Atlantic Union Bankshares (AUB) Q3 2023: $17M Expense Reduction Program Drives Operating Leverage Amid Margin Compression

October 19, 2023 | By EarningsIQ Research

Atlantic Union Bankshares delivered disciplined execution in Q3, implementing a $17 million annualized expense reduction and balancing loan growth with deposit inflows, even as margin headwinds persisted. The bank’s proactive balance sheet and cost actions position it for sustainable profitability, while the pending American National Bankshares acquisition sets up incremental growth opportunities in new markets. Investors should watch for further margin stabilization and integration progress in the coming quarters.

Summary

• Proactive Cost Discipline: Expense reductions and balance sheet repositioning support positive operating leverage.
• Strategic Franchise Expansion: American National Bankshares deal unlocks new growth vectors in North Carolina and southern Virginia.
• Margin Headwinds Persist: Deposit remix and higher funding costs continue to compress net interest margin into Q4.

Business Overview

Atlantic Union Bankshares (AUB) operates as a diversified, traditional full-service bank with a primary footprint in Virginia and adjacent markets. The bank generates revenue through net interest income (spread between loan yields and funding costs) and non-interest income from service charges, trust fees, and merchant services. Its major segments include commercial and industrial lending, commercial real estate, consumer lending, and a growing treasury management business. The company’s business model emphasizes local relationship banking, prudent credit management, and measured geographic expansion.

Performance Analysis

AUB delivered solid core results in Q3, marked by positive adjusted operating leverage as revenue growth outpaced expense increases, even after adjusting for notable one-time items. The $17 million annualized expense reduction program, fully implemented by July, contributed to a decline in operating expenses and underpinned a 10.6% increase in pre-tax, pre-provision adjusted operating earnings year over year. The bank’s loan growth (5.7% annualized in Q3) was led by commercial lending, while deposits grew at a 9.1% annualized pace, supporting funding stability and franchise health.

However, net interest margin (NIM) compressed by 10 basis points quarter over quarter due to continued upward pressure on deposit costs and ongoing remixing from non-interest to interest-bearing accounts. The cost of funds rose as depositors shifted to higher-yielding products, only partially offset by higher loan yields. Asset quality remained benign, with negligible charge-offs and a stable credit environment across the footprint. A strategic sale-leaseback and securities restructuring, executed as a capital-neutral transaction, are expected to add five basis points to NIM and incrementally lift earnings in Q4 and beyond.

• Deposit Growth Outpaces Loans: Customer deposits increased faster than loan balances, reducing funding risk and supporting growth.
• Expense Cuts Take Hold: The expense reduction program delivered immediate savings, with further benefits anticipated.
• Fee Income Grows: Service charges, trust fees, and debit interchange benefited from 2%–4% net new client growth and seasonal activity.

Overall, AUB’s Q3 showcased disciplined cost management and healthy franchise fundamentals, though margin compression remains a key watchpoint heading into year-end.

Executive Commentary

Strategic Positioning

1. Expense Discipline and Operating Leverage

AUB implemented a $17 million annualized expense reduction program in response to faster-than-expected deposit cost increases. This move, announced in June and executed by July, aligns with management’s commitment to maintaining positive operating leverage—growing revenues faster than expenses—even in a challenging rate environment. The program’s early benefits were visible in Q3, with further run-rate savings expected in Q4 and beyond.

2. Franchise Expansion via American National Bankshares Acquisition

The pending all-stock acquisition of American National Bankshares will extend AUB’s reach into southern Virginia and the contiguous North Carolina markets, especially the I-40 corridor and Piedmont Triad. Management sees this as an incremental growth platform, adding scale, new commercial and industrial banking talent, and deeper presence in attractive industrial markets. The deal is on track to close in Q1 2024 and is expected to be accretive to financial performance.

3. Balance Sheet Repositioning for “Higher for Longer” Rates

AUB executed a sale-leaseback of 27 properties and a restructuring of its securities portfolio, unlocking equity and reinvesting in higher-yielding securities. This capital-neutral move is projected to be immediately accretive, boosting NIM by five basis points and earnings per share by 2% annualized starting Q4. It demonstrates management’s agility in optimizing asset yields and capital deployment as the rate environment evolves.

4. Diversification of Loan Mix and Fee Streams

Loan growth is increasingly driven by commercial and industrial (C&I) and equipment finance rather than commercial real estate, reflecting the benefits of a multi-year effort to diversify lending capabilities. Fee income streams, including trust and debit card interchange, are also growing steadily, supported by net new client acquisition and expanded treasury management offerings.

5. Prudent Credit Risk Management

Asset quality remains a core strength, with negligible net charge-offs and a conservative approach to commercial real estate and office lending. AUB’s footprint avoids boom-bust cycles, and proactive monitoring of office exposure and credit migration supports stable credit costs, even as management expects some normalization in charge-offs over time.

Key Considerations

AUB’s Q3 was defined by a balance of cost discipline, franchise expansion, and margin management, set against a backdrop of stable credit and moderate economic optimism in its core markets. The following considerations will shape the bank’s trajectory in coming quarters:

Key Considerations:

• Expense Reduction Sustainability: Investors should track the durability and incremental impact of the $17 million annualized cost savings as run-rate benefits flow through Q4 and FY24.
• Margin Stabilization Timing: With management guiding to a NIM trough in Q1 2024, the pace of deposit remix and funding cost increases warrants close monitoring.
• Integration and Synergy Realization: The American National Bankshares deal brings new markets and scale, but execution risk and integration costs must be managed to capture anticipated accretion.
• Credit Normalization Path: While current asset quality is benign, management expects charge-offs to eventually normalize to a 15–20 basis point range; timing and drivers will be key to watch.

Risks

Margin compression remains a material risk, as deposit costs and remixing continue to outpace loan yield repricing. Integration challenges from the American National Bankshares merger, including talent retention and system harmonization, could disrupt near-term performance if not carefully managed. Macroeconomic shifts, including potential recession or unexpected credit deterioration, would pressure both growth and asset quality, though AUB’s footprint remains relatively insulated for now. Regulatory and market volatility, especially around funding and liquidity, also warrant attention.

Forward Outlook

For Q4 2023, Atlantic Union Bankshares guided to:

• Net interest margin compression of 5–10 basis points, with stabilization expected in Q1 2024 around 3.25% (excluding American National impact).
• Continued mid-single-digit loan and deposit growth, supported by healthy pipelines and stable economic conditions in core markets.

For full-year 2023, management maintained guidance:

• Loan growth at the high end of mid-single digits, largely matched by deposit growth.
• Net interest income up mid-single digits year over year, with positive adjusted operating leverage as revenue growth outpaces flat expenses.

Management highlighted several factors that will influence results:

• Deposit remix is slowing but remains a headwind to NIM.
• Loan production yields are holding near 7%, supporting incremental margin offset.

Takeaways

AUB’s Q3 execution validates its disciplined, diversified banking model, with cost actions and balance sheet moves providing earnings momentum even as margin compression persists. The pending American National Bankshares acquisition is set to unlock new growth levers and geographic scale, though integration and credit normalization will require careful navigation.

• Disciplined Cost Actions: The $17 million expense reduction program delivered immediate leverage, reinforcing management’s commitment to shareholder value and operational efficiency.
• Margin Management Remains Central: Ongoing deposit remix and funding cost pressures will continue to impact NIM, but strategic asset moves and loan repricing offer partial mitigation.
• Growth and Integration Watch: Investors should focus on the integration of American National, the durability of loan and deposit growth, and the pace of margin stabilization for forward returns.

Conclusion

Atlantic Union Bankshares enters Q4 with a healthy franchise, clear cost discipline, and a strategic expansion path via the American National Bankshares deal. While margin headwinds will persist into early 2024, operational execution and prudent risk management provide a stable foundation for future growth and value creation.

Industry Read-Through

AUB’s quarter highlights several sector-wide themes for regional banks: proactive cost control is increasingly vital as margin compression from deposit remix and funding cost escalation persists. Franchise expansion through targeted M&A remains a lever for scale and market density, but integration risk is non-trivial. Stable credit in local markets contrasts with pockets of industry stress, especially in commercial real estate, but normalization is expected. The interplay of deposit competition, balance sheet optimization, and non-interest income growth will continue to define winners in the regional bank space, especially for those able to maintain positive operating leverage and prudent credit discipline.

AUB Financials Regional Banks Expense Management Net Interest Margin Deposit Growth Loan Growth Acquisition