Atlantic Union Bankshares Corporation (NYSE:AUB) Q4 2022 Results Earnings Conference Call January 24, 2023 9:00 AM ET

Company Participants

Bill Cimino - Senior Vice President and Director of Investor Relations
John Asbury - President and Chief Executive Officer; Chief Executive Officer, Atlantic Union Bank
Robert Gorman - Executive Vice President and Chief Financial Officer
David Ring - Executive Vice President and Wholesale Banking Group Executive
Doug Woolley - Chief Credit Officer

Conference Call Participants

Casey Orr Whitman - Piper Sandler & Co.
David Bishop - Hovde Group
Catherine Mealor - Keefe Bruyette & Woods Inc.
Laurie Hunsicker - Compass Point Research & Trading LLC

Operator

Good day and thank you for standing by. Welcome to the Atlantic Union Bankshares Fourth Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. [Operator Instructions] Please be advised today's conference is being recorded.

I would now like to hand the conference over to your speaker today, Bill Cimino, Senior Vice President, Investor Relations. Please go ahead.

Bill Cimino

Thank you, Michelle. 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 the 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 through on this webcast are available to download on our Investor website, investors.atlanticunionbank.com.

During today's 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 the appendix to our slide presentation and in our earnings release for the fourth quarter and fiscal year of 2022.

We will make forward-looking statements on today's call, 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 expectations or results expressed or implied by these forward-looking statement. We undertake no obligation to publicly revise or update any forward-looking statements.

Please refer to our earnings release issued today and our other SEC filings for 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 from those expressed or implied in any forward-looking statement. And all comments made 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.

Before I turn the call over to John Asbury, I wanted to remind everyone that Atlantic Union Bankshares common stock and depository shares, each representing 1/400 interest in the share of our preferred stock, are both now trading on the New York Stock Exchange. Our common stock symbol remains AUB, while our depository shares traded under AUB. PRA to conform with the NYSE nomenclature for preferred stock.

I'll now turn the call over to John.

John Asbury

Thank you, Bill. Good morning, everyone. And thank you for joining us today. Atlantic Union Bankshares delivered a strong quarter to close out 2022. Importantly, we hit our top tier financial targets during the fourth quarter as we said we would. We recorded low double-digit annualized loan growth, our net interest margin expanded meaningfully, asset quality remained strong, we kept expenses in line and generated significant positive operating leverage.

As in prior quarters. I would like to begin by commenting on the macroeconomic environment and our primary operating footprint before I delve more deeply into details on our results.

For perspective, traditionally, Virginia has been a stable economic area and not one prone to big swings in either direction. The federal government acts as both a significant catalyst and shock absorber to the Commonwealth's economic engine and the economic base here is diverse. Given how Virginia has fared in the past, we currently expect the effects of any potential recession to be somewhat muted as here, although we believe we are well positioned should economic conditions worsen from historical trends.

Virginia's last reported unemployment rate of 2.8% in November notched up slightly from 2.6% at the end of last quarter, but it remains below the national average of 3.6% during the same time period. This is relatively in line with where it was before the pandemic.

As I like to do, I've been out meeting with our clients, the Virginia business community and our teams, and I can report that, anecdotally, we still do not believe dreary economic headlines nationally reflect what we see going on in our footprint. Our markets appear to be healthy, and our lending pipelines, while down about 5% lower than the same time last year, are strong. We still don't anticipate any near-term shift away from the positive trends of low unemployment in a benign credit environment, but we will continue to monitor conditions in our markets.

While we do expect the Federal Reserve to further raise short term rates in the first half of 2023. Since we are fairly asset sensitive, additional short term rate hikes over the next few quarters should support our operating results and helped to offset increases to cost of funds in the rising rate environment and accelerating deposit rate competition.

As usual, we remain focused on generating positive operating leverage. That is, growing our revenue faster than our expenses. Our numbers have been noisy for the past few years with pandemic-related loan loss provisioning swings, the revenue impact of the Paycheck Protection Program and various expense reduction items such as branch and facility rationalization.

But if you drill down and adjust for those factors, which were not as material this quarter, you can see the strength of the core franchise over time. And to that point, pre-PPP adjusted revenue growth was approximately 11% year-over-year and was 7% on a linked-quarter basis from the third quarter of 2022. As a result of prior expense management actions, our adjusted operating non-interest expense run rate increased 4% year-over-year and was flat quarter-over-quarter. The company generated positive pre-PPP adjusted operating leverage of approximately 7% on a year-over-year basis and 7% quarter-over-quarter. I'd also like to point out that, excluding PPP, pre-tax pre-provision adjusted operating earnings increased 23% year-over-year and 17% from the prior quarter.

Now let me turn to some of the high points for the quarter end 2022. We posted annualized loan growth of approximately 15% point to point in the seasonally high fourth quarter. And for the full year, we recorded point to point loan growth of approximately 11% excluding PPP. This was our fifth consecutive quarter of high-single digit annualized loan growth or better, excluding PPP. We believe that we are well positioned to deliver 6% to 8% loan growth for 2023, given the strength of our current pipeline, our competitive positioning, the market dynamics and fundamentals in the markets that we serve.

We do recognize that the economic environment in our footprint could change as persistent inflation, higher interest rates and the threat of recession do loom, but currently we expect to remain in a moderate growth mode in 2023.

C&I line utilization picked up at the end of the quarter to 35%. And that's still below our pre pandemic levels of over 40%, but better than at this time last year, which was approximately 28%. We believe we have further upside here as working capital needs continue to normalize among our clients over time.

Our loan production in the fourth quarter of 2022 nearly equaled our record production in the fourth quarter of 2021. About 43% of production in the fourth quarter came from new-to-bank clients and 57% came from existing clients.

CRE payoffs continued to slow year-over-year and are well off the peaks we saw in the second through fourth quarters of 2021. As I've said for the last two quarters, rising term rates have suppressed both refinance activity into the long term institutional markets on commercial real estate and too good to refuse offers on commercial real estate properties.

In the fourth quarter, we saw a notable acceleration in deposit rate competition. While deposits averaged up 3% quarter-over-quarter, we did experience runoff at the end of the year, largely in transaction accounts, impacting our point-to-point growth comparisons and more than offsetting the $418 million deposit increase we experienced in the third quarter. Nearly all of the third quarter increase was also in transaction accounts.

For the full year, point-to-point deposits declined 4.1%, and that was actually consistent with our original expectations for the year. There were a number of factors behind the late December transaction account runoff. These include a relatively small set of larger commercial clients and affluent consumer clients with excess liquidity, moving funds to higher yielding alternatives, normal seasonality outflows and some spending increases due to inflationary factors.

At year-end, our loan-to-deposit ratio was 90.7%, which is at the lower bound of our targeted range of 90 to 95%. As of yesterday, the loan-to-deposit ratio was approximately 88%, with the improvement coming from deposit growth we posted month to date in January.

Deposit rate competition intensified in the fourth quarter along with a rapid and unprecedented rise, short term rates, and we have made further rate adjustments to seek to maintain competitiveness and defend the deposit base. Since our deposit base overall is pretty granular and comprised of 57% transaction accounts, we do expect deposit betas throughout the remainder of the rising rate cycle to increase, but still be manageable.

Our latest modeling shows that our net interest margin is likely now at or approaching an equilibrium point. By that, I mean we expect NIM to hold steady from here and further rate actions by the Fed will allow us to offset higher rates paid on funding with higher yields on their loan portfolio, half of which is variable rate. It's difficult to forecast exactly what will happen, but we believe this is the most likely outcome. Rob will provide additional perspective on this during his comments.

I do want to touch on a few new fee-based activities I mentioned last quarter. We retooled our SBA 7(a) program in June and executed our first 7(a) loan sale during the fourth quarter. Additionally, loan syndications, originations were active and we are building a run rate with our foreign exchange program. The combination of these three new capabilities resulted in $1.3 million of fee-based net revenue for the quarter, and we expect them to generate around $6 million of net revenue over the course of 2023. Worth noting is that these new revenue streams should largely offset fee income declines from the various customer friendly NSF OD changes we made last year.

Asset quality remained strong, with annualized net charge-offs of 2 basis points for the fourth quarter. For the full year. net charge-offs were also 2 basis points.

Credit losses will eventually normalize to historical norms, and one-offs can come at any time. But given the continued low unemployment rate and still solid fundamentals in our markets and client base, we have yet to see any sign of a systemic inflection point in our asset quality metrics. While economic uncertainty and the threat of recession could negatively impact our markets, the current economic situation and the footprint appears to remain study and, as noted, we expect the impact of any macroeconomic slowdown to be somewhat tempered here in our home state of Virginia.

Because we believe we're in the late stages of a NIM expansion cycle, we also took additional expense actions during the quarter. Among other efficiency initiatives, we decided to consolidate five additional branches set for closure in March. Since the pandemic began, we have consolidated 27% of our branch network, yet still posted net positive consumer household growth for the year.

In sum, 2022 was not only a good year for Atlantic Union, but also a good demonstration of the value and earnings power of the franchise we have all built.

Looking back at my now six years to the company, we have been clear, consistent and intentional in our strategy. We've made great progress in successfully diversifying our product lines and capabilities, while building our core franchise, our culture and our brand. We're far from done with these efforts. And in fact, we'll never be done since we view our transformation is continuous and not an event. But we have come a long way, a very long way. And for that, I'd like to express my gratitude to our teammates, since they are the ones who make this all possible, delivering each and every day for our customers, shareholders and the communities we serve.

Looking ahead, I remain confident that we're well positioned to manage our way through the challenges that lie before us. While the operating environment may be uncertain, what is certain is the Atlantic Union Bankshares remains a uniquely valuable franchise. It is dense, it is compact in great markets with a story unlike any other in our region. We're scalable, and we're growing our capabilities, operating in the right markets with the right team to deliver top tier financial 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?

Robert Gorman

Well, thank you, John. And good morning, everyone. Thanks for joining us today. Now let's turn to the company's financial results for the fourth quarter. In the fourth quarter, reported net income available to common shareholders was $57.6 million and earnings per common share was $0.90. This was up approximately $12.5 million or $0.16 per common share from the third quarter's reported net income available to common shareholders.

Return on tangible common equity was 22.9% in the fourth quarter, up from 17.2% in the third quarter. Return on assets was 1.39% in the fourth quarter, up from the 1.15% reported in the prior quarter. And on an operating basis, the efficiency ratio was 50.6% in the fourth quarter, down from 54.1% in the third quarter.

Also during the fourth quarter, the company continued to generate positive operating leverage as total revenue grew approximately 7% and operating expenses were flat on a linked-quarter basis. Importantly, as John previously mentioned, we hit all of the top tier financial targets we set on a run rate basis in the fourth quarter.

Turning to credit loss reserves, as of the end of the fourth quarter, the total allowance for credit losses was $124.4 million, which was an increase of approximately $5.4 million from the third quarter, primarily due to net loan growth during the quarter and increased uncertainty in the macroeconomic outlook.

The total allowance for credit losses as a percentage of total loans remained at 86 basis points at the end of December. The provision for credit losses of $6.3 million in the fourth quarter was relatively flat from the prior quarter's $6.4 million provision for credit losses. Net charge-offs remain muted at $810,000 or 2 basis points annualized in the fourth quarter. And for the year, the net charge-off ratio came in at 2 basis points as well.

Now turning to pre-tax pre-provision components of the income statement for the fourth quarter, tax equivalent net interest income was $168 million, which was up approximately $13.4 million or 8.7% from the third quarter, driven by higher interest income due to increases in loan yields on the company's variable rate loans due to rising market interest rates and average loan growth, as well as increases in investment income primarily due to increased yields on taxable securities. These increases were partially offset by higher interest expense due to higher cost of funds, primarily reflecting the impact of increases in short term interest rates on borrowings and deposits, increased use of short term funding and higher average deposits from the prior quarter.

The fourth quarter's tax equivalent net interest margin was 3.70%. That's a net increase of 27 basis points from the previous quarter due to an increase of 66 basis points in the yield on earning assets, partially offset by a 39 basis point increase in our cost of funds.

The increase in the fourth quarter's earning asset yield was primarily due to the 70 basis point increase in the loan portfolio loan yield, which had a 62 basis points positive impact on the fourth quarter's net interest margin. In addition, higher investment securities yields in the fourth quarter drove a 3 basis point increase to the quarter's net interest margin.

The loan portfolio yield increased to 4.90% in the fourth quarter from 4.2% in the third quarter, primarily due to the impact of rising short term interest rates on variable rate loan yields. The 39 basis point increase in the fourth quarter's cost of funds is due primarily to the 32 basis points increase in the cost of deposits, driven by increases in interest checking, money market and time deposit rates, as well as increased wholesale borrowing rates due to rising market interest rates.

Non-interest income decreased $1.1 million to $24.5 million, primarily due to declines in equity method investment income, partially offset by increases in loan syndication, SBA 7(a) and foreign exchange revenues, each included within other operating income line item.

In addition, mortgage banking income decreased $1.0 million from the prior quarter due to lower mortgage origination volumes and gain on sale margins. And bank-owned life insurance declined $796,000, reflective of the impact of prior quarter's mortality benefit received.

These non-interest income category decreases were partially offset by increases in loan-related interest rate swap fees of $1.6 million due to an increase in average deal size among swaps executed in the quarter.

Non-interest expense decreased $130,000 to $99.8 million for the fourth quarter versus $99.9 million in the prior quarter. Notable expense activity in the fourth quarter of 2022 included a gain related to the sale and leaseback of an office building, refunds of prior-period FDIC assessment expenses, costs related to the closure of five branches expected to close in the first quarter of 2023, as well as other restructuring expenses, the write-off of obsolete software during the quarter and increased variable incentive comp and profit sharing expenses, as well as professional services fee increases related to strategic projects incurred during the quarter.

Our effective tax rate for the fourth quarter declined to 14.3% from 17% in the third quarter due to changes in the proportion of tax exempt income to pre-tax income. In 2022, the full-year tax rate came in at 16.2%. In 2023, we expect the full-year effective tax rate to be in the 17% to 17.5% range.

Now, turning to the balance sheet. Total assets were $20.5 billion at December 31, and that's an increase of $511 million or approximately 10% annualized from September 30 levels. The increase was primarily due to loan growth during the quarter.

At period end, loans held for investment net of deferred fees and costs were $14.4 billion, inclusive of $7.3 million remaining in PPP loans net of deferred fees, an increase of approximately $530 million or 15.1% annualized from the prior quarter. If we exclude PPP loans, adjusted loans held for investments in the fourth quarter actually increased 15.3% annualized from September 30, driven by increases in commercial loan balances of $478 million or 16.2% linked quarter annualized, and consumer loan balance growth of $57.1 million or 10.2% annualized. Excluding the effects of PPP loans, adjusted loans held for investment in the fourth quarter increased $1.4 billion or 10.7% from the same period in the prior year.

At the end of December, total deposits stood at $15.9 billion, and that's a decrease of $615 million or approximately 14.7% annualized from the prior quarter, while average deposits were actually up $123.5 million or 3% annualized for the quarter.

At December 31, the transaction-related deposit accounts comprised 57% of total deposit balances, which is down a bit, a basis point from third quarter levels. And as John mentioned, the loan-to-deposit ratio is now at the lower bound of our targeted range of 90% to 95% at year-end.

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.

Regarding the company's capital management strategy, capital ratio targets are set to seek to maintain the company's designation as a well-capitalized financial institution and to ensure that capital levels are commensurate with the company's risk profile, capital stress test projections and strategic plan growth objectives.

At the end of the fourth quarter, Atlantic Union Bankshares and Atlantic Union Bank's regulatory capital ratios were well above well capitalized levels. The company's tangible common equity to tangible assets capital ratio increased from the prior quarter, primarily due to the increase in the value of the available for sale securities portfolio as long term rates decreased somewhat during the fourth quarter.

Again, we believe that the GAAP accounting versus regulatory account and capital impacts of unrealized mark-to-market losses from rising interest rates in the available for sale securities portfolio will be recouped over time. Therefore, we also track tangible common equity ratio and tangible book value excluding this non-cash GAAP accounting requirement.

During the fourth quarter, the company paid a common stock dividend of $0.30 per share, which was consistent with the prior quarter and also paid a quarterly dividend of $171.88 each outstanding share of Series A Preferred Stock. The company did not repurchase any shares during the quarter in order to preserve capital for organic loan growth and to position the company for any adverse developments arising from the current macroeconomic environment managed to the following top tier financial targets and, as noted, achieved them during the quarter. Return on tangible common equity within a range of 18% to 20%, return on assets in the range of 1.3% to 1.5% and an efficiency ratio of 51% or lower.

Regarding the efficiency ratio target, I'd again like to point out that it is difficult to compare our efficiency ratio to banks that don't have significant operations in Virginia since Virginia banks do not pay state income taxes, but instead pay a franchise tax that flows through non-interest expenses and not income taxes. The franchise tax quarterly non-interest expense run rate of approximately $4.5 million added approximately 2.4% to the company's fourth quarter efficiency ratio. So setting the efficiency ratio target at 51% or lower is akin to a 49% or lower efficiency ratio target for peer banks not headquartered in Virginia.

As a reminder, our top tier financial targets are dynamic and are set to be consistently in the top quartile among our proxy peer group regardless of the operating environment. As such, we reset these targets periodically to ensure they are reflective of the financial metrics required to achieve top tier financial performance versus peers in the prevailing economic environment.

We do expect to achieve our financial targets for the full year based on the following key assumptions. We expect to produce 6% to 8% loan growth in 2023. We expect the net interest margin to stabilize in the 3.7% to 3.75% range in 2023 as a result of the company's asset sensitive position and the assumption that the Federal Reserve Bank will increase the Fed funds rate to 5% and maintain it at 5% throughout 2023.

As a result of loan growth and a stable net interest margin, we expect net interest income to grow by 13% to 15% in 2023 from full-year 2022 levels. We also expect that the company will generate meaningful positive adjusted operating leverage in 2023 due to low teen revenue growth outpacing mid-single digit expense growth in 2023.

On the credit front, while we have not seen any systemic credit quality issues to date, due to expectations for a mild recession to begin sometime in 2023, for modeling purposes, we are assuming an uptick in the net charge off ratio which at 10 basis points in 2023 from 2 basis points in 2022.

I would reiterate that we do not see evidence of a turn in the credit environment at this point, but one-offs are bound to pop up every now and then. The allowance for credit losses to loan balances is also projected to remain within the range of 85 basis points to 90 basis points in 2023.

In summary, Atlantic Union delivered strong financial results in the fourth quarter of 2022 as evidenced by hitting each of our top tier financial targets. As a result, we believe we are well positioned to generate sustainable, profitable growth and to build long term value for our shareholders in 2023 and beyond.

And with that, I'll turn it back over to Bill Cimino, who will open it up for questions from our analyst community. Bill?

Bill Cimino

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

Question-and-Answer Session

Operator

[Operator Instructions]. And our first question comes from the line of Casey Whitman with Piper Sandler.

Casey Orr Whitman

I guess, first, bigger picture, John. Can you just remind us your views on sort of how you're thinking about bank M&A for Atlantic Union this year?

John Asbury

I would say nothing has changed, Casey, for what you've heard for a while. We view that as a possible supplemental strategy. We believe we can accomplish what we intend to accomplish without that, which does not mean that we wouldn't consider it. We would. But it would be a supplemental strategy.

Big picture, the preferred approach, if we were to look at it, would be to do something – actually, let me backup. Clearly, it would have to make a strategic and financial sense and meet our acquisition parameters, et cetera, or we wouldn't consider it. The ideal scenario would be something that is on the smaller side. And it would be more likely than not an infill within our existing markets where we can continue to increase density across Virginia, which would be the first choice and really drive brand power, extract cost, and use that for investment everywhere. We love continuing to densify in Virginia. We think we have a long way to go. We're not about to run out of room. We would consider contiguous markets. The most logical ones for us would be Maryland and North Carolina that becomes much fewer and further between.

So again, a secondary strategy is not a primary strategy. It is a tough environment to do it. You have to think about the rate marks. And so, I think that one of the bigger constraints could potentially be just having to come to grips with whether it's going to pencil out in terms of financial metrics. Anything to add to that, Rob?

Robert Gorman

Well, I think you've got all the objectives that we would have from an M&A point of view. And we'll see where we go from here. But it is a secondary strategy, as you know. A lot about organic opportunities that we want to work on

John Asbury

In this environment, a good core depository franchise becomes more attractive than ever. I would add that as well. It goes without saying we would have to have great confidence in asset quality and the due diligence. So that's our thinking about it, Casey.

Casey Orr Whitman

Just looking at the loan production this quarter, Rob, can you give us a sense for where like the new loan yields are coming on, either during the quarter or where they're coming on now?

John Asbury

During the quarter, as we said, we had really strong production this quarter. And if you look at the various originations, about 65% of the new production came on from a variable rate – actually, it's a bit more than that cost, 75% we include prime loans. Those are coming in in the 6.5% to 7% range in terms of yields. And then, the remainder is fixed. And those have been coming in, call it, the lower 5s, 5% to 5.50% on those. So, overall, it's a bit above 6% when you blend it all together in terms of new yields coming on. Of course, the spreads over the indexes, as LIBOR has increased and primes increased. Those have remained fairly constant as rates have been rising, but those would be the yields that we're seeing right now in terms of the new book.

Casey Orr Whitman

Appreciate the updated guide. I guess I'm wondering what kind of position you will be in if the Fed does begin to pivot. Like, have you taken some of your asset sensitivity off the table at year-end from where you were at 9/30 or maybe just walk us through how expectations might have to shift in that sort of environment?

Robert Gorman

As I noted in my comments, we do expect that the Fed will get up to around 5%, maybe a little higher, kind of stay there for a while, likely, in our minds, into 2024 before they start thinking about lowering rates back down. Certainly, we don't expect that they would go back to a zero rate environment. But we have taken some asset sensitivity off the table. We've entered into a few swaps in terms of protecting ourselves on the downside where we're capped out on where SOFR goes, for example, put about $500 million on the books where we're in the money if SOFR drops below, I think, about 3.60% or 3.75%. So there is some of that going on.

Of course, that doesn't take the full asset sensitivity off the table for us. So, there would be some compression, if you will, net of that, those strategies we put on, if that were the case.

Operator

Our next question comes from the line of David Bishop with Hovde Group.

David Bishop

John, just curious from maybe a macro perspective. As you look out, depending on how the Virginia economy holds up and your experience in the market, do you expect anything different, if we do enter a recession in terms of how the state is positioned to respond? And then, in that, how you're positioned relative to maybe the financial crisis in 2008/2009?

John Asbury

Well, I don't expect anything different, which does not mean that we couldn't experience something different. It actually was not here in 2008/’09. At the time, I was in the Southeast. But I can tell you, and you know this, David, because you live in the area, Virginia would have been one of the more resilient areas, the Greater Washington D.C. for the reason we keep pointing back to, which is you just have the stabilizing fact force of the U.S. government, the U.S. military, et cetera.

The economy has only become more diversified since then. You look at all that has happened across the state, we feel quite confident. One of the things I keep looking at is the unemployment rate. And so, the unemployment rate right now is 2.8%. Thank you very much. It ticked up 2 basis points. 2.8%. U.S. average is something like 3.6%. And it's really hard to see it falling off a cliff. I think our CECL modeling, Rob, assumes we go to what, on the unemployment standpoint.

Robert Gorman

From that point of view, we're very conservative in our CECL modeling, assuming there's a recession. It averages about 6% over the two years.

John Asbury

That is a long way away from where we are currently. So, David, I would just say bottom line, if anything, the fundamentals should have only gotten better in Virginia in terms of the diversity of the economy. So, I would fully expect that we will do much better than average. Anything could happen. But that's our view of it. We're ready for anything. But we should, as we have traditionally done for good reason, fare better than most.

Robert Gorman

David, maybe just another data point on that. During the height of the unemployment and during the Great Recession, Virginia's unemployment peaked at 7.6%. So if you look at that relative to where we've got our CECL modeling at 6%, you can see we're pretty conservative in that.

David Bishop

That sort of ties to my next question regarding the CECL model. I don't know if you have this offhand. But like you said, just Virginia unemployment rate forecasted to 3.1% under Moody's, you guys are using 6%. If you were even to say to tamp that down to 5%, just curious, maybe what that would have an impact maybe from a provisioning perspective and if that's the proper way to look at it.

Robert Gorman

David, you're talking about – if the rate gets up to around 5% or so. Yeah, it really be dependent on what losses were actually coming through. The model will be very sensitive to that unemployment rate, and we would be increasing, obviously, the allowance for the additional potential of losses as a result of unemployment, which would indicate that it's a fairly significant recession going on. So we would definitely be raising the allowance for credit losses accordingly.

David Bishop

Appreciate the guidance of 6% to 8%. Just curious where you see the best prospects for growth either by loan segment or maybe geographic regions in 2023?

John Asbury

It's going to come out of the commercial bank. Dave, do you want to speak to where you see opportunity. I think we've done a good job of diversifying the bank. We have our new business lines as well, which provide supplemental growth. I'm feeling pretty good across the board. What do you think, David? David Ring is Head of Wholesale Banking, which is what we call commercial.

David Ring

We actually grew in every vertical and in every region in 2022. So each region currently has pretty strong momentum. So there isn't anywhere in Virginia we don't feel pretty comfortable generating growth in 2023.

John Asbury

I will say several things. The Greater Washington region is to us like Atlanta is to the Deep South banks. That's kind of the big market. So we've got plenty of room to run up there. Asset-based lending definitely has upside. That's something we've been working on for several years. We have additional capabilities there. So I think it'll be a pretty good diversified play. To generally speaking, it's fair to say the larger markets tend to do better than the smaller markets. That's just the fact of the size of the economies.

David Bishop

Operating expenses, I know there's some noise in other expenses. Just maybe, I don't know if you can quantify the dollar amount this quarter, maybe where we think a good run rate in the first quarter might be as the expenses reset?

Robert Gorman

From that point of view, David, you would expect to see seasonally increase in the expense base, kind of the run rate we're coming out of the year with – for fourth quarter, it was $99 million, probably looking in $4 million or $5 million on top of that in the first quarter due to FICA resets and the like, and then merit start kicking in at the end of the – in March. So, that's our thought.

Now, the FICA resets and unemployment resets start to dissipate over the remainder of the year. So, you'll see kind of a spike up and then it will start coming down, checking third, fourth quarter.

Operator

[Operator Instructions] And our next question comes from the line of Catherine Mealor with KBW.

Catherine Mealor

I wanted to go back to fees. You talked a little bit about some of the initiatives that are increasing fees for this year. But it looks like your fee guide is a little bit more conservative today than it was last quarter. Can you just talk a little bit about where that's coming from.

John Asbury

Yes. Actually Catherine, it's kind of a an apples and orange kind of thing. We changed up how we looked at it. If you look at the previous guidance, we said we would grow after we excluded the impacts of the sale of our RIA business. This time around, what we basically said is – we took that out of the equation and said, okay, we're about $910 million of non-interest income in 2022, that's going to come down mid-single digits, as we say. So we basically just took that out of the equation if you take that out. It would actually have grown if you adjust for the RIA reduction due to the sale to Care Street Partners or the investment we made in Care Street Partners. So it's really apples and apples when it comes down to the absolute number. But the way we described it, we changed how that got put in the deck.

Catherine Mealor

That makes sense. Okay thank you so much for clarification. And then on deposit costs, can you give us just a sense as to where deposit costs were maybe towards the end of the quarter? Or where new deposit costs are coming on? And as you think about deposit growth over the next year, you think it's coming more in CDs or money market and maybe kind of where those rates are today?

David Ring

Yes. We certainly from a growth point of view, going into 2023, we're projecting kind of low single digit overall deposit growth. But to your point, most of that's coming into the higher cost categories, both money market and CDs, and we've been increasing our rates. We have some promotions and specials on those. And that's where we're seeing some growth. As John mentioned, we have seen some deposits come back from the fourth quarter or year-end.

In terms of the rates going on, so if you look at our December rates for the total deposits, it's coming on at 85 basis points, is what we reported in December. So, that's ticked up. And then interest bearing, in particular, now up to 1.23%. So if you look at that versus what we reported on average for the quarter, the cost deposits was 72% in the quarter, average going up, that's 85% if you look at on a spot basis. And the $105 million on interest bearing deposits, now 123.

Now, we do expect that those will continue to increase in 2023. As deposit betas actually increase, we've seen a lag in deposit betas, we now see more competition in in these categories in competition for deposits. So we are expecting that, on average, you start to see interest bearing deposits kind of landing in the, call it, 1.80% to 2% next year in total deposits, in 1.25% to 1.35%.

So, again, if you look at our betas to date, we're about 25% on interest-bearing deposits, 17% total deposits through the fourth quarter during the cycle. That's up from 18% and 12%. As we go forward, we're now looking at through the entire cycle, through the end of 2023, we think interest-bearing deposits will cycle out at 37% beta and total deposits about 27%, 28%. So, you're going to see those start to pick up in a more fairly accelerated basis, some of which we saw in the fourth quarter and we expect in the first few quarters of 2023.

John Asbury

Catherine, let's face it. As an industry, we saw the change happen in December in terms of deposit rate behaviors, increasing rate competition, not just from other banks, but U.S. Treasury bills, money market, mutual funds, et cetera. And so, we've had to respond to that.

Our strategy is not to pay the highest depository rates. This is where I think we’re in an environment now where, I hope, we'll be able to demonstrate the strength of the great deposit base, which I've referred to for six years as the crown jewel of the franchise. I am impressed that, despite having closed 27% of our branches, we actually grew net consumer households last year. I've heard through the years questions of why do you even have a retail bank at this point. This is why. So granular, diversified deposit base. I am glad that we have a diversified deposit base across these markets and isn't concentrated in any one given metropolitan area, for example. So we're not immune from deposit, beta. We'll feel it, but I think we'll be able to weather the storm.

It's another reason why I am so grateful that the strategy of this company has been not to make long-term fixed rate real estate lines. That's not a good place to be right now. So having half the deposit base and variable – primarily the loan book and variable rate is why we said what we did, which is we may be at an equilibrium point right now, but we should be able – on the NIM, we should be able to use additional asset beta to help cover increasing deposit base. So we'll see where it goes from here.

Catherine Mealor

That’s great. And certainly, it looks from the – where new loans are coming on, you've got a lot of upside from that current core loan yield. As you look out, you think the kind of quarterly betas probably continue at this pace from on the loan side.

Robert Gorman

Yeah, yeah, definitely, Catherine. Definitely, on the loan side, we'll see that pace continue. It's really about how the deposit betas are going to react, both the individual banks having to fund their loan growth, but also the competition and what rates look like in terms of what betas end up being. We will be definitely competitive on that front.

Catherine Mealor

Maybe just one more on the margin on just on borrowings. I saw the end of period borrowings were up a little bit. How are you thinking about overall borrowing levels into this year?

Robert Gorman

As we said, we had a late quarter run-off in deposits. So, we had to pull in some funding as loans continue to fund out, which we want to make sure that we put those loans and have the funding accordingly. We ended up borrowing from the Federal Home Loan Bank. We will continue to see some of that kind of as a play between what deposit growth is and what loan growth is. But we'll be pretty disciplined around using wholesale funding mechanisms, whether brokered CDs or Federal Home Loan Bank. We've typically run at higher levels through the pandemic. We didn't need to. But we got run off late in the quarter, we had to call on those resources, and we did. But we've got a number of levers to pull on that front. And the way we look at it is that the lowest cost wins the battle, if we need to go on those.

John Asbury

These are good levers to have, they're important from a diversification standpoint. But, ideally, you wouldn't use them at all. It serves FHLB in particular, I think it was a swingline, meaning we were able to tap that as we needed at year end. We'll see how things continue from here. But we've had a good month in January in terms of deposit growth. I hope that means Rob will be paying it down. But we'll go in and…

Robert Gorman

Yeah. That’s right. Obviously, we'd rather have core deposits on the books – not have to draw down on wholesale because they're obviously a little more expensive funding. But I think we'll always have some of that.

John Asbury

Having been here in a year is the only time I've never seen us not use the FHLB line at all was during the pandemic. So some amount of it is typical for us.

Catherine Mealor

Great quarter.

Operator

Our last question comes from the line of Laurie Hunsicker with Compass Point.

Laurie Hunsicker

John, Rob wanted to say where Catherine was on the funding side. I'm just trying to understand this. You had a significant jump in the short-term borrowings. And they are, on a percentage basis, one of the highest we've seen, right. So, you're up at $1.8 billion. And I just wanted to make sure I sort of heard that. You're going to likely rewind that back down? Or just looking at the average ounces, it looks like most of that came out late in the quarter. So not rolled into, obviously, a full quarter impact. Just trying to connect all the dots there.

And then, just one more question to around that. Do you have a spot margin at December 31? Or maybe even current how we should be thinking about that?

Robert Gorman

Yeah. Spot margin at December 31 is 3.74%. Laurie, for the month of December. That's what you're looking for.

Yeah. So as I mentioned, we did use the Federal Home Loan Bank, and that's kind of outsized borrowings at the end of the quarter. Not all of that was short term. I think it was about $1 billion of short term laddered in Federal Home Loan Bank. We also have some long term borrowings. But those are trucks and other non-FHLB borrowings, if you will, that roll into that line item. We do expect that as deposits come in, we will be paying those down. Again, I don't think we'll be staying at this level unless we see more deposit outflows than they we're expecting, but remains to be seen at this point.

John Asbury

Correct. And Laurie, one thing I'll point out is that if you step back, point to point for the full year, deposits declined just over 4%. Truth is we had forecast when we did our budgeting a little more than that. So that's better than the original expectation. It is also true that we saw an unexpectedly large run up in deposits in Q3. So, over $400 million. So, part of what you're seeing is that delta or the absolute value, the difference between big increase in Q3, yes, we saw a larger decrease in Q4 and it all came pretty quick in the month of December. And thankfully, we're on a pretty good footing. As indicated, loan to deposit ratio yesterday was 88%. We'll see what happens. The year is early, but we'll go in and out of the FHLB line as needed.

Laurie Hunsicker

Can you just comment specifically on the demand deposit drop linked quarter, going from in round numbers $5.3 billion down to $4.9 billion.

John Asbury

Go back and look at Q3. So, you're going to see the increase, over $400 million go up in Q3. You are right, is the rise in Q3 and the drop in Q4 was largely in transaction accounts. It's not uncommon for us to have some degree of drop late in the year due to some of the larger clients. You'll particularly see this in the government contractor space. But it was more than we expected. That's not just seasonality. We did, in fact, see money begin to go looking for higher yielding assets. There's no question about it. Mostly on the business account side, Laurie, if you look at – on the consumer side, we had some of that with more affluent clients. But the reality is we're just looking at our consumer deposit base by quartile and it's down a little bit in terms of average balances, but it's held better than you might think.

So fundamentally, there's some element of year-end seasonality that's probably explaining, in part, part of why we're seeing deposits rise again right now because we can see some more volatile deposits with some of the larger ones, some money going and looking for higher yield. And then just some usual year-end activities as small business, for example, maybe on cash basis of accounting, like a professional practice will pay out profits right at year end to minimize tax proposes and tax obligations. But I've hit the main drivers of it.

Laurie Hunsicker

I guess switching over to expenses. Just a couple questions there. The one-time expenses that you have this quarter, can you help us think about that? In other words, the branch costs, branch closure costs, the gain on the sale leaseback of the office, the write down on the software, and maybe the refund that you got back on the FDIC. And then, along those same lines, what are the costs going to be on the branch closures in the first quarter of 2023 and do you have a benefit there quantified?

Robert Gorman

Yes, we do. Yes. In terms of the fourth quarter, notable items, that kind of continued as one-time non-recurring. Basically, the positives and negatives basically come out to zero. So we didn't think it was necessary to kind of dissect and report each individual component. So, if you think about it that way, the total expense that you see reported is kind of our run rate because all this other stuff netted out.

In terms of the – what was the other question there at the end.

Laurie Hunsicker

Yes. Maybe if you could just drill down what the cost of the branch closures are and then what those look like in the first quarter?

Robert Gorman

Yes, right. Laurie yes. So from the branch closure point of view, five branches will close in March of 2023. Annualized savings is going to be about $1.5 million starting then. And we are going to incur a few more one-time costs associated with that due to getting out of some leases that we have. That's probably in the tune of about $400,000 in the first quarter.

And then, overall, we're looking at mid-single digit expense growth off of the run rate that we have. So, this is kind of way to think about it. There's an uptick in the first quarter due to seasonality. And then overall for the year, we should be up mid-single digits.

Laurie Hunsicker

Got it. And then on your expense guide, was your base $398 million or is it going to headline more...

Robert Gorman

I'm sorry. $398 million was the baseline that we've been using.

Laurie Hunsicker

Okay. And then just one more question on expenses. The total cost of the branch closure, so $400,000 in the first quarter of 2023, what's your total?

Robert Gorman

Yeah, it was about $700,000 in total, split between Q4 and Q1.

Laurie Hunsicker

Got it. Perfect. Okay. Got it. Okay. And then just quickly, Rob – or maybe this is to David, the jump in the commercial real estate, non-performers, the owner occupied – and clearly, your asset quality is looking great. But the jump that we saw there, was that one loan, are there several loans or can you share with us maybe even the type of loans?

John Asbury

Doug Woolley, Chief Credit Officer, is here. We'll let him answer that.

Doug Woolley

It's just a handful of small loans.

Laurie Hunsicker

Any particular type or…?

Doug Woolley

No pattern.

Laurie Hunsicker

No pattern. John, last question to you. Can you talk a little bit about buybacks, why you're not being active? We're seeing other banks start to ramp up in that. Can you help us think about how you're approaching that?

John Asbury

That's a capital management decision. Rob, you touched on it earlier. Just given the uncertainty out there, we like the idea of buybacks, to be clear. Do you want to pick it up from here?

Robert Gorman

Yes. Certainly, we've been active in buybacks over the years. We just felt that at this point in time, with – especially, as you saw loan growth come in 15% annualized, we want to make sure we preserve our capital and keep that dry powder for growth, as well as really not knowing if we've got a recession comment on how deep that might be. So it's really, let's call it, more of a short term pause until we can see some clarity around a potential recession and where loan growth goes from.

John Asbury

I like that characterization. As we get more clarity, we'll revisit that decision because, as you know, Laurie, as Rob says, we do have a history of using buybacks as we accumulate surplus capital. Obviously, we want to grow the bank, but we're not a hyper growth bank under really any scenario.

Laurie Hunsicker

Great. Thank you, gentlemen.

John Asbury

Thank you so much, Laurie. By the way, I also want to thank you for being one of our two diehard analysts, and Catherine and Mealor, the two survivors. I hope you both go ask your bosses for raises, and we are delighted to have the new analysts. We're expecting one more to initiate that will be on next quarter, we hope. So thank you all very much. It was a good year for Atlantic Union Bank. It was a good quarter for Atlantic Union Bank and we are cautiously optimistic about where we go from here. Thank you.

Bill Cimino

Thanks, everybody. And as a reminder, this call will be available on our investor website investors.atlanticunionbank.com. Thanks, and we look forward to talking with you next quarter. Goodbye.

Operator

This concludes…