Atlantic Union Bankshares: Rosy Earnings Outlook Appears Mostly Priced In
Summary
- The high allowance level and limited credit risk will likely lead to net reversals of provisions for the full year.
- Economic recovery in Virginia and efforts to improve the digital banking platform will likely boost loan growth.
- The reinvestment of cash flows from maturing fixed-rate loans will likely pressurize the net interest margin.
- The December 2021 target price suggests a small upside from the current market price. Moreover, Atlantic Union is offering a modest dividend yield.
Earnings of Atlantic Union Bankshares Corporation (NYSE:AUB) will likely receive a boost from reversals of provision expense. Further, an improvement in Virginia's economy and investments in digital customer experience will likely boost loan growth. On the other hand, low reinvestment rates will likely pressurize the net interest margin, which will constrain the earnings growth. Overall, I'm expecting Atlantic Union to report earnings of $1.97 per share in the last three quarters of 2021, taking full-year earnings to $2.64 per share, up 36.5% year over year. The year-end target price is quite close to the current market price. As a result, I'm adopting a neutral rating on Atlantic Union Bankshares.
Net Reversals of Provisions Likely for 2021
Atlantic Union Bankshares reversed a large amount of provisions for loan losses in the last two quarters. In my opinion, further reversals cannot be ruled out because the allowance level is quite high relative to actual loan losses. Allowances made up 1.09% of total loans at the end of March 2021 as opposed to net charge-offs of 0.03% of average loans in the first quarter, as mentioned in the first quarter's earnings release. Further, the allowances are quite high from a historical perspective. Allowances averaged only 0.47% of loans from 2016 to 2019.
Moreover, the portfolio's credit risk is currently at a low level. Loans requiring payment modifications made up just 0.5% of total loans, excluding Paycheck Protection Program loans, as mentioned in the first quarter's investor presentation. However, Atlantic Union Bankshares has material exposure to the hotel industry, which will likely be one of the last industries to recover from the pandemic. As mentioned in the presentation, loans to hotels made up 4.7% of total loans.
Overall, I'm expecting Atlantic Union to report a net reversal of provisions of $5 million in 2021 as opposed to a net provision charge of $87 million in 2020.
Low Reinvestment Rates to Counter Modest Loan Growth
The loan portfolio will likely continue to expand in the year ahead because of the vaccine-driven economic recovery. Atlantic Union operates in Virginia, whose economy has been faring much better than the rest of the country. As shown in the chart below, Virginia's unemployment rate is better than the national unemployment rate.
The company's commercial line utilization dropped to 25% in the first quarter, which is well below the normal line utilization of 40%, as mentioned in the first quarter's conference call. I'm expecting the economic recovery to lead to an increase in commercial line utilization towards a more normal level. Further, the company has planned digital customer experience improvements which will let customers complete mortgage applications entirely online.
On the other hand, the upcoming forgiveness of Paycheck Protection Program ("PPP") loans will likely constrain the loan growth. As mentioned in the earnings release, round one PPP loans totaling $1.03 billion remained to be forgiven at the end of March, representing 7.2% of total loans. I'm expecting these loans to get forgiven before the mid of 2021. As mentioned in the earnings release, unamortized fees totaling $10.7 million remained to be recognized at the end of the first quarter. Due to the unamortized PPP fees, I'm expecting the net interest income to remain high in the second quarter before declining in the second half of 2021.
The management mentioned in the conference call that it expects 4% to 5% loan growth for 2021, excluding PPP. Considering the factors mentioned above, I'm expecting the loan portfolio to increase by 1.5% by the end of December from the end of March 2021. For the full year, I'm expecting the loan portfolio to increase by 3.5% year-over-year.
Meanwhile, the deposit growth will likely continue at a normal rate. I'm expecting deposits to increase by 3% by the end of December from the end of March 2021, leading to full-year growth of 6.8% year-over-year. The following table shows my estimates for loans, deposits, and other balance sheet items.
As mentioned in the presentation, around 50% of total loans, excluding PPP, were based on fixed rates at the end of the last quarter. As a result, it is safe to assume that a large part of the portfolio is yet to fully price in the interest rate cuts of last year. Due to the maturity of fixed-rate loans and the reinvestment of cash flows from maturing loans at lower rates, I'm expecting the average portfolio yield to remain under pressure in the year ahead.
On the other hand, certificates of deposit ("CDs") repricing will likely ease the pressure on the net interest margin. As mentioned in the conference call, the management expects CD repricing to reduce deposit cost to the mid-teens level from 21 basis points in March.
Overall, I'm expecting the net interest margin to decline by 6 basis points in the last three quarters of 2021, excluding the impact of accelerated PPP fees. As a result, I'm expecting the average net interest margin in 2021 to be 22 basis points below the average margin for 2020.
Based on the outlook for loan growth and margin compression, I'm expecting the net interest income to decline by 0.8% year-over-year in 2021.
Expecting Full-Year Earnings of $2.64 per Share
The anticipated reversal of provisions and the loan growth will likely drive the bottom line in 2021. On the other hand, the margin compression will likely constrain bottom-line growth. Further, mortgage banking activity will likely decline in the year ahead due to stable interest rates, which will pressurize the earnings. As mentioned in the earnings release, around 60.5% of originations in the first quarter were attributable to refinancing volume, which is quite far from the stable mix foreseen by the Mortgage Bankers Association ("MBA"). MBA expects refinancing volume to make up only 25% of total mortgage volume by next year. As a result, I'm expecting the fall in mortgage banking revenue to decrease the non-interest income by 1.4% year-over-year in 2021.
Overall, I'm expecting the company to report earnings of $1.97 per share in the last three quarters of 2021, taking full-year earnings to $2.64 per share, up 36.5% year-over-year. The following table shows my income statement estimates.
Actual earnings may differ materially from estimates because of the risks and uncertainties related to the COVID-19 pandemic and new variants. The portfolio's exposure to the hotel industry adds to the risks.
Current Market Price is Quite Close to the Year-End Target Price
Atlantic Union Bankshares is offering a dividend yield of 2.6%, assuming the company maintains its quarterly dividend at the current level of $0.25 per share. The earnings and dividend estimates suggest a payout ratio of 36% for 2021, which is below the five-year average of 46%. As a result, there is room for a dividend increase. However, to be prudent, I haven't incorporated a dividend increase in my investment thesis.
I'm using the historical price-to-tangible book ("P/TB") and price-to-earnings ("P/E") multiples to value Atlantic Union. The stock has traded at an average P/TB ratio of 1.82 in the past, as shown below.
Multiplying the average P/TB multiple with the forecast tangible book value per share of $21.0 gives a target price of $38.3 for the end of 2021. This price target implies a 0.9% downside from the April 30 closing price. The following table shows the sensitivity of the target price to the P/TB ratio.
The stock has traded at an average P/E ratio of around 16.3x in the past, as shown below.
Multiplying the average P/E multiple with the forecast earnings per share of $2.64 gives a target price of $42.9 for the end of 2021. This price target implies an 11.0% upside from the April 30 closing price. The following table shows the sensitivity of the target price to the P/E ratio.
Equally weighting the target prices from the two valuation methods gives a combined target price of $40.6, which implies a 5.1% upside from the current market price. Adding the forward dividend yield gives a total expected return of 7.6%. Hence, I'm adopting a neutral rating on Atlantic Union Bankshares.
The company's earnings are likely to surge this year because of reversals in provisions for loan losses and subdued loan growth. However, the earnings outlook appears to be mostly priced in as the current market price is quite close to the year-end target price.
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