Atlantic Union Bankshares Corporation (AUB) Q2 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by, and welcome to the second quarter Atlantic Union Bankshares' Conference Call. [Operator Instructions]. I'd now like to hand the conference over to your host today, Mr. Bill Cimino, Investor Relations. Please go ahead, sir.

Thank you, Liz, and good morning, everyone. I have Atlantic Union Bankshares' President and CEO, John Asbury; Executive Vice President and CFO, Rob Gorman; and Chief Credit Officer, Doug Woolley, all with me socially distant 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 and the accompanying slide presentation we are going to run on the webcast are available to download on our investor website, investors.atlanticunionbank.com. During the call today, 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 second quarter 2020 and in the back of the earnings supplemental slides. 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 undertake no obligation to publicly revise any forward-looking statement. Please refer to our earnings release for the second quarter 2020 and our other SEC filings for further discussion of the company's risk factors and important information regarding our forward-looking statements, including factors that could cause actual results to differ. All comments made today during today's call are subject to that safe harbor statement. At the end of the call, we will take questions from the research analyst community. I'll now turn the call over to John Asbury.

Thank you, Bill. Thanks to all for joining us today, and I hope everyone listening is safe and well. Since early March, we have consistently said we are managing through 2 significant and distinct challenges: First, 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. Having said that, so far, so good, and we believe we're managing quite well. Looking ahead, 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, customers, teammates and the communities we serve. We remain keenly focused on reaching the full potential of this powerful franchise despite the present challenges. Now more than ever, we continue to operate under our 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 our company well during the Great Recession, and it will serve us well during the economic challenges brought about by the pandemic. But soundness isn't just about credit, it's also about capital. During the quarter, we issued $166 million in preferred equity, net of issuance costs, which fortified our Tier 1 capital levels and better positions us to ride out the storm. Rob will have more to say about the strength of our capital position in his remarks. Our second priority is profitability, and we've taken action to align our expense run rate to the new revenue reality of the lower rate environment, and we'll also outline that in our commentary. As for growth, well, that will be a conversation for a later quarter. Let me begin by updating you briefly on our pandemic response. On March 16, we pivoted to a new operating model with 90% of non-branch personnel working from home, still are, and having branch lobbies closed except for appointments, and that continues to go smoothly and effectively. I'm proud of our team for having pulled together and worked well throughout this time. The best proof point I can think of is our team's performance with the Paycheck Protection Program. I will take you through all the details on that again, but I will remind you that our teams set up our online application portal and automated workflow system in about 5 days and at peak, we had nearly half the company mobilized on the program because we recognized how important it was for our customers and our communities. We think that PPP has been a brand builder for Atlantic Union and the numbers and our share of loans processed in Virginia support that statement. Speaking of our Paycheck Protection Program performance, here's a look at our numbers through June 30 per SBA data. Atlantic Union Bank generated approximately $1.7 billion in PPP loans that were approved and funded by the SBA, which represents a PPP loan market share of 11.1% in Virginia, which compares favorably to our depository market share of 7%. More than 11,000 total applications were approved and funded. More than 3,000 of the approved loans were made new to bank customers. And when you look at the total PPP loans made in Virginia, we ranked #2, behind Truist, but strikingly, we had only 6 fewer loans than the biggest bank operating in the Commonwealth. Bear in mind, Truist, of course, means 2 banks: SunTrust plus BB&T, and has 25% depository market share in Virginia compared to our 7%, so they're over 3x our size here. In Virginia, we ranked #1 in the number of PPP loans in 22 counties or cities and top 3 in 50 counties or cities. More broadly, we were #1 by this measure in the Richmond Metropolitan Statistical Area. The Charlottesville MSA and impressively, in all of Northern Virginia. We also nearly doubled the amount of approvals since the next closest Virginia headquartered bank. The average approval loan size was $141,000, and the median loan size was $36,000. 82% of our PPP loans by count are under $150,000. And while it's difficult to measure precisely, our analysis indicates that PPP clients still had cash equal to approximately 50% of their PPP funds from Atlantic Union in a deposit account at the bank as of the end of the quarter. Moving beyond the Paycheck Protection Program, not only have we learned to work differently, but our customers have learned to bank differently. Our branch lobbies remain by-appointment only, and we continue to evaluate the right time to fully reopen them. We rolled out a new mobile and online appointment scheduling system for our branches, and that has been well received by our customers. We're currently seeing more than 1,100 appointments scheduled per week through this application. We've seen usage of our digital channels increased substantially from the prior year. For example, mobile users are up 17%. Mobile check deposit utilization is up 58%. Zelle utilization is up 52% since the end of 2019. And online account opening has more than doubled since the first quarter, with an average of 35% of accounts opened online in the second quarter. Our call center volume has decreased from its peak, and it's now about 25% higher than February. The average call time has dropped back to nearly the same level as February. Wait time averages have decreased from 4 to 5 minutes at peak to around 2 minutes, which compares to about a minute before the crisis, yet call center customer satisfaction remains consistently above our previously recorded highs. All the while, 90% of call center personnel work from home. We've begun mass reissuing contactless debit cards to give customers a no-touch form of payment and one that is also more secure against fraud. This will be staggered over the remaining second half of the year. We further improved our online account opening by launching a chat feature, and we improved our alerts to near real-time for better fraud detection and customer experience. We continue to work on new projects and improved the omnichannel customer experience with quarterly releases and upgrades to our product offerings. During the second half of the year, we expect to roll out an online appointment scheduler for our mortgage and wealth management business; enhance the mobile check deposit and bill pay products; allow customers to select the account level rather than customer level, which should improve e-statement penetration and reduce our expenses; improve the online platform for small businesses and build a small business account opening product for the web; kick off a new project to improve the wealth-client relationship management platform; and roll out our new credit monitoring tool, Credit Savvy, for our customers. Now importantly, turning to credit. For most of our customers, the storm is still here, but it is abating to some degree. We feel confident about weathering the storm. We don't have outsized exposure to the industries most directly impacted by social distancing measures put in place, such as hotels, restaurants and retail. Let me speak to the steps we've taken to solidify our credit position. Our goal is to help as many of our clients through this time as possible, while at the same time, mitigating our risk of loss. We've reached out proactively to our business customers to assess the COVID-19 impact on them and implemented payment modifications where appropriate. While these conversations are continuous, we did complete our latest client survey last week. As for payment deferrals, in the last part of the second quarter and in the first 2 weeks of July, we had a number of loans roll-off of their modifications. The total modification balances as of Friday, July 17, were approximately 3,500 loans under modification with a balance of $1.6 billion or 11% of our total portfolio. If you exclude the PPP loans, it would be about 12% of our total portfolio. This is down from $1.9 billion in 4,000 loans as of April 24, which was then approximately 15% of the portfolio under deferral. The modifications, however, peaked in May at around 17%. Most modifications were originally granted in April, not March, so we're still in the middle of processing the first round of 90-day modifications. As a reminder, we placed most hotel loans, not all, but most, on 180-day deferrals. So far, of all of the loans with an initial modification, only 11 commercial loans with a balance of $5 million have gone under a second modification with about $350 million of loans becoming current and making the next payment. We do have approximately $130 million of loans that could go under another modification as they are in the middle of their July billing cycle and we're discussing the need, if any, with the borrower for a second modification. The modifications run a range of options and are tailored for each borrower. The majority of them, though, about 80 -- pardon me, about 78% are principal and interest deferrals, mostly for 90 days, with a total balance of $1.2 billion as of last Friday, and that's about 9.5% of the total loan portfolio after adjusting out the PPP loans. As the quarter ended, commercial line utilization decreased from 40% to 27%, a historic low for the company. Line paydowns accelerated in June, which caused loans for the quarter outside of PPP to decrease by about 2%, which brought year-to-date loan growth to 1.6%, excluding PPP. It's still too early to project what loan and deposits will be for 2020, at the end of year, until we get more clarity on the macroeconomic conditions for the second half of the year. Our exposures to the most in-focus industries are limited and are outlined on Slides 9 and 10 of our accompanying presentation. The amount of loans under a modification in these segments decreased from 755 loans for $914 million on April 24, to 577 loans for $706 million as of July 17. As a reminder, our hotel portfolio is entirely within our footprint and comprises $680 million, or about 5% of our total loan portfolio. And it consists primarily of limited service, non-resort hotels flagged by name brand that don't rely on conventions and conferences. The hotel's portfolio of debt service coverage ratio and the loan-to-value is the best among any of our commercial real estate property types. Going into the crisis, portfolio of debt service coverage was 1.9x, and the median loan-to-value was 60%, providing a good equity buffer to ride out this shot and accommodate deferred payments. During the recent survey, we've seen that occupancy rates are climbing across the footprint and with about half of our hotel operators expecting more normalized operations before the end of the year. Our restaurant balance is $229 million, or less than 2% of total loans. It's granular. And it's 85% secured by real estate collateral, 25% of them are under the PPP. Restaurants in Virginia have been open for indoor and outdoor dining since early June at 50% occupancy, a cap that was released on July 1. The primary constraints on restaurants today in Virginia are social distancing requirements, closed bar seating and, of course, customer demand. Our retail trade exposure is less than 4% of total loan exposure. About half of this is to local convenience stores with gas and to auto dealers. And 80% of the retail trade exposure is secured by real estate collateral with 20% in PPP. Regarding senior living facilities, we financed independent living, assisted living and continuing care communities. These represent $285 million and 2% of the total loan portfolio. They're managed by good operators with established track records. Our health care segment is also granular, heavily secured by real estate, and they've been opened with social distancing and PPE rules since May. 26% of health care clients are in the PPP. 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 $81 million, and it continues to run off. Payment deferrals in the lending club portfolio declined by 55% to less than $5 million during the quarter. And those accounts went off of modification and became current. Our quarterly financial metrics were impacted by the elevated provision for credit losses due to the continuing weak economic outlook related to COVID-19, and Rob will walk you through all those details. Overall, we continue to proactively work through this event with our clients, while mitigating credit risk wherever we can. We think that the Paycheck Protection Program was a great benefit to the businesses during the lockdown and has helped to bridge them while the economy slowly reopens. Since the vast majority of our exposure is here in Virginia, we're grateful to the Virginia state government that they chose a responsible and relatively conservative approach to reopening despite of having received some criticism for having not taken a more aggressive approach. The benefit of the strategy is that, so far, Virginia has been described by some observers as relatively successful in flattening the curve on COVID-19, and we sure hope it continues to be that way. Moving on to our expense reduction actions. I've told our team that the current normal is not the new normal. However, we think the next normal, post COVID-19, will be different still, and we must adjust now for that coming reality and not wait for it to arrive. In March, we developed and started executing on initiatives to reduce the company's expense run rate to match lower revenue expectations due to COVID-19 and the lower-for-longer interest rate environment. These expense reduction efforts include the consolidation of 14 branches, and that's about 10% of our branch network that we expect to close in mid-September. In addition to moving some projects to next year and eliminating others, we put a hiring freeze in place in March, which has reduced the FTEs by 38 since the end of the first quarter. In addition, we eliminated a number of positions in June, and including branch consolidation personnel, we will reduce total headcount by 6.2% 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 other cost reduction initiatives, such as tighter management to reduce overtime, contract labor and outside consultant spending, requesting pricing concessions from third-party vendors, and renegotiating contracts to include leases. We're improving teammate productivity through process reengineering and robotic process automation. These expense reduction actions will reduce the company's expense run rate by approximately $6 million versus the first quarter run rate and $24 million on an annualized basis. Our goal remains to achieve and maintain top-tier financial performance regardless of the operating environment. Our full year 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 recession in our markets. We continue to face great uncertainty at this point, mostly the duration of COVID-19, but we believe we are in a swoosh-shaped recession. Think of the Nike logo. And expect recovery before the year is out. We do believe we've hit the bottom of the swoosh and are in an upward swing, but we don't expect the upward curve to be smooth. There'll probably be some dips along the way, but we do believe the overall trend should be upward. At this time, we simply don't know, but the signs are pointing toward a stronger economic performance in our footprint is what is seen overall on the national economic model projections. The economy in our footprint is faring relatively better than most other areas of the country as we would expect. So far, unemployment in Virginia peaked at 11.1% in April. That was an all-time high, dropped to 9.4% in May and continued down to 8.4% in June. The Virginia economy is fairly unique with a broadly diverse set of regional economies and with about 20% of it anchored in some fashion by the federal government. The federal government spending in Virginia is mainly for government agencies and Department of Defense with only a small fraction going towards income assistance programs, education and transportation. Clearly, we've had a sea change in the economy brought on by the pandemic, resulting in a systemic downturn that we think we're slowly climbing out of now. Credit losses were minimal during Q2, but of course, the real impact is yet to be seen. We expect Q3 to be a transitional quarter in credit losses, whatever they may be, begin to materialize, rise in Q4 and spill over into the early quarters of 2021. We expect to return to more normalized levels of credit losses after the impact of the pandemic works its way through the economy, hopefully, sooner versus later in 2021. Having said all of the above, we see nothing at this time that causes us to think we are anything but well-positioned and readily able to absorb the delayed impact of COVID-19 on credit losses at Atlantic Union. Moving away from the quarterly results. We continue to work towards the objectives of a 3-year strategic plan, which we believe will create a company with differentiated performance, but the path to finish the work on this plan will take longer than we had expected. Also, recent expense reduction actions aside will continue to work on ways to make the company more efficient, more scalable, while improving the customer experience. As you can tell from my earlier remarks about upcoming projects, we're not standing by, waiting for things to happen. We continue to push the organization forward. Looking down the road toward other strategic opportunities, it should be clear from my comments that we're busy. We're focused on credit risk mitigation, incident response and aligning our expenses for the new reality. As I said last quarter, for now, we will do what we need to do to fight another day. I continue to believe we'll emerge from this crisis stronger, better, more efficient than we were before. We're making the tough choices we need to make, and we're demonstrating not only that the company is resilient, but that it has also become more agile and innovative in response to a most unexpected operating environment. If there is such a thing as a silver lining to COVID-19, this is it. To that point, we don't want to go back to the way things were, but rather we want to leverage these learnings and capabilities and grain our new found agility and innovation into the company's culture from now on. This bodes well for our future. In summary, I believe in chaos lies opportunity. We remain focused on weathering the storm, taking care of our teammates and customers and protecting this bank. We've taken actions to reduce the expense structure to match the lower-for-longer rate environment and maintain top-tier financial performance. We'll continue to work on our strategic plan, but we'll shift our time lines as needed to adjust to the new reality. I am incredibly proud of our teammates and all they've done and their 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. And I will end by saying one thing, COVID-19 has not changed business. Atlantic Union Bankshares is a uniquely valuable franchise, dense and compact in great markets with a story unlike any other in our region. Now more than ever before, I believe 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 Chief Financial Officer, Rob Gorman, to cover the financial results for the quarter. Rob?

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 second 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, made even stronger through the issuance of preferred stock during the quarter, which will allow us to weather the current storm and come out stronger once the crisis has passed. During the quarter, the company also added to its loan loss reserve to cover additional expected credit losses as a result of further deterioration in the economic outlook related to COVID-19 since the first quarter. As John noted, we also took action to reduce the company's expense rate, including the decision to consolidate 14 branches in September, to more closely align expenses with declining revenue levels resulting from the protracted lower-for-longer interest rate environment. As a matter of some 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 inform 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 COVID-19. Now let's turn to the company's financial results for the second quarter of 2020. GAAP net income for the second quarter was $30.7 million or $0.39 per share, up significantly from $7.1 million or $0.09 per share in the first quarter. Non-GAAP pretax pre-provision operating earnings increased $2.2 million to $70.4 million or $0.89 per share, up from $68.3 million or $0.86 per share in the first quarter. Please note that the second quarter reported GAAP financial results and non-GAAP pretax pre-provision operating earnings include the following financial impacts of the strategic actions taken in the second quarter to reposition the balance sheet and to reduce the company's expense run rate in light of the current and expected operating and interest rate environment. The company repaid $200 million in long-term Federal Home Loan Bank advances, which resulted in a debt extinguishment loss of approximately $10.3 million recorded in noninterest expense. By repaying these high-cost fixed rate advances, we are able to improve the go-forward net interest margin by approximately 3 basis points and increased annual earnings by $3.2 million or about $0.04 per share. In addition, the company sold approximately $77 million of securities and recorded a gain on the sale of investments of approximately $10.3 million during the quarter. Second quarter noninterest expenses also includes $1.8 million in severance expense and $1.6 million in real estate-related write-downs related to the company's expense reduction initiatives, including the elimination of several positions across the bank and the consolidation of 14 branches expected to occur in September. Of the $24 million in annualized savings, John mentioned earlier, the action taken in the second quarter to reduce headcount, including the impact of the company's hiring freeze and to further rationalize our branch network will result in an annual run rate savings of approximately $12 million or about -- about half of which will be realized in the third quarter. Slide 13, turning to the credit loss reserves. At the end of the second quarter, the allowance for credit losses was $181 million, comprised of the allowance for loan and lease losses of $170 million and the reserve for unfunded commitments of $11 million. In the second quarter, the allowance for credit losses increased $31 million as the allowance for loan and lease losses increased by $29 million, and the reserve for unfunded commitments increased $2 million from the first quarter, primarily due to the worsening economic forecast related to COVID-19 since March. Excluding PPP loans, which are SBA guaranteed, the allowance for loan and lease losses as a percentage of adjusted loans increased 24 basis points to 1.34% from the prior quarter and the allowance for credit losses as a percentage of adjusted loans increased 24 basis points to 1.42% from the prior quarter. The coverage ratio of the allowance for loan and lease losses to nonaccrual loans was now at 429%. And compared to 320% at March 31. The 1.34% allowance for loan and lease losses represents approximately 70% of Atlantic Union's peak 2-year loss rates in the Great Recession and approximately 75% of the projected 9-quarter losses in the company's most recent internal stress testing scenarios. The $31 million increase to the company's allowance for the credit losses took into consideration the COVID-19 pandemic impact on credit losses both through the 2-year reasonable and supportable macroeconomic forecast utilized in the company's quantitative CECL model and through management's qualitative adjustments. Beyond the 2-year reasonable and supportable forecast period, the CECL quantitative model estimates expected credit losses using a reversion to the mean of the company's historical loss rates on a straight-line basis over 2 years. And estimating expected credit losses within its loan portfolio at quarter end, the company utilized Moody's June baseline macroeconomic forecast for the 2-year reasonable and supportable forecast period. Moody's June economic forecast worsened considerably since March and now, assumes that on a national level, GDP will decline by 33% versus 18% in the March forecast in the second quarter and that the national unemployment rate would peak at approximately 14% versus 9% in March in the second quarter. Moody's June forecast for Virginia, which covers the majority of our footprint, assumed a peak unemployment rate in the state of about 10.4% versus 6.5% in March in the second quarter and remaining at about 7% versus 5% in the March forecast throughout the forecast period. In addition to the quantitative modeling, the company also made qualitative adjustments for certain industries, U.S. being highly impacted by COVID-19 as discussed by John earlier. The qualitative factors also consider the potential favorable impact on estimated credit losses of the massive U.S. government stimulus support funding, including the Small Business Paycheck Protection Program. The provision for credit losses for the second quarter was $34.2 million, which is a decline of $26 million compared to the prior quarter. The provision for credit losses in the second quarter consisted of $32 million in the provision for loan losses, which was 1.02% of average loans, excluding PPP loans on an annualized basis, down from 1.8% in the first quarter. It also included $2 million in the provision for unfunded commitments. In the second quarter, net charge-offs were $3.3 million or 9 basis points of total average loans on an annualized basis compared to $5 million or 16 basis points for the prior quarter and $4.3 million or 14 basis points for the second quarter last year. Excluding the impact of PPP loans, net charge-offs were 10 basis points on an annualized basis. As in previous quarters, a significant amount of net charge-offs, approximately 57%, came from nonrelationship third-party consumer loans, which are in run-off move. Now turning to the pretax pre-provision components of the income statement from the second quarter, tax equivalent net interest income was $140.1 million, which was up from $137.8 million in the first quarter. Net accretion of purchase accounting adjustments added 14 basis points to the net interest margin in the second quarter, which was down 10 basis points from the 24 basis point impact in the first quarter, primarily due to lower levels of loan-related accretion income. The second quarter's tax equivalent net interest margin was 3.29%, which was a decrease of 27 basis points from the prior quarter. The 27 basis point decline from the prior quarter was principally due to the 60 basis point decline in the yield on earning assets, partially offset by a 33 basis point decline in the cost of funds. Quarter-to-quarter earning asset yield decline was primarily driven by the 70 basis point decline in loan portfolio yields as well as the impact of excess liquidity held in low-yielding cash equivalents. The decline in the loan portfolio yield from 4.83% to 4.13% was driven by lower average core loan yields of 53 basis points, resulting from declines in market interest rates during the quarter, most notably, the significant declines in the average 1-month LIBOR rate, which was down 106 basis points and the average prime rate, which was lower by 117 basis points. Loan yields were down an additional 6 basis points due to the net impact of lower yielding PPP loans, which was partially offset by the net increase in loan yield -- loan fees. In addition, loan accretion income reduced loan yields by 11 basis points from the prior quarter. The quarterly 33 basis point decrease in the cost of funds to 61 basis points was driven by 33 basis point decline in the cost of deposits down to 53 basis points. Interest-bearing deposit costs decreased 37 basis points from the prior quarter to 73 basis points due to the aggressive repricing of deposits as market interest rates declined. Also contributing to the first quarter's lower cost of funds was 48 basis point decline in wholesale borrowing costs and the positive impact from changes in the overall funding mix between quarters. Noninterest income increased $7 million to $35.9 million in the prior quarter, primarily driven by the $10.3 million gain on the sale of investment securities recorded during the quarter and an increase of $1.5 million in loan-related interest rate swap income. In addition, mortgage banking income was higher by $3.8 million, primarily due to increased mortgage loan refinance volumes due to the current low interest rate environment. Partially offsetting these increases was a decline in service charges on deposit accounts of $2.6 million, primarily due to lower overdraft incidence volumes, $2.5 million in unrealized losses related to FDIC fund investments due to the current economic environment related to COVID-19 as well as a decline of approximately $500,000 in wealth management fees from the prior quarter. Noninterest expense increased $7.2 to $102.8 million from $95.6 million in the first quarter, primarily driven by the $10.3 million loss on debt extinguishment resulting from the prepayment of long-term FHLB advances. The quarterly increase also includes $3.4 million in severance expense and real estate-related write-downs related to the company's expense reduction initiatives as well as approximately $620,000 in COVID-19 response expenses, which is up from $379,000 spent in the first quarter. The increase was partially offset by declines in most expense categories, including lower marketing expenses of approximately $700,000 and lower business travel-related costs of approximately $700,000. Please note, we expect to incur an additional $3.2 million in branch closure costs, primarily related to lease terminations in the third quarter. The effective tax rate for the first quarter increased to 15.2% from 12.2% in the first quarter, primarily due to excess tax benefits related to share-based compensation recorded in the first quarter. For the full year, we now 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 $19.8 billion at June 30, an increase of $2 billion from March 31, primarily due to PPP loan balances and the buildup of excess liquidity. The quarter end loans held for investments were $14.3 billion, which was an increase of $1.5 billion or approximately 48% annualized from the prior quarter. Overall loan growth in the second quarter was driven by PPP loans of $1.6 billion. Excluding the impact of PPP loans, loan balances actually declined by approximately 2 basis points on an annualized basis in the second quarter as consumer loans declined approximately 10% annualized during the quarter, driven by mortgage and HELOC balance declines and third-party consumer balance runoff partially offset by growth in our indirect auto portfolio. Commercial loans, excluding PPP loans, were relatively flat to the first quarter balances, primarily due to revolving line of credit paydowns, offset by growth in equipment finance and commercial real estate loans during the quarter. As noted, the average loan portfolio yield dropped 70 basis points to 4.13% in the quarter. At the end of June, total deposits stood at $15.6 billion, an increase of $2.1 billion or approximately 60% from the prior quarter. The increase in deposits in the second quarter was primarily due to the impact of government stimulus programs, including the Paycheck Protection Program, economic stimulus checks and enhanced unemployment benefits, the deferral of tax payment deadlines, and changes in customer spending and saving habits in response to the pandemic. As a result, transaction account demand, which are demand deposits and NOW accounts, balances grew significantly during the quarter, partially offset by declines in our retail time deposit balances. Low-cost transaction accounts comprised 51% of total deposit balances at the end of the second quarter, up from 46% at March 31. The average cost of deposits declined by 33 basis points to 53 basis points in the second quarter as previously discussed. Turning to liquidity. We continue to feel good about our liquidity position at the bank and holding company level with multiple sources that can be tapped if needed. To date, we have only borrowed $190 million from the Federal Reserve's Paycheck Protection Program liquidity facility that the PP loan-related deposits remain at elevated levels as of June 30. 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 is well-positioned to manage through the COVID-19 pandemic and its impact on the company's financial results. At the end of the second quarter, Atlantic Union Bankshares and Atlantic Union Bank's regulatory capital ratios were above regulatory well capital levels. In June, the company opportunistically raised $166.4 million in additional Tier 1 capital through the issuance of preferred stock. The goal of the transaction was to rebalance and diversify the company's Tier 1 capital stack, while opportunistically fortifying the company's capital base for the uncertainties of COVID-19. During the second quarter of 2020, the company paid a common dividend -- common stock dividend of $0.25 per share. Regarding the common stock dividend, the company has no current intention of reducing it at this time. But management and the Board of Directors will continue to monitor the business environment and would be prudent in managing capital levels going forward. So in summary, Atlantic Union again delivered solid pretax pre-provision financial results in the second quarter despite the continuing business disruption associated with the COVID-19 pandemic and the headwinds of the lower interest rate environment. The company took significant actions to reduce its expense run rate to align with 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 first 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.

Thank you, Rob. And Liz, we are waiting for our first caller, please.

[Operator Instructions]. Our first question comes from William Wallace with Raymond James.

Hello?

This question will come from Eugene Koysman with Barclays.

Liz, are you there?

Yes, Mr. Koysman, your line is open.

Can you hear me? So I had a question on net interest margin. It looked like core net interest margin ex-accretion was closer to about 3.50% in this quarter, which was actually at the bottom of the range that -- the 3.15%, 3.20% range that you expected to get over the next several quarters. Can you help us gauge how much more downward repricing pressure you expect to see on the core NIM going forward? And what's the trajectory from here?

Yes. Thank you for that question, Eugene. We expect to pretty much stabilize at this 3.15% to 3.20% core margin level. As mentioned, we did have some pressure from excess liquidity, which we expect will dissipate over the next couple of quarters, which should help us. We've also done some additional balance sheet restructuring, as I mentioned, which will improve margin a bit going forward. We do expect to have some continuing challenges with our loan yields. As you know, LIBOR came down over 100 basis points during the quarter to, on average, 35 basis points, and that declined to less than 20 now. So we'll see some pressure in some of that repricing. But overall, we also have opportunities. We continue to be aggressive on price -- down pricing our deposit base. We took some more actions in the last week or two and expect that to come down as well. So all in all, we do expect -- I don't think our guidance has changed materially from the 3.15% to 3.20% on a core basis going forward.

That's actually really helpful. And I actually have another question on expenses, if I may. So when I look at the second quarter core expense run rate, I get to about $89 million, excluding the impact of severance, real estate charges and debt extinguishment cost, which is already about $6 million below the first quarter run rate of $95 million. Are there any moving parts there? I know that your advertising expenses are lower. Can you help us reconcile that with your comment that you expect to realize about half the saves just through the third quarter?

Yes. So yes, you're right, Eugene, it's about, call it, $89-or-so million on a run rate basis when you exclude the 1x. We do expect that -- we had -- some additional expenses will climb back. As you know, we did have some -- related to PPP loans, we had some additional [indiscernible] deferred costs that shouldn't recur. So that add back a bit to that run rate. We also have, as John mentioned, some investments we're making in contactless cards as well as we've got some costs related to -- as we go into the forgiveness phase of PPP, we are outsourcing some of that processing to the SBA that will add expenses. So all in all, we do expect that it's a bit higher than what we're showing here in the third and fourth quarters, but then you back out the cost saves, and we're probably in the $88 million or so range coming out of the third and fourth quarters is the way we're looking at it.

Our next question comes from Catherine Mealor with KBW.

Just a clarification on the expense question. So you're saying you get to the third and fourth quarter and you're at about $88 million. And at that point that -- is that only about half of the savings are realized? Or does that include the -- that doesn't include full realization of savings, right?

No. Well, there's a bit -- yes, the branch-- what's not included in the third quarter is the branch closures. We'll pick that up in the fourth -- starting the fourth quarter once the branches closed. So pretty much will be at that level going into the fourth quarter. We have already achieved some of those savings, as Eugene mentioned, our run rate is down significantly from the first quarter. We've achieved quite a bit of the overall cost saves, and we will add to those from actions we took in reducing positions in June, which will be effective in July as well as the branch closures. And then again, we do have some add-backs, as I mentioned, that would go against that level, which gives you about an $88 million run rate, give or take.

Okay. And then -- but -- I'm sorry, so of the $88 million as we go into the fourth quarter and we get the branch savings, is that -- will we see another -- is that a $6 million quarterly reduction in the fourth quarter? So we're kind of -- we're more around like $82 million in the fourth quarter?

No. Yes, the run -- recall, the $12 million is an annualized number. So we're talking about $3 million a quarter, about half of which, $1.5 million, would be realized in the third quarter and another $1.5 million would be in fourth quarter for a total of $3 million quarterly run rate impact.

Got it. Okay, okay. I'm sorry, I just -- I don't mean to be confusing, but so then, how does that compare to the $24 million that you originally talked about? Or is some of that already in this reduction that we saw this quarter?

Yes. It's already in the reduction. And we -- if you look across all of our line items, including salaries and benefits, occupancy, et cetera, we've made some good progress on achieving the $24 million run rate -- annualized run rate. And with some add-backs, we expect that will be down to about the $88 million. Now remember, the first quarter run rate was around $96 million. So -- but some of that included some increased payroll taxes, et cetera, that declined over the year. So when we come out of the year, we're in the $88 million mark.

Okay. Got it. So maybe we think about it maybe just annually, kind of thinking about 2019 expenses, and that was $368 million. And so then if we look at kind of -- well, I guess, your run rate in different quarters?

Yes.

So I was just trying to -- kind of trying to think about that, it's the total reduction. So maybe on the year, we're kind of -- on the year, we're near kind of $358 million for 2020, and then you're kind of going in from the mid-80s run rate in '21?

Yes. That's the way to think about it. Remember -- yes, last year, we also had made some inflationary cost adjustments in the first quarter, which added to that run rate coming out of '19, and then we're bringing it back more in line with more of a flat year. And hopefully, that will continue to lower in 2021.

Okay. That's really helpful. And then give us the dollar amount of PPP fees that came through this quarter?

In terms of the revenue that came through, it was about $10.5 million.

Okay. And that -- is that inclusive of the fees and the interest?

Yes. So it's about $3 million of interest, the 1% loan yield and then about $7.5 million, a little over $7.5 million was related to the fees amortizing through income.

Okay. Great. And you don't have any deferred costs coming out of the expense line?

Say, again, sorry?

Yes. Any kind of costs are coming out of the expense line versus being netted out in NII?

Any additional expenses related? No. We do it -- as I mentioned, we do expect to incur a bit more expenses as we outsource the forgiveness process. So that will add, call it, about $400,000, $500,000 to a run rate over the next 2 quarters is the way we're looking at it. Now that depends, of course, on what happens to the congressional bill that is suggesting that loans less than $150,000 would be forgiven in an auto manner. I mean we don't have to process those. So we're still trying to figure that up. We'll see what happens through the Congress. And that would save us -- as mentioned in the back, I don't know if you saw that, but we had about 9,600 loans of the 11,000 plus loans were less than $150,000, which is a lot of processing if we don't have to do it.

Your next question comes from Brody Preston with Stephens.

So I guess, I just want to circle back on the core NIM. There was a 4 basis point drag from PPP that was within the headline NIM, right?

That's correct. Yes.

All right. So I guess, backing that out, you kind of get to the middle of that 3.15% to 3.20%. And I understand that there's going to be some loan yield pressure moving forward. Just wanted to key in on any loan -- any yield floors that you have within the portfolio? And if any of those have kicked in?

Yes. We've got about 11% of our total loan portfolio has floors. And I think 6% or 7% or so have kicked in already. So that's helpful going forward. We're not expecting that we will see further declines in rates, but that's what's currently the current position.

Okay. And so I guess, maybe switching over to deferrals. So if I go back to the 1Q deck, and I take out the hotel loans that you had, understanding that there's some that weren't 180 day, but I think you know that most of the deferrals in the hotel portfolio were 180-day deferrals. So that leaves about $1.45 billion in non-hotel deferrals last quarter. And so I guess, like of that book, as of 7/17, how much of that book had you sort of processed and gone through? I guess I'm just trying to gauge some of the stats that you give on the roll-on, roll-off in that portfolio and what's taken a second modification? I'm just trying to better gauge the cure rate on the deferred book.

Brody, this is Doug. Thanks for that question. Let me point you to Slide 10, and I'll share for hotels because those are the remaining mods. Those are the still live mods on there for hotels. The total hotel mods that we approved were 142. So we now have 108 active. And the total dollars was about 67% of aggregate mods over the mod approval process period.

Okay. But I guess maybe focusing on the rest of the deferred book. I think on Slide 8, you mentioned $485 million rolled off their initial modification, $350 million made next payment and $5 million have rolled into a second modification. And so I'm just trying to better understand, I guess, what percentage of the book -- I guess, like what portion of this -- the $1.558 billion has yet to, I guess, be examined in terms of like they're still on their first modification? And when should we expect those to roll off?

Okay. Those figures on that slide are the current modifications, meaning active live, which reflects -- which is after that footnote -- the second footnote.

So in other words, they haven't matured?

Right. They have not. Now a lot of them, of course, since 2/3 or so of the dollars and numbers of loans that are -- that went under a mod were had a 90-day mod. And just -- as we all know, just because of the timing of the calendar and earnings release and COVID hit, they are happening in large volumes every day. So these figures are the, let's say, the first 3 weeks of mod expirations, that's that second footnote. So we were cautiously optimistic. A second modification request is need based. The first round, of course, as we all know, was accommodative. So it's need based. And many of these customers that are no longer on a mod but made their payment, didn't even bother contacting us to chat about whether a mod was necessary because they received the bill. So payments resumed once the 30-day -- I'm sorry, a 3-month mod expired. So these are very early good indicators, but obviously, very early.

And Brody, this is John. I just want to reiterate a point we made earlier. I've heard a few people make comments that they seem to think that most modifications were made in March. That's not true at all. Modifications were being made in April into May. Our mods actually peaked in May at 17% of the total portfolio. Now we're down to about 12%. But the point is, remember, what was happening in early April, PPP. So we had mobilized the company, and so we're being overwhelmed with PPP and simultaneously managing the whole deferral conversation where necessary. So there was a lot going on. So you'll see that those deferrals were kind of skewed toward the back end of April into May, which means that what you're looking at here, this $1.5 billion, the 90-day ones are going come due until, I guess, there'll be a big slug of them, Doug, come August 1. And then there'll be some that will even continue into September 1, and then we're kind of done with the first round.

Okay. So I guess, if the current sort of rate of needing a second modification were to hold, I guess, this sort of indicates that we should see a significant portion of these roll the modification and be behind us come the third quarter.

It's like watching election returns. The early returns look good. But the other returns -- now we are in -- obviously, we're in continuous conversations with the client base. Of course, we are, to be clear. And we'll see how things play out, but the early returns look pretty good.

And Brody, if we offer a mod after doing the underwriting because it's a much higher bar to receive a second 90-day mod, it is need based. The preference and the encouragement is that it'd be -- it go off a full deferment to an interest only, so that it's a sign of returning to health. So it's not -- if you need a mod, you get a full payment deferment.

Okay. All right. And I appreciate that. I guess just sticking on this discussion with the modifications, some of the regulator guidance that we've seen over the last couple of days, sort of indicates that loans modified before the year-end, if you give those like a full sort of TDR kind of re-underwrite, they don't need to be booked as TDRs for the life of the loan. I guess, are you guys interpreting that sort of OCC guidance similarly? And I guess, maybe does this give banks some added flexibility to modify some of their weaker borrowers through 2021? And I guess, could that help with loss rates moving forward?

Yes. Brody, this is Rob. Yes, in reading that -- interpreting that, we think that, that will be the case, but we're unsure as how it would be implemented. We also need to look at whether the SEC/FASB through GAAP accounting will also concur with what the OCC is saying or the regulators are saying on that. Certainly, the CARES Act or Congress suggest that. Again, like they did in the CARES, I think that will happen. But there's still some uncertainty around that at this point in time. So we need to get more guidance on that, both from regulators as well as our external auditors.

And Brody, this is Doug. Let me jump in on that, too. Because the regulators and FASB gave banks an up to 6 month, I guess, you call it a haul pass way back on TDRs. For a second set of mods, we aren't offering anything beyond 90 days so that the whole book stays within and up to 180 days' worth of mods until we get better direction on that. We didn't want to end up in October with a bunch of TDRs that we didn't anticipate could be TDRs. So in that guidance that you're talking about is fascinating. We certainly hope it becomes certified so that banks can rely on it.

Okay. All right. And then I guess, just wanted to gauge, I guess, maybe the health of borrowers. Are you seeing any difference, I guess, in the performance between your smaller borrowers versus your larger borrowers just in terms of deferral needs? And I guess, for the ones that you've sort of seen their new business plans, is there any bifurcation there?

Brody, this is Doug again. I'd say not yet. Obviously, smaller borrowers, fewer cushions of financial protection and whatnot. We haven't yet seen that. The incidence doesn't have anything other than a distribution across dollar size, best way to determine or to designate client size. So not yet on weakness, certainly, we would expect, when all is said and done. And whenever it starts, there'd be more losses on smaller loans than on larger loans simply because smaller borrowers have less flexibility and financial cushions than larger ones, generally speaking.

We need to get to our next caller, please.

Our next question comes from Laurie Hunsicker with Compass Point.

Just going over your slide here, and I really appreciate the color you provided again this quarter on Slide 10. I just wondered a couple of things. If you can help us think about the retail exposure. Just to remind us, small exposure, big box exposure, where you stand on that, just of the $553 million? And then also, what your LTV is on the retail?

Yes. Laurie, this is Doug. Thanks for that question. We don't finance big box, never have. So there really is nothing there in that. It's small retails, either stand-alone and then certainly in CRE retail, neighborhood shopping centers and whatnot. So the incidence of -- I'm sorry, what was the last -- the specific question was what?

Loan to value, the LTV.

Yes. The LTVs are, I mean, not nearly strong as the hotel, I'd say, 65% to 70%. Our focus, of course, is not in the retail trade and the CRE retail. The focus is on tenants paying the landlord, our client. So we're spending time understanding that too on the CRE retail. But that's different from retail trade. Obviously, those are the direct retailers.

Right, sir. And so on the retail, you said half of it is service retail to gas, convenience, et cetera. So what is the other half?

It's everything else. There's no, let's say, sub-concentration in that. It's small stores, local stores or any national chains in there. It's just the local community stores, anywhere from a $50,000 loan to a $2 million loan.

You'll have it back. Laurie, homebuilder supply. One of the things I've been looking for as we dug into the data, the incidence of the things you would most -- I most worry about, little boutique type shops, jewelry stores, men's wear, ladies dress shops, things like that. It's a single-digit percentage of this category that you're looking at here. So it's pretty broadly distributed. Sporting goods, homebuilding supplies, nursery type operations. And if you look at the percentage that's under modification, that's a pretty good indicator that that's actually doing not so bad.

And Laurie, another perspective on that. So it says 16%, that's remaining under mod, right? The total dollars aggregate that had a mod is 26%.

So at the peak...

Right. At the peak.

So at the peak, you're saying that 16.4% was 26%, okay?

Right. Right. So we're down that approximate 10 percentage points after the initial wave of mods are coming off.

No -- that -- I mean, there are going to be impacts in this portfolio, to be clear, but we're greatly comforted by the -- first of all, the real estate collateral, everything is overall 80% real estate secured. The convenience stores with gas, they're doing okay. The auto dealers are actually really picking up, and this is financing showrooms, not floor plan, et cetera.

Okay. Okay. I'm sorry, so just one last question then. If I'm thinking about this book, then additionally, in other words, half convenience stores at gas stations, you probably have another floor that's not included in that 50% number that would be grocery-anchored drug store, that type of thing, liquor store. Is that correct that kind of would fall into that more service category since you said single-digit on the retail stores? Am I just -- am I hearing that right?

That would be outside of that category. That would be investment real estate, shopping centers, drug stores and stuff.

Okay. Perfect. That's very helpful. Okay. And then restaurant, did you have -- I know you're 85% secured here. Did you have an LTV on that?

It'd be 75% to 80%. It is often part of the collateral for the smaller ones. They're second owners houses. There's all kinds of collateral there. But invariably, it is the location of the restaurant itself. But there are various ways to structure such a loan.

Okay. Okay. That's helpful. And then you gave the lending club balance, but did you have what the third-party consumer dollar number is?

Yes. So are you talking about the balances, Laurie? Or is it...

Yes. The third-party originated consumer was $215 million last quarter.

Yes. It's just a bit below $200 million now in total. The lending club is about $81 million. That's come down.

Liz, I think we have time for one more caller. I know we're running a little bit long.

Yes, we're in overtime now, but that's okay. We had longer than usual comments even for us.

This question comes from William Wallace with Raymond James.

One big picture question, John. You gave a lot of information in your prepared remarks around the utilization of the digital channel of delivery. I would like to see if you would speculate or talk about how that has changed your thinking on the branch network outside of, obviously, the 10% of the branches that you're consolidating now. How has that changed your thoughts as an organization on the network say over the coming year or 2? And on top of that, how has the increased use of the digital channel changed for better or worse, the -- a lot of the efforts that you guys had undertaken as a management team on Project Sundown?

Yes. I would say this has emboldened us. I'm going to invite Maria Tedesco, who's President, to step in and help comment on this. Actual experience has definitely emboldened us, Wally, in terms of being more aggressive. For example, the decision to consolidate 10% of the branch network and around numbers. That's the analytics I've ever seen in my career surrounded that. True statement. This closed September 15, which means notifications to customers those branches went out, what July -- no, June 15. It's been almost dead quiet. Why? Because we're not asking people to drive more than, say, 2 miles or so. So all measures of digital adoption and utilization have gone up. Maria, do you want to just share what is your perspective in terms of actual experience, the increased capabilities to the bank around digital. How does that change your view of the future of the retail branch network?

Yes. I don't really want to comment on how many more branches we might, in fact, close. I think it's something we have to assess every single year, take a look at our customers' behavior. Certainly, COVID and this incident has helped find multiple ways in which the bank and using digital, which John mentioned in outlook, the incredible usage that we've seen digital channels from our customers. So again, we will assess this every year and watch our consumer behavior. But of course, it's apparent that we will likely have more opportunity in the future in terms of our network. I'd also say that we also remain bold about what Project Sundown will do for us in the future because within this period, we have introduced several new initiatives, as John mentioned earlier, in the digital space, which I think just makes it easier for customers to bank where, when and how they want to bank. And obviously, they're getting used to digital channels. So I'm not -- I would also say that because of our appointment setting capabilities, we've been able to keep both our customers safe and our teammates by not opening up branch lobbies and doing our appointment setting either by Zoom or in a branch with a banker, which helped us keep the number of customers coming and going out of our branches [indiscernible]. And I would just say, we feel really good about our ability through the branch network to serve our clients any way they want, whether it's digital or in-person.

And Wally, we don't expect, based on recent comments, Truist to actually convert their brand in Virginia until 2022, and the truth is that, that's actually giving us time to continue to close gaps. The reason why I went to such specificity spelling out what we've done in digital and what's coming is I simply want to demonstrate, even with all of this craziness going on, we are very focused, and we're making steady progress. We have a quarterly release schedule. Kelly Dakin, leading the digital team. He's done a fantastic job for us. So we keep chipping away at this. And it does change the nature of the business.

Thanks for everyone for joining us today. A replay will be available on the website, investors.atlanticunionbank.com, and we look forward to talking with you in October. Have a good day.

Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.