Having said all of the above, we see nothing at this time that causes us to think we're anything but well-positioned and readily able to absorb the delayed impact of COVID-19 on credit at Atlantic Union. Moving beyond credit, our goal remains creating a company with differentiated performance. We'll continue to work on ways to make the company more efficient and scalable while improving the customer experience and could see further improvements to our expense base as a result. As I said last quarter, we're not standing by waiting for things to happen, we're pushing reorganization forward. While we always think a few steps ahead towards strategic opportunities and how the industry is evolving, at this time, we remain sharply focused on credit risk mitigation, positioning for success and slowly returning to a more normalized operating environment. I'm convinced we will emerge from this crisis stronger, better and more efficient which will give us opportunities, both organic and otherwise within our operating footprint. We're leveraging our learnings and ingraining our newfound capabilities, agility and innovation into the company's culture so that we have the flexibility to adapt to the lower-for-longer rate environment and the coming next normal, whatever that may be. We still believe that in chaos lies opportunity. We're weathering the storm, taking care of our teammates and customers and protecting this bank. We took decisive actions to reduce the expense structure to match the lower-for-longer rate environment in an effort to maintain top tier financial performance. We'll continue to work our strategic plan, but we will shift our timelines as needed to adjust to the new reality. I'm so very proud of our teammates, all they've done and their demonstrated ability to adjust to a new way of working in the midst of all of this uncertainty. I remain confident in what the future holds for us and the potential we have to deliver long-term sustainable financial performance for our customers, communities, teammates and shareholders. All of that has happened this year only convinces me more. Atlantic Union Bankshares is a uniquely valuable franchise. It's dense, it's compact in great markets with a story unlike any other in our region. We have assembled the right scale, the right markets and the right team to deliver high performance even in the most trying of times. I'll now turn the call over to Rob to cover the financial results for the quarter, Rob.

Robert Gorman, Executive Vice President and CFO

Thank you, John, and good morning everyone. Thanks for joining us today. I hope you, your families and friends are all safe and staying healthy. Before I get into the details of Atlantic Union's financial results for the third quarter, I think it's important to once again reinforce John's comments on Atlantic Union's governing philosophy of soundness, profitability and growth in that order of priority. This core philosophy is serving us well as we manage the company through the current COVID-19 pandemic crisis and preparing us for what comes next. Atlantic Union continues to be in a strong financial position with a well-fortified balance sheet, ample liquidity and a strong capital base, which will allow us to weather the current storm and come out stronger once this crisis has passed. As a matter of sound enterprise risk management practice, we periodically conduct capital, credit and liquidity stress tests for scenarios such as the operating environment we now find ourselves in. Results from these stress tests help to form our decision-making as we manage through the current crisis and gives us confidence the company will remain well-capitalized and has the necessary liquidity and access to multiple funding sources to meet the challenges of the current economic environment. Now, let's turn to the company's financial results for the third quarter of 2020. GAAP net income available to common shareholders was $58.3 million or $0.74 per share, which is up significantly from $30.7 million or $0.39 per share in the second quarter. Non-GAAP pre-tax pre-provision earnings increased $8.1 million to $78.6 million, from $70.4 million in the second quarter. Please note that the third quarter reported GAAP and non-GAAP financial results include expenses of approximately $2.6 million related to strategic actions taken to reduce the company's expense run rate in light of the current and expected operating and interest rate environment, including the consolidation of 14 branches in September. These actions are expected to reduce the company's quarterly expense rate by approximately $1.1 million beginning in the fourth quarter. Turning to credit loss reserves, as of the end of the third quarter, the total allowance for credit losses was $186.1 million which was comprised of the allowance for loan and lease losses of $174.1 million and the reserve for unfunded commitments of $12 million. In the third quarter, the total allowance for credit losses increased $5.1 million, primarily due to the continued economic uncertainty related to COVID-19. The allowance for loan and lease losses as a percentage of the total loan portfolio was 1.19% at September 30, which was up 2 basis points from 1.17% at the end of the second quarter, and the total allowance for credit losses as a percentage of total loans was 1.29% at the end of September, up from 1.26% in the prior quarter. If you exclude SBA-guaranteed PPP loans, the allowance for loan and lease losses as a percentage of adjusted loans increased 2 basis points to 1.36% from the second quarter and the total allowance for credit losses as a percentage of adjusted loans increased 4 basis points to 1.46% from the prior quarter. The coverage ratio of the allowance for loan and lease losses to nonaccrual loans was above 4.5 times at September 30, compared to 4.3 times at June 30. The $5.1 million increase to the company's total allowance for credit losses took into consideration the COVID-19 pandemic impact on credit losses, both through the two-year reasonable and supportable macroeconomic forecast utilized in the company's quantitative CECL model and through management's qualitative adjustments. Beyond the two-year reasonable and supportable forecast period, the CECL quantitative model estimates expect the credit losses using a reversion to the mean of the company's historical loss rates on a straight-line basis over two years. In estimating expected credit losses within the loan portfolio at quarter end, the company utilized Moody's September baseline macroeconomic forecast for the two-year reasonable and supportable forecast period. Moody's September economic forecast improved since June, and it is now assumed that on a national level GDP spikes up approximately 27% in Q3 and then averages between 3% and 4% over the forecast period. Moody's September forecast for Virginia, which covers the majority of our footprint, had previously assumed that the unemployment rate in the state would remain at about 7% through the forecast period, but that has been revised to trend down to 5% in the third quarter of 2022. In addition to the quantitative modeling, the Company also made qualitative adjustments for certain industries viewed as being highly impacted by COVID-19, as discussed by John earlier. Additional qualitative factors were added this quarter to take into consideration the uncertainties pertaining to the future path of the virus and additional government stimulus. Provision for total credit losses for the third quarter was $6.6 million, a decline of $27.6 million compared to the prior quarter. The provision for total credit losses in the third quarter consisted of $5.6 million in the provision for loan losses, which is 17 basis points of average loans excluding PPP loans on an annualized basis, down from 102 basis points in the second quarter. It also included $1 million in provision for unfunded commitments during the quarter. Net charge-offs during the third quarter came in at $1.4 million or 4 basis points of total average loans on an annualized basis, which compares to $3.3 million, or 9 basis points for the prior quarter, and $7.7 million or 25 basis points for the third quarter of last year. As in previous quarters, the majority of net charge-offs, approximately 80% in Q3, came from non-relationship third-party consumer loans, which are in run-off mode. Now, turning to the pre-tax pre-provision components of the income statement for the third quarter. Tax equivalent net interest income was $143 million, which was up slightly from the second quarter. Net accretion of purchase accounting adjustments added 8 basis points to the net interest margin in the third quarter, down 6 basis points from a 14 basis point impact in the second quarter, primarily due to lower levels of loan-related accretion income of $2.6 million. The third quarter's tax equivalent net interest margin was 3.14%, which was a decline of 15 basis points from the previous quarter. This 15 basis point decline in the tax equivalent net interest margin in the third quarter was principally due to a 31 basis point decline in the yield on earning assets, which was partially offset by a 16 basis point decline in the cost of funds. The quarter-to-quarter earning asset yield decline was driven by the 29 basis point decline in the loan portfolio yield, as well as the impact of lower yields on securities of 38 basis points. The loan portfolio yield declined to 3.84% from 4.13% in the second quarter and was primarily driven by lower average core loan yields of 21 basis points, resulting from declines in market interest rates during the quarter, most notably, the decline in average one month LIBOR rate, which was lowered by 19 basis points from the second quarter average of 35 basis points. In addition, lower loan accretion income adjusted loan yields by approximately 8 basis points from the prior quarter. Reduction in the securities portfolio yield to 2.19% from 3.29% was a result of the deployment of excess liquidity during the quarter into new investments at yields lower than the existing portfolio yield. Additionally, higher yielding securities are paying down and the proceeds are being reinvested at today's market interest rates. The quarterly 16 basis point decline in the cost of funds to 45 basis points was primarily driven by a 40 basis point decline in the cost of deposits to 39 basis points. Interest-bearing deposit cost declined by 18 basis points from the second quarter to 55 basis points in the third quarter, due to the aggressive repricing of deposits as market interest rates declined. Also contributing to the quarter's lower cost of funds was a 20 basis point decline in wholesale borrowing cost and the positive impact from changes in the overall funding mix between quarters. Non-interest income declined $1.5 million to $34.4 million from the prior quarter. Adjusted for the securities gain of $10.3 million recorded in the second quarter, non-interest income increased $8.8 million, driven by an increase in mortgage banking income of $3.1 million due to higher mortgage loan origination volumes, resulting from the current low interest rate environment. In addition, customer-related fee income increased by $2.2 million due to higher overdraft fees, higher interchange income and fiduciary and asset management fees in the third quarter. During the quarter, the company also recaptured approximately $1.7 million of the $2.5 million in COVID-19 driven unrealized SBIC fund investment losses recorded in the second quarter and bank-owned life insurance income increased $1.4 million primarily due to a death benefit proceeds received in the quarter. Partially offsetting these increases was a decline of $2.3 million in loan related interest rate swap income, which was due to lower transaction volumes in the quarter. Non-interest expense decreased $9.6 million to $93.2 million from the prior quarter, primarily driven by the $10.3 million loss on debt extinguishment resulting from the prepayment of long-term Federal Home Loan Bank advances recorded in the second quarter. Total non-interest expense in the third quarter included $2.6 million in costs related to the company's expense reduction actions, including the closure of 14 branches in September, and also included approximately $639,000 in costs related to the company's COVID-19 response and an increase in marketing expenses related to donations that the company made in support of organizations that fight for racial equality and contribute to change in our communities. In addition, PPP-related deferred loan origination costs declined by approximately $2.9 million from the second quarter and that was due to the non-recurring impact of PPP loans originated during the second quarter. Partially offsetting these expense items was the decline in the FDIC assessments of approximately $1.1 million due to the positive impact of PPP loans on the company's assessment rate. Effective tax rate for the third quarter increased slightly to 50.3% from 50.2% in the second quarter. For the full year, we still expect the effective tax rate to be in the 15.5% to 16% range. Now, turning to the balance sheet. Period end total assets stood at $90.9 billion at September 30, which was an increase of $178 million from June 30 levels, primarily due to an increase in the company's securities portfolio, partially offset by a reduction in cash balances. At quarter end, loans held for investment were $40.4 billion, an increase of $75 million or approximately 2% annualized from the prior quarter. The overall loan growth in the third quarter was driven by increases in commercial loans of $123 million, or 4% on an annualized basis, which was partially offset by reductions in consumer loan balances of $48 million, or 9% on an annualized basis. The commercial loan growth was primarily driven by growth in equipment finance loan and lease balances during the quarter, while the decline in consumer loan balances was driven by continued pay downs in mortgage and HELOC balances and third-party consumer loan balance runoff, which was partially offset by an annualized growth in indirect auto balances of 7.8%. As noted earlier, the average loan portfolio yields were down 29 basis points to 3.84% during the quarter. At the end of September, total deposits stood at $15.6 billion, a slight decline of $29 million or less than 1% from the prior quarter. The decline in deposits in the third quarter was primarily due to lower NOW and CD balances, mostly offset by growth in demand deposits, money market and savings account balances. Low-cost transaction accounts comprised 51% of total deposit balances at the end of the third quarter, which is in line with the 51% at the end of the second quarter. The average cost of deposits declined by 40 basis points to 39 basis points in the third quarter. The company's liquidity position remains strong at both the bank and holding company levels with multiple sources that can be tapped if needed. Today, we have about $189 million from the Federal Reserve's Paycheck Protection Program Liquidity Facility, as PPP loan-related deposits remained at elevated levels at the end of the third quarter. From a shareholder stewardship and capital management perspective, we remain committed to managing our capital resources prudently, as the deployment of capital for the enhancement of long-term shareholder value remains one of our highest priorities. From a capital perspective, the company continues to be well-positioned to manage through the pandemic and its impact on the company's financial results. At the end of the third quarter, Atlantic Union Bankshares and Atlantic Union Bank's capital ratios were well above regulatory well-capitalized levels. During the third quarter of 2020, the company paid a common stock dividend of $0.25 per share and also paid a quarterly dividend of $156.60 on each outstanding share of preferred stock. Now, to summarize, Atlantic Union delivered solid financial results in the third quarter, despite the continuing business disruption associated with COVID-19 and the headwinds of the lower interest rate environment. Our financial performance has benefited from the decisive actions the company has taken to reduce its expense run rate to more closely align with revenue growth pressures, driven by the lower-for-longer interest rate environment, as we strive to maintain top tier financial performance regardless of the operating environment. Finally, please note that while we are proactively managing through this unique and unpredictable pandemic and are taking the proper steps to weather the economic downturn to ensure the safety, soundness and profitability of the company, we also remain focused on leveraging the Atlantic Union franchise to generate sustainable, profitable growth and remain committed to building long-term value for our shareholders. And with that, I'll turn it back over to Bill to open it up for questions.

William Cimino, Investor Relations

Thanks, Rob. Josh, we're ready for our first caller, please.

Operator, Operator

Thank you. Our first question comes from Eugene Koysman with Barclays. You may proceed with your question.

Robert Gorman, Executive Vice President and CFO

Good morning, Eugene.

Eugene Koysman, Analyst

Good morning, thanks for taking my question. The last quarter you said that you expected your core net interest margin excluding accretion to stabilize in the 315 to 320 range. In this quarter, the core net was closer to 306, excluding the accretion. How do we think about the net interest margin and the net interest income trajectory into the fourth quarter, especially as we start seeing PPP forgiveness come off?

Robert Gorman, Executive Vice President and CFO

Thank you, Eugene. This is Rob, I'll take that one. We were guiding toward the 3.15% range for core, and you correctly came in at about 3.06% to 3.07%, depending on how you count the PPP in that calculation. Basically, we saw a lot more excess liquidity and decided in the quarter to put that excess liquidity to work rather than leave cash balances earning only 10 to 12 basis points. So we leveraged up the securities portfolio, accepting a trade-off between the core margin and the net interest income we could derive from that excess liquidity. If you look at page 13 of our presentation, the drivers of change graph shows we had expected earning asset yield compression to be offset by cost of funds declines. That largely played out, except for securities yield, which was a negative impact on the overall margin, including the core margin. Going forward, we expect to stabilize at this lower level. We haven't yet seen the full impact of the securities portfolio leveraging strategy: the average for the quarter for securities was about $1.8 billion, and at quarter end we were at about $1.8 billion; we have about $3.1 billion now. We added about $400 million in the quarter. There were also higher paydowns and prepayments on higher-yielding securities than we had projected, and those proceeds were redeployed into the securities portfolio at lower yields than the existing portfolio. So that's where we stand. We expect some continued earning asset yield compression on a core basis, but we feel good about our ability to mostly cover that with funding cost declines, especially deposit cost declines. We have opportunities there. In particular, we have a CD portfolio with about $1.6 billion of maturing CDs over the next 12 months, roughly $130 million to $140 million per month. The average cost of those CDs is 1.5%, and those will be repriced monthly to the 20 to 25 basis point range. Hopefully that helps.

Eugene Koysman, Analyst

Yes, that's very helpful. Thank you. Now, just to jump on expenses, also the color in your prior guidance, as well. Do you still expect to get to the $80 million quarterly core expense run rate by the end of the year and how do we get there from here? And should we expect the FDIC expenses to stay low and what happens to the corporate expenses, as well?

Robert Gorman, Executive Vice President and CFO

We're pretty much in line with what we have projected. If you back out the one-time costs related to the branch closures and other actions we took this year, and you adjust for COVID and traditional marketing expenses that we talked about from a charitable donation perspective, we get to about an $89 million or so run rate. The branch closure's impact, which is about $1.1 million on a quarterly basis hasn't really occurred prior to the fourth quarter. That will take effect in the fourth quarter. So, we are still feeling good about the $88 million on a core run rate basis.

Eugene Koysman, Analyst

Got it. Thank you. Appreciate that. Just a little follow-up, of the $2.6 million one-time charges related to branch closures, how much was in the compensation versus other expenses?

Robert Gorman, Executive Vice President and CFO

Yes, actually in the salaries line, we had accrued about $1.8 million of severance. In fact, we were able to redeploy many of the positions coming out of the branches into open positions elsewhere, so severance declined about $400,000 this quarter. So that was a positive in the salary and benefits line. The remainder is in other expenses related to lease terminations, and other write-offs. So think about it as about $1.8 million in salaries and benefits originally, offset by redeployments, and the balance in other expenses related to lease and contract termination costs.

Eugene Koysman, Analyst

Thank you. Appreciate that color.

Robert Gorman, Executive Vice President and CFO

Thank you, Gene. And, Josh, we're ready for our next caller, please.

Operator, Operator

Thank you. Our next question comes from Casey Whitman with Piper Sandler. You may proceed with your question.

Robert Gorman, Executive Vice President and CFO

Hi, Casey.

Casey Whitman, Analyst

Hey, good morning. Just a quick follow-up on Eugene's question about the FDIC assessment charge, just to make sure we're understanding correctly. I mean, should that go back up when the PPP is forgiven, or am I thinking about that wrong?

John Asbury, President and CEO

It should not go up actually. Related to that, when we were doing our projection for the FDIC assessment, we included PPP loans as deposits from a liquidity perspective, and the FDIC came out with guidance, and so we should treat those as cash which affected the assessments. Part of that $1.1 million adjustment was reducing the previous accrual in the second quarter and then picking up about $400,000 or $500,000 with the new assessment. That should continue to be lower in terms of the assessment; it wasn't an increase. We should see about half of that be added back in the fourth quarter, so it's a benefit, but not the full $1.1 million benefit. As that comes down, our assessment will recalculate prior PPP levels which were lower.

Casey Whitman, Analyst

Okay, thank you. And then maybe another question on PPP, can you give us what the margin impact was this quarter from it, and then maybe the dollar amount you guys reported?

Douglas Woolley, Chief Credit Officer

For PPP, yes. It was actually a net benefit to us this quarter. In total, it was about $40 million of PPP related balances that impacted the quarter. About $9.8 million related to the amortization of deferred fees that we recognized. And then there was about $4 million related to the 1% fee income that we earned on origination.

Casey Whitman, Analyst

Okay, perfect. Thank you. Just one last one from me. Sorry if you gave this earlier, but can you give us an update on where criticized and classified loans were this quarter versus last quarter? And maybe just help us out, if you saw any negative migration there, in particular, within some of the at-risk segments?

John Asbury, President and CEO

If you look at the classified categories, we basically didn't move much at all. We did have some migration into what we call the watch category this quarter related to hotels as we evaluate the credit component of our portfolio there. That's being evaluated. We expect that some migrated to what we call a watch rating from the prior levels and some could migrate back once conditions improve. We took a really close look this quarter at each of those properties. So from a real classified perspective, not much has changed. But if you consider watch categories, that did increase, largely because hotels were moved into more closely monitored categories.

Douglas Woolley, Chief Credit Officer

Rob explained it spot on with some categories on watch that we're looking at. Our reserve reflects the potential for loss coming up. We don't have any meaningful incidence of known problems and we have downgraded loans to watch so that we pay more attention to them according to our credit risk management protocols, so we're comfortable with where we are, but we certainly expect deterioration at some point in some categories or some borrowers.

Casey Whitman, Analyst

Understood. Thank you, guys and good quarter.

Robert Gorman, Executive Vice President and CFO

Thanks, Casey. Josh, we're ready for our next caller, please.

Operator, Operator

Thank you. Our next question comes from Catherine Mealor with KBW. You may proceed with your question.

Robert Gorman, Executive Vice President and CFO

Good morning, Catherine.

Catherine Mealor, Analyst

Thanks, good morning. Just a follow-up on the margin. Can you give us some color around core loan yields and where new and renewed loan yields are coming on right now and how much downside you see similar pressures next year? Thanks.

John Asbury, President and CEO

As you can imagine, core loan yields are coming down in the commercial book. We're seeing average commercial yields move down; the total commercial book yield was around the mid-3% range and declined modestly quarter-to-quarter, primarily driven by LIBOR coming down and repricing. Based on where we look, you may see a bit more pressure on fixed-rate loans as they reprice or renew at lower levels. We feel that most of the LIBOR-based or variable rate component will stabilize from this level; LIBOR appears near its bottom around 15 to 16 basis points. We did see approx a 19 basis point decline quarter-to-quarter from LIBOR.

Robert Gorman, Executive Vice President and CFO

If you look at slide 13 of the presentation on the right, you can see that 30-day LIBOR averaged 35 basis points in Q2 and averaged 16 basis points in Q3. By the end of Q3 it was down to about 17 basis points and currently around 15, so to John's point LIBOR should be at or near the bottom and we should have felt much of the impact on the portfolio already in terms of down-pricing of existing LIBOR-based credits.

Catherine Mealor, Analyst

Great. Okay, and so then, on the fixed rate side, that's where the pressure is coming moving forward, but would you say even on fixed the new and renewed loan yields are coming in lower relative to the current yield? Maybe more on the fixed rate side.

John Asbury, President and CEO

Yes, the fixed-rate renewals are coming in a bit lower versus the portfolio average as of the end of September. If you look at the mix in total commercial lending, the impact is probably around a 10 basis point headwind on new and renewed fixed-rate loans versus the existing portfolio average, so expect some continued pressure albeit modest.

Catherine Mealor, Analyst

On the securities book, what's your best guess as to where this bottoms, assuming rates kind of stay as they are today as you think about that churn?

John Asbury, President and CEO

We're about 2.91% on the securities portfolio yield currently and we think it could drift down toward the 2.60% range over time as higher coupons pay down and proceeds are reinvested at lower market yields.

Catherine Mealor, Analyst

Thanks. And then, one last one on PPP, just your outlook as you're looking at PPP applications for forgiveness: what's your best guess as to how much you think you'll see this quarter and then into next year?

John Asbury, President and CEO

At the end of this quarter, we've got deferred fees of about $32 million remaining. We think the bulk of those fee recognitions tied to forgiveness will occur starting in the first quarter of next year, though we may see some modest activity this quarter as smaller loans under $50,000 are eligible for the streamlined forgiveness application. So the expectation is more concentrated in early next year rather than Q4.

Robert Gorman, Executive Vice President and CFO

We have begun to invite borrowers under $50,000 to apply for forgiveness. I can tell you we have 177 loans for $378 million that have been approved by us and submitted to the SBA waiting to hear from the SBA. I think we had two approved as of yesterday. We've got about 1,638 invitations that have gone out. We'll work our way through it. We've continued to say to our under $150,000 borrowers that it may be advantageous to wait and see if Congress provides an automatic forgiveness pathway for smaller loans; if someone needs to apply, we'll process it, but this looks more like an early next year event than a large Q4 event.

Catherine Mealor, Analyst

Great, very helpful. Thank you.

John Asbury, President and CEO

Thanks, Catherine. Josh, we're ready for our next caller, please.

Operator, Operator

Thank you. Our next question comes from William Wallace with Raymond James. You may proceed with your question.

Robert Gorman, Executive Vice President and CFO

Good morning, William.

William Wallace, Analyst

Hi. Good morning, guys. Thanks for taking my question. On the expense, John, in your prepared remarks, you made some comments about some ongoing initiatives outside of branch consolidation. Sounds like a lot of technology kind of streamlining and processes, etc. If I look at this $88 million run rate, after the branch consolidation, and I think about additional initiatives and also, as I think about just seasonal increases going into next year, how should I be thinking about the cadence of the expense line with initiatives versus natural pressures that we typically see to expenses?

John Asbury, President and CEO

Let me start and I'll ask Rob to chime in. We're not done with expense reduction initiatives and we believe there are other opportunities to continue to rationalize the branch network, though I wouldn't expect the same magnitude as this round. We've seen strong digital adoption and the branch consolidation was about 10% and we've had almost no complaints. The changes in consumer behavior and our digital capabilities, like Zoom meetings and other pilots, further embolden us to continue to look hard at the branch network. We also have technology initiatives underway that will reduce cost through process improvement. Up and down the line, we're looking at everything. On the other hand, there are investments that need to be made as well. So it's a balancing act. Rob, how would you answer this specifically?

Robert Gorman, Executive Vice President and CFO

Correct. We continue to evaluate opportunities to reduce our run rate and become more efficient and we will continue to do that. Our view is that the $88 million run rate we expect should be able to be improved going into next year, although the magnitude of that absolute reduction needs to consider things like wage inflation and other inflationary pressures. At this point in time, we are driving to at least be flat to that $88 million inclusive of those inflationary adjustments on the expense line by getting other expense savings. We hope that maybe we can improve that even further. But we are evaluating all opportunities to do that.

John Asbury, President and CEO

We have more to say on that as we get through our planning process in the January earnings call.

William Wallace, Analyst

Okay, all right, thank you. And then as a follow-up on the NIM question from earlier. Rob, you were suggesting flattish from the core perspective excluding PPP and accretion noise. Do you think that flat next year is actually achievable? You talked about some pretty significant pressures on the securities portfolio and obviously loans are repricing lower, do you think you have enough on the deposit and funding side to offset those or should we think about maybe there is more downside pressure?

John Asbury, President and CEO

I would suggest there is more downward pressure than opportunity to expand the margin. At this point in time, we feel like there are opportunities on the cost of funds side to offset the majority of any earning asset yield compression from the securities book or the loan portfolio. However, I would suggest that there could be around the edges some further compression. After this quarter's moves, we could be between 3.00% and 3.06% going forward. The big lever we have is on deposit costs: we were 39 basis points during the third quarter; by September levels we were down to 36 basis points, and we've taken actions to reduce costs. We think we can land in the low 20s on deposit cost through various actions, both CD repricing and reducing rates on other deposit categories like money market and NOW accounts.

Robert Gorman, Executive Vice President and CFO

In some of the surge that we've seen in deposit growth we had assumed was a temporary phenomenon. We're beginning to rethink that. It's interesting: about 42% of PPP fundings came out of deposit balances at the bank. That surprises us because you would think those borrowers would have used those funds for eligible expenses. We're not sure that deposit balances will drain as fast as we thought. We continue to see depositor behavior that may allow us to be more aggressive with deposit pricing. We'll continue to test price elasticity of the deposit base and act accordingly.

William Wallace, Analyst

Okay, thanks. And, John, just one last question. If you look across your footprint and the western part of the state versus Northern Virginia, Richmond and Hampton Roads, are you seeing any difference in activity among your borrowing base, whether it's existing customers or a difference in demand within the regions that you operate in in Virginia?

Dave Ring, Head of Commercial Banking

Sure. As you go across regions—Western, Northern, Eastern, and Central—demand is still pretty stable. In Western Virginia, activity is more real estate related so we're a bit more particular in underwriting. In Northern Virginia, we still have strong demand, but utilization of lines of credit has decreased quite a bit. Overall demand is stable, but we are being more particular across the board on the types of assets we're willing to finance and the structures we're willing to approve.

William Wallace, Analyst

What is one market pricing looking like? Are spreads stabilizing?

Dave Ring, Head of Commercial Banking

New, better-credit assets are still commanding tight spreads. On renewals, we've seen renewal spreads stabilize or even tick up a little bit. So overall, spreads have started to stabilize instead of continuing to decline. We feel pretty good about spread stability at least for the next quarter.

William Wallace, Analyst

Thank you. Thank you all.

Robert Gorman, Executive Vice President and CFO

Thanks, Wally. And, Josh, we're ready for our next caller, please.

Operator, Operator

Thank you. Our next question comes from Laurie Hunsicker with Compass Point. You may proceed with your question.

John Asbury, President and CEO

Good morning, Laurie.

Laurie Hunsicker, Analyst

Great. Hi, good morning and thanks for taking my questions. I just wanted to go back. When you were chatting with Catherine about PPP loans, I thought I heard you say there were $32 million in potential fees and I thought that number was closer to $50 million. So just looking for clarification on that.

John Asbury, President and CEO

So, Laurie, that's the current deferred fee balance we've yet to recognize into income; the difference is due to the amount we've already amortized into income. We had about $9.8 million amortized this quarter and about $7.5 million last quarter, so starting from a total origination fee pool closer to $50 million, after amortization the remaining deferred balance is about $32 million.

Laurie Hunsicker, Analyst

Got it. Okay, so then just to clarify, in essence, if all PPP were forgiven right this second, the net gain that would top into net interest income is only a net $32 million remaining, is that correct?

John Asbury, President and CEO

That's correct. If everything were forgiven immediately, the remaining deferred income to recognize would be about $32 million.

Laurie Hunsicker, Analyst

Okay. I just wanted to jump over to credit and appreciate Slide 9. I'm looking at the $676 million of hotels, and maybe this is a question for you, Dave. What is the breakdown between what's C&I and what's CRE? And then can you just remind us on what LTV was for the hotels? I thought it was running around approximately 50%, just didn't know if you had a payout number on that.

John Asbury, President and CEO

Most of the hotel exposure is secured by the real estate itself rather than being booked as C&I. The loan-to-value on the hotel portfolio going in was in the roughly 60% range overall, and the debt service coverage and LTV were better than our other commercial real estate property types going into the crisis. Doug, do you want to add detail on the composition?

Douglas Woolley, Chief Credit Officer

Yes, Laurie, all the hotel loans are secured by the hotels themselves and in most cases are single-asset entities even when sponsored by larger operators. The PPP loans tied to hotels were made to the operators. We don't classify those hotel loans as C&I in the sense of unsecured corporate lending; they are secured by the real estate.

Laurie Hunsicker, Analyst

Perfect. We'll follow up offline on some detailed breakdowns. Also on the restaurant CRE piece, you mentioned $190 million of the $223 million is CRE. What is the LTV running on that?

John Asbury, President and CEO

The restaurant portfolio LTVs vary, but many of them are secured by the property itself and others are partially secured by additional collateral like owner guaranties or second liens. Typical LTVs at origination tend to be in the 60% to 70% range on those real estate-secured restaurant loans, but it does vary by borrower and location.

Laurie Hunsicker, Analyst

Okay, that's helpful. And then how much of your CRE is in office and do you have an LTV on that?

John Asbury, President and CEO

Our office exposure is not large relative to the total CRE portfolio; quarter-end outstanding on office was about $840 million. LTVs are generally no worse than 75% at origination and typically in the 60% to 65% band across our CRE book. We're not originating a lot of new office loans right now.

Laurie Hunsicker, Analyst

And then regarding leveraged loans, I thought those were running around $300 million; do you have a more accurate number and how much of that book is modified?

John Asbury, President and CEO

Our leveraged loan outstandings are about $350 million. There is not meaningful deferral activity in that portfolio; it's been a lower-risk area for us and we haven't seen significant modifications there.

Laurie Hunsicker, Analyst

That's helpful. And on retail, any exposure that's movie-theater anchored within the $546 million retail number?

John Asbury, President and CEO

No, we don't have notable movie theater-anchored exposure. Much of the retail is local convenience stores with gas and auto dealers, which have been relatively resilient.

Laurie Hunsicker, Analyst

One last question, John. You mentioned potentially pursuing consolidation within your footprint in the future. Can you help us think about the size of deals you might consider, timing, and whether you might do something while COVID is still an active issue or wait until after?

John Asbury, President and CEO

Big picture, we see an opportunity set for bank M&A as the industry continues to evolve. We're not actively pursuing near-term deals right now; we think clarity on asset quality will be important and that will take a few quarters. I would view meaningful consolidation opportunities across the industry as more likely in the second half of next year as buyers and sellers have more comfort on asset quality. Strategically we like contiguous, dense, Mid-Atlantic franchises. Financially a deal would have to make perfect sense. We're focused on internal execution and positioning; M&A is in the toolkit but not top of mind right now.

Robert Gorman, Executive Vice President and CFO

Thanks, Laurie. We're going to try to squeeze in one last caller here so Josh we're ready for the last caller.

Operator, Operator

Thank you. The last question comes from Broderick Preston with Stephens. You may proceed with your question.

John Asbury, President and CEO

Hi, Broderick.

Broderick Preston, Analyst

Hey, thanks, guys. I'll be brief. Rob, I just wanted to clarify on the one-time expenses, it seemed a little mixed between the severance and whatnot. I guess I just wanted to get the all-in $2.6 million amount, the $0.639 million for COVID and then was there any additional severance that was in the expense number?

Robert Gorman, Executive Vice President and CFO

No other severance beyond what we discussed is in those numbers. The $2.6 million includes branch closure costs including severance accruals we discussed, and the $639,000 is related to COVID response costs. Those are the main one-time items in the quarter.

Broderick Preston, Analyst

All right. Then you had strong growth in other commercial. I'm assuming that's coming from equipment finance. I wanted to get a sense for what you're seeing for opportunities there and whether there are specific industries you're having greater success in.

Dave Ring, Head of Commercial Banking

If you recall, we started the equipment finance business last December. We have a full team that we brought over and have added employees. We built an internal referral program to drive referrals from the footprint into the equipment finance company so some of the loans that previously might have been term loans are now being booked in equipment finance. The business is also self-sourcing. It's doing about $100 million in outstandings per quarter right now and is performing well. We target asset classes we know in our markets, and we've added a few additional asset classes like transportation and shipping that help us penetrate the market better within our footprint. It's the same types of companies we've always banked, but with more specialized coverage and products.

John Asbury, President and CEO

It filled an important gap in our product set where we weren't competitive, typically versus super-regional or national banks. This gives us an on-balance-sheet way to finance assets like trucks or mixers and compete more effectively. The team timing has been fortunate and they've exceeded expectations.

Broderick Preston, Analyst

That's really great color. Maybe one more. John, you commented about waiting for greater clarity before doing M&A. As reserves peak and deferrals head lower, at what point do you consider putting the pedal back down on growth and accelerating hiring? And longer term, what do you see the organic growth rate of the bank looking like?

John Asbury, President and CEO

We believe the business model should be able to generate sustainable high-single-digit organic growth in a normalized environment. There's significant runway in Virginia alone given market share dynamics relative to larger competitors. Equipment finance is an incremental growth engine as well. We are hiring throughout the year, though the fourth quarter tends to be less attractive for external hires due to compensation timing. We're focused on selectively hiring relationship managers and credit-oriented portfolio managers and have added double-digit hires this year from larger banks that are experiencing disruption. We expect to be opportunistic and accelerate hiring as the environment stabilizes and as we see the opportunity to convert new-to-bank customers into full relationships.

Dave Ring, Head of Commercial Banking

We are hiring all year long. During the course of the year, we've acquired talent from larger institutions and have offers out today. We've added to our government contractor banking team and focused on hiring strong credit-oriented portfolio managers. Overall, we've hired in the double digits during the course of the year from large institutions. We remain attractive to candidates who want to focus on client coverage in our footprint.

Broderick Preston, Analyst

That's great color. I appreciate the time this morning, everyone.

John Asbury, President and CEO

Thanks, Brody.

Robert Gorman, Executive Vice President and CFO

Thanks, Brody.

William Cimino, Investor Relations

Thanks, everyone for joining us today. We appreciate your interest and as a reminder, a replay of the webcast will be available on our website investors.atlanticunionbank.com. Thanks so much and we'll talk to you next quarter. Goodbye.