First Horizon Corp
NYSE:FHN
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First Horizon Corp
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Good morning everyone, and welcome to the First Horizon National Corp., First Quarter 2019 Earnings Conference Call. [Operator Instructions]. Please also note, today’s event is being recorded.
And at this time I would now like to turn the conference over to Aarti Bowman, Investor Relations. Please go ahead.
Thank you, Jamie. Please note that the earnings release, financial supplement and slide presentation we'll use in this call are posted on the Investor Relations section of our website at www.firsthorizon.com.
In this call we will mention forward-looking and non-GAAP information. Actual results may differ from the forward-looking information for a number of reasons outlined in our earnings materials and on our most recent annual and quarterly reports.
Our forward-looking statements reflect our views today and we are not obligated to update them. The non-GAAP information is identified as such in our earnings materials and in the slide presentation for this call, and is reconciled to GAAP information in those materials.
Also, please remember that this webcast on our website is the only authorized record of this call. This morning's speakers include our CEO, Bryan Jordan; and our CFO, BJ Losch. Additionally, our Chief Credit Officer, Susan Springfield will be available with Bryan and BJ for questions.
I'll now turn it over to Bryan.
Thank you, Aarti. Good morning everyone and thank you for joining the call. I'm pleased with the start of 2019 and remain optimistic about the full year prospects. I'm also confident that our team is controlling those things that we can control.
In the first quarter our balance sheet showed real momentum with 7% loan growth and over 10% customer deposit growth on a linked quarter annualized basis. We achieved positive operating leverage and took action to position us better for ongoing improvement. Credit quality remained good and we returned capital to our shareholders, taking advantage of attractive share prices to repurchased stock. We increased our common divided by 17% in the quarter.
As it looks now, today, this morning, this week, interest rates are likely to be somewhat more challenging than we might have thought three months ago while we recognized it's probably likely going to be further volatility. Given that, we do think our margin should be reasonably stable from where they are here over the remainder of the year. We can't control interest rates, but as I said earlier we can and are controlling those things that we can.
We remain focused on achieving our strategic priorities laid out at our November Investor Day. We are making good progress and profitably growing our presence in key markets and maintaining strengthen in our core Tennessee franchise. Our markets are providing better than average growth opportunities.
We're seeing solid loan demand across our markets, particularly in our specialty lending areas. Deposit growth is excellent helping improve our funding mix. We've been able to hire experienced bankers in new markets who are adding to our customer base and profitably building our franchise.
During the first quarter we grew customer accounts in mid-Atlantic and South Florida very aggressively contributing to the new deposit inflows. We are optimizing our expense bases well, maintaining good operating expense discipline, while continuing to invest in technology and business development. During the first quarter we took new efficiency actions that will provide additional funds for reinvestment and lower our annual expense run-rate. BJ will give you more details in a few minutes.
Looking ahead, we expect the economy and its rates to be relatively steady for the rest of 2019. Our key markets should continue to grow at a faster than average rate providing us good organic growth opportunities. While the interest rates outlook is moving around, we think it will be relatively stable in terms of impact on our margin and we do expect our loan and deposit growth to continue to be strong.
Our credit quality and net charge-offs remain low. We expect if they do begin to normalize, that our strong disciplined and underwriting and our highly diversified balance sheet will help benefit us. Our capital position is also strong. We continue to control what we can control focused on delivering profitable growth and strong returns for our shareholders throughout 2019.
I'll now turn it over to BJ to go through the quarter and then I'll come back with a few closing comments. BJ?
Great! Thanks Bryan. Good morning everybody, thanks for joining us.
I'll start on slide six with our financial results. For the first quarter our reported EPS was $0.31 and $0.35 on an adjusted basis. In the quarter we saw strong balance sheet trends for both loans and deposits as Bryan mentioned, improve revenue and good expense discipline. Our credit trends remain benign with net charge offs down to less than $5 million, but loan loss provision up modestly reflecting loan growth in the regional bank that was somewhat offset by a provision in credit in non-strategic.
Total revenues were up 6% linked quarters and 3% on an adjusted basis. Fee income in particular was meaningfully higher, driven by a strong quarter from our fixed income business and fee income related to deferred compensation, only partially offset by lower NII in the quarter due to fewer days and expected lower loan accretion.
Total expenses were up 5% linked quarter and 3% on an adjusted basis. Restructuring charges, deferred compensation expenses and variable comp from higher revenues and fixed income were the drivers. All other expenses were down nicely $9 million linked quarter, driven by strong expense discipline across the organization.
In addition, you'll see on the bottom right at slide six that we had about $12 million of restructuring charges related to some actions we took in the first quarter to improve our go forward expense run rate. We will discuss those in a little more detail in a few minutes.
You will note that in both fee income and expense there are fairly large, but offsetting deferred compensation related impacts. You may recall that we saw the same kind of impacts in the fourth quarter. This occurs when there are large swings in equity market valuation quarter-to-quarter as we saw with equity market declines and gains in 4Q ‘18 and 1Q ‘19 respectively.
Finally balance sheet trends across both loans and deposits were quite strong in the quarter with broad based C&I growth particularly in some key markets and specialty businesses, as well as strong deposit growth in both consumer and commercial businesses.
Looking at the loan growth a bit more on slide seven, the strength clearly came from new business in our C&I portfolio as that growth more than offset the run-off from non-strategic as we saw 7% linked quarter annualized growth in the total aggregate loan book. Period end C&I growth for the quarter was a little over 4% or 17% [ph] linked quarter annualized and was up 9% year-over-year.
In the commercial real-estate portfolio we did continue to see an elevated level of pay-off as borrowers refinanced that of our portfolio into the permanent market and we saw some strategic exits as well. Consumer portfolio was down primarily to the continued strategic run-off as expected and as I said earlier, the C&I growth was broad based across several markets and specialty businesses. So let's take a look at that a bit more on slide eight.
As we discussed on the fourth quarter call we started to see some really good customer activity and momentum in December towards the end of the year and it certainly continued into the first quarter. We saw good execution on our key priority of profitably growing our key markets and specialty areas, driven by that strong C&I growth and overall the regional bank posted total loan growth of 8% linked quarter annualized with increases in key markets such as South Florida, Middle-Tennessee and Houston.
Our specialty areas grew 14% linked quarter annualized driven by increases in loans to mortgage companies, our healthcare business and our corporate banking business. The focus on growing our specialty areas which comprised 40% of the regional banking loan portfolio remains a key growth opportunity and a differentiator for us.
Turning to the deposit side on slide nine. We saw excellent growth across all our market in Tennessee, in our Mid-Atlantic region and our Florida markets. As we discussed at our investor day, we have an opportunity to improve deposit and funding mix over time by reducing our higher cost market index deposits and transitioning into new customer deposits.
As you can see, in the quarter we were placed $1 billion in 100% beta market index deposits at 2.52% rate paid with lower beta new customer deposit at 191 basis points and approximately 60 basis points funding advantage. Over time our plan is to continue to deepen those customer relationships and we see further opportunity to reduce market index deposit and improve our overall funding costs and mix.
Even though we were able to reduce our market index deposits by about $1 billion by period end, average market index deposits only declined by 4% linked quarter. The combination of very strong customer deposits flows and excess market index deposits for much of the quarter led to a large excess cash position at the Fed, which has only a modest impact on NII, but reduced the net interest margin by about 6 basis points. We will continue to work these excess balances down.
Let's shift to slide 10 and talk about the drivers of net interest income and net interest margin for the first quarter. Linked quarter, you see net interest income was down $8 million as solid balance sheet growth benefits were offset by fewer days in the quarter, about $4 million as a decline and by lower accretion another $4 million as a decline.
The NIM overall declined 7 basis points as about 4 basis points of the positive impact of balance sheet growth were offset by the excess cash at the Fed that I just mentioned, which caused a 6 basis point drag on the margins and lower loan accretion quarter-to-quarter which had about a 4 basis point impact.
Moving on to fixed income on slide 11, activity in the quarter was strong as economic and interest rate dynamics benefited FTN and demonstrates the counter cyclical benefit of this business. Average daily revenues in the first quarter were $729,000, up 48% with all trading debt seeing increases in the quarter.
Fixed income, pre-tax income increased $8 million linked quarter from both the higher average daily revenues and the benefit of the fixed cost reduction efforts that the business had been making over the last several quarters. This quarter's performance is a good example of two things, number one how quickly FTN can capture market and profit opportunity and number two, the counter cyclical nature of this business.
We’ve showed the table in the bottom right before, but thought it would be a good reminder of how the market environment affects FTN. Three of the four conditions for higher revenue for this business were present in the quarter, the direction of rates, market volatility and uncertainty about the economic outlook and the business was well prepared and took advantage of market conditions.
Let's turn to expenses on slide 12. Well, there are few moving parts in the quarter. The underlying expense discipline is very evident as you can see in the chart on the bottom of this page. And if you look at that chart starting with the 4Q ‘18 adjusted expense of $270 million, first you will see a $13 million increase quarter-to-quarter from the differed compensation expense changes that I talked about earlier. Again, this is not actual payments, but changes in the valuation of the liability we have for deferred compensation participants.
As noted in the chart, the deferred compensation net pretext impact was about $1 million linked quarter with that expense increase offset by fee income increases of $12 million.
Second, you'll see the fixed income expense increase for variable compensation related to the $14 million of higher revenue in the quarter and thirdly, you'll see all other expenses in the company were down $9 million linked quarter, as we saw broad based declines across numerous categories as we continue to be disciplined about controlling expenses.
In addition with some continued acquisition related expenses, the first quarter did include those restructuring charges of $12 million and those actions that we took in the first quarter are expected to reduce the annual run-rate by about $30 million. These actions were taken in a variety of areas across the organization in our regional banking group, FTN and our support areas to free up expense dollars to reinvest into strategic hires and customer facing technology, while maintaining lower levels of expenses to drive positive operating leverage.
Turning to asset quality on slide 13, we see continued solid asset quality across our portfolios. In the first quarter our net charge-offs were just under $5 million, down from $12 million in 4Q ‘18. The linked quarter provision increase was due to the solid loan growth within the regional bank, and as you can see overall credit trends remain solid with linked quarter declines in 30 day delinquencies, as well as overall criticizing classified loans in the commercial portfolio. We continue to see steady credit performance with issues being more idiosyncratic or one off and do not see broad based deterioration in the book.
Turning to slide 14, as many debate how long the current economic expansion will last, this slide serves as a good reminder of just how much our balance sheet has evolved into a much higher quality portfolio over the last several years. As you can see our loan portfolio has shifted from a real-estate oriented portfolio a decade ago, to a much higher quality commercially oriented portfolio. We now have a much smaller but much higher quality consumer portfolio with no sub-prime and minimal exposure to high risk consumer lending and relative to our risk profile and earnings power, our capital levels are strong.
Looking at the most recent stress testing and it's severely adverse economic scenario, we showed a stronger credit performance and capital resiliency compared to our peers. First, we have significantly lower stress loss rates as our net charge offs are less than half of the average of all the DFAST peers in a severely adverse scenario, and our stress scenario CET1 decline of 90 basis points is well ahead of the DFAST peer average decline of about 440 basis points.
So on wrapping up 1Q ‘19 highlights on slide 15, we are seeing steady profitable loan growth, strong deposit growth across our markets and specialty areas. We had good expense discipline and are taking additional efficiency actions to reinvest in the company and drive further earnings improvement. FTN performance was encouraging with higher levels of ADR. Credit quality stable with continued prudent underwriting and we deployed capital effectively with share buybacks and the dividend increase.
We are pleased with the execution across our key priorities and we are controlling what we control. What we can't control as Bryan mentioned are interest rates and sentiment about the macro economy.
If you look at slide 16, you'll see that while our balance sheet trends, expense discipline and credit quality remains strong and consistent with our expectations coming into 2019, the outlook for Fed rate actions and the subsequent changes in the forward curves over the last couple months have moderated our view of our NIM and NII growth opportunities for 2019.
Coming into the year, as you know we had assumed one fed funds rate hike and a corresponding increase in one month LIBOR over the course of the year, but the markets have clearly reversed that expectation. Therefore our current expectation is for our net interest margin to approximate current 1Q ‘19 levels over the course of 2019. That expectation now assumed no changes the fed funds rates in 2019. A stabilization of one month LIBOR at current levels and steady decline in our capital bank related loan accretion.
On July 17, while the balance sheet growth fixed income and expense discipline show positive results, based largely on the macro rate averment we've updated our full year outlook. The changes made on each of these metrics are based largely on the change in our margin outlook, with our views on operating performance related to balance sheet growth and expense discipline remaining intact. We're encouraged by our solid performance in the first quarter and we remain focused on continuing to improve earnings power and profitability.
With that I'll turn it back over to Bryan.
Thank you, BJ. Early second quarter signs continue to be good as well. We see good trends in the balance sheet and we're very optimistic about the quarter and the momentum going into the latter parts of the year.
We are very encouraged about what we're seeing in our newer markets. Our bankers are now up to speed on the new products and services and they're doing a great job of delivering those to our customers.
I'm also excited about our organic growth opportunities and we believe that we are increasingly well positioned to maximize the opportunities in our market and the customer opportunities that we see out there.
Thank you to all of our First Horizon colleagues for all of their hard work, all of their doing to grow our business and deliver customers exceptional experiences and differentiated products and services.
With that Jamie, I’ll now open it up for questions.
[Operator Instructions]. Our first question today comes from Steve Alexopoulos from J.P. Morgan. Please go ahead with your question.
Hey, good morning everybody.
Good morning Steve.
Good morning Steve.
Just to start on the capital markets business, the surge seemed to be much stronger than the environmental factors would have implied. Could you give more color there and are you seeing this level of ADR continue into 2Q?
Yeah, so hey Steve, it’s BJ. Yeah, you think about what's been going on the last couple years with let’s start with direction of rates. The bias has clearly been rates up, which means bond price is down, and so you know that coupled with you know the flattening of the curve really dampened any fixed income activity over the last couple years.
What you started to see particularly towards the end of December and continuing into the first quarter this year is fed signaling that they were on pause and the market sentiment potentially saying rates would be down. Rates down for the business means, you know bond prices going back up and people taking advantage of an opportunity to maybe jump in and purchase bonds at lower price points.
So we saw some of that activity. What was very encouraging to us as well is that it was more broad based than sometimes we usually see. It was not necessarily very large trades that we did; of course have some of those, but it was a cross our different trading desks. GGL had a very good core, our Government Guaranteed Landing, our SBA business had a good quarter as well. So you know again the broad based aspect of it and that was very helpful.
The last thing I'll mention is the sentiment on the economy. Now clearly there was bullishness over the last couple years. There is still some improvement in the economy to come, we believe, I believe, but there's a little bit more debating questioning about that and that market uncertainty leads to more activities and repositioning of portfolios and again fixed income took advantage of that.
The last thing I’ll mention that shouldn't be lost is that our FTN business and the leadership that Mike Kisber has over there, that leadership team has done an excellent job taking fixed expense out of that organization over the last several quarters. It’s been hard to see with muted revenues, but you could certainly see the positive operating leverage that they created in this quarter with revenues up 14%, but expenses only up 4%. They really, really have done a good job taking as much fixed cost out, while being able to take advantage of market opportunity when it comes back.
Steve, this is Bryan. BJ did a good job summarizing. I would just add you know 16 days into the second quarter not a trend, but we do see average daily revenues on the same current line as we saw in the first quarter. So we are optimistic about at least how we start the second quarter and how that might play out over the rest of the year.
Okay, thanks Bryan. On the expense front, I want to make sure I understand the picture given there are so many moving parts to the quarter. So if I take the $278 million adjusted and annualize that, then we take out the $30 million from the restructuring, I'll give about a little over $1.08 billion as the base. My question is, how should we think about growth from that base?
Yeah, I think Steve – its BJ. It’s really the growth is going to be related more to what fixed income does and the variable compensation from fixed income.
Now I talked about our expectation for 2019 ex net interest margin, being largely consistent with what we were saying at Investor Day, which was expense is flat to down for 2019 with the only delta being fixed income. So we still believe that we are taking cost out of the organization, we are being very disciplined. As Bryan talked about, we are re investing some of it, but we expect that our expense discipline is going to be very good this year.
Steve, this is Bryan. I'm going to backed up a little bit from the modeling and just talk about how we think about the expense base. If you go back and you start in 2009 and ‘10 and you look at the trend line, we have taken and been pretty aggressive over the years looking for opportunities to gain efficiency and to deliver on greater efficiency and then reinvest in that in the business and we've done that over the years and updating our technology and so on and so forth.
As we look out into the future, we think a couple of things are likely to be true. One is, you know what BJ had described about the interest rate environment. That is going to be more stable than seeing a significant run up in interest rates. And two, that expense control is going to continue to be extraordinarily important and I say extraordinarily because one, there is a lot of upward pressure on the expense base and I think on an industry wide basis as more technology is required, changes in technology accelerating, to that nature.
And we believe very firmly that we need to get out ahead of that and we need to look for opportunities to continually redefine our expense base, so we can bring our aggregate cost levels down one, and two that we can make the investments necessary to be competitive from a customer perspective.
So what you see us doing is trying to get out ahead of those things that we think are going to be required investments in the business and at the same time, bring down the aggregate cost levels in the organization.
So we’ve taken some actions that I think get us ahead and I think we see greater opportunities as we move into the latter part of the year and even into 2020 as we continue to look for ways to realign our business for greater efficiency, better products and services for our customers and deliver better shareholder results.
So Bryan, when we think about, not that I’m looking for 2020 expense guidance, but even at the Investor Day I’ve been surprised you guys continue to find areas to cut right. We saw the $30 million benefit realized this quarter. But as you look out beyond 2019, I mean are you running out of areas to cut expenses. Like at what point should we be expecting expenses to start building the company?
We’re not going to defy the laws of gravity. Inflation will have some impact, but we think you know there could be another $40 million, $50 million, $60 million of opportunity beyond what we've already talked about. So we still think that as we continue to work, that we still have opportunities as we go into 2020. Since you are not asking for guidance in 2020, I’m not going to give it for ’21, ‘22 or ’23 either.
Fair enough. Thanks for all the color.
Our next question comes from Ebrahim Poonawala from Bank of America Merrill Lynch. Please go ahead with your question.
Good morning guys.
Good morning.
Good morning.
I just wanted to get a better sense in terms of outlook for spread income BJ. So I get your guidance on the margin to be relatively flat around 3.3. Can you talk about just what you expect in terms of average earning asset growth like, should we look at your loan deposit growth guidance as reflective of that or I'm just trying to understand the remix from the market index into core deposits and how that's may play into sort of NII for full year ‘19.
Yeah, really Ebrahim, like I said our expectations for everything that we can control including earning asset growth, loan growth is intact. So we think that that will stick. The only change, material change in earning assets versus loan growth would be the level of cash that we would have. So we had very elevated levels of cash that obviously hurt our margins. This quarter we expect to be able to manage that down, so that’s going to actually dampen earning asset growth, but the core loan growth we think it's still very solid and we expect that to continue.
Understood. And would you say that incrementally like – so you talked about 190 basis points of cost of the deposits that’s coming in. Is it safe to assume that your incremental balance sheet growth is accretive to the 3.2 margin ex-accretable.
Yes, yes. I had to think about how you were asking that question, but yes it is.
Understood, and just following up on a Steve, I just wanted to make sure I understand the expense outlook correctly. So we were at $278 million, are we saying that the $30 million that you outlined is all going to flow through and as a result at some point by late this year we should be closer to a $270 million run rate, ex-cap markets?
So what we talked about, Bryan said it, I said it, is we are looking to reduce our annual run rate in areas where we can't afford to have that cost and redeploy it into areas that we think give us better potential for revenue generation and profitability going forward. And so I don't think that we will reinvest all of that money in 2019, but we will reinvest some of that money in 2019. So I wouldn't assume that it all drops to the bottom line, but we would expect that some of it does.
Our next question comes from Casey Haire from Jefferies. Please go ahead with your question.
Yeah, thanks. Good morning guys. I wanted to follow-up on some of the NIM commentary. So as you mention BJ, you're going to be working to, looking to work down the excess liquidity which obviously hurt the NIM this quarter, and then you have mortgage warehouse seasonality on the comp. What's preventing the NIM from expanding in the second quarter here?
It could, it certainly could. You know I think what we've seen just to step back for a second Casey, if you look at these macro curves that we outlined on slide 16 and you overlay our current forecast. So if you take that rate curve that we would have had at investor day and that's the market rate curve and you overlay what we're putting on in terms of our deposit loan growth and how we're changing our mix, we would have actually ended up at the higher end of our NIM forecast. That’s how well we are executing in terms of growing the business.
Unfortunately the sentiment on the curves has changed so materially that it's now down. So what we've done as we’ve lowered our expectations, we want to be a little bit more on the conservative side if we can. But clearly you know the 6 basis point drag in this quarter for excess cash we think lifts off and comes off. The accretion will still be a net drag quarter-to-quarter as that comes down. But the way that we are remixing the deposits, the way that we see accretive loan growth coming on, we think that there is certainly opportunity to move it up, but we don’t, we want to set the expectations at a place where we feel most comfortable.
Okay, I understood. And then on the loan to deposit growth guide, you guys – I mean through the first quarter here you guys are tracking above your guidance and it feels pretty constructive, the tone on pipelines. So just discourage why you know do you assume the loan growth to moderate from the first quarter pace or just why hold the loan and deposit growth guide here when you are tracking about it?
We feel really good about the pipelines and the momentum. You know I think period end growth to us is a really good indicator of what we are likely to see in the second quarter and that's really why we showed it and we still feel very good about the business activity. So if we come in above those levels, I'm sure everybody on this call would be happy, so would we. But right now are early in the year. We’re staying to the 3% to 6% range and obviously we're working to exceed it and we’ve started off rate and hopefully that will continue.
You know we think Casey, if we get a few things that go in our directions, you know one example is as we look at commercial real-estate again this quarter, we continue to have a fairly high level of pay off refinance either to sales or refinance, which is a healthy part of having a commercial real estate portfolio, you want to see it turn.
I think we had something like $232 million of pay-off, pay-downs out of a $3 billion portfolios. If you analyze that, that's you know in the ballpark a third of the portfolio on an annual basis and if you look at it over the entire portfolio it probably impacted growth a percent or two.
So we did a few things like that. Moving in the direction improves our confidence about the aggregate growth in the portfolio and I think we can't push the higher end of that range that BJ has articulated in the slides.
Our next question comes from Ken Zerbe from Morgan Stanley. Please go ahead with your question.
Okay thanks. I just wanted to ask about the ROA and ROE, RTC guidance versus last quarter or your last updated. It looks like they’ve come down to fair about a percent or two in the RTC and maybe you know 5 to 15 basis points on the ROA side.
I want to make sure we're not double counting for the restructuring costs. Like is the restructuring cost part of that? Like was this a surprise or is this truly a sort of your outlook as I would say meaningfully lower in terms of the numerator of these ratios.
Yeah, so Ken its BJ. Really what drives the difference between the current outlook and 1Q ‘19 is the change in the macro rate averment and the margin outlook. So we've essentially flattened our margin outlook for the year and that flows through all of these. It's not any change in expense discipline. As a matter of fact expense discipline I'd say fell a little bit better. Fixed income activity is a little bit better. It's really you know the change in the margin outlook that is the net decline.
On ROTCE what I would say there is, the tangible common equity is actually up fairly meaningfully because of the rate environment. The value of our investment securities portfolio is much better and that is actually accretive to tangible common equity. So the driver of ROTCE is much more the denominator, higher TTU to TEA than what we would have expected because of the change in rates.
That had some what 70, 75 basis points.
Yeah, relative to Investor Day, yes 70, 75 basis points.
Got it, okay. All right, that helps thank you very much.
Thanks Ken.
Our next question comes from Brady Gailey from KBW. Please go ahead with your question.
Hey, good morning guys.
Good morning Brady.
Good morning.
So maybe just one more on the net interest margin, and this time relating to levels of accretive yield just form the CBF deal. I think I remember right, you know when we were talking 90 days ago you all talked about how yield accretion level should be coming down roughly $1 million a quarter kind of from here on out. They came down a little over $4 million this quarter, and it feels like you know BJ you are saying that they'll continue to decline from here. I’m just wondering, has something changed with your accretable yield forecasts and I know – I thought I remember from the last earnings call we talked about a $40 million number for 2019. It feels like that's going to be a lot lower where we sit today.
Yeah Brady, its BJ. So there are really two parts to the accretion. There is what’s called scheduled accretion, which is normal payments on existing loans and then un-scheduled accretion which is pay-offs.
The second bucket is a little bit more lumpy and based on what we had seen over the first four quarters in 2018, you know we thought that there was a general cadence that we could reasonably expect for the un-scheduled part. We saw more this quarter than we did we earlier. We saw more this quarter than we would have expected. We would have expected something like 1 million a quarter; this was a little bit more. It doesn't necessarily mean it's a trend. It could moderate and stabilize at this level, but to be conservative we are assuming that it will continue to go down modestly from here.
Okay and then just on the credit quality front, I know last quarter you’ll had a couple of net charge offs driven by some C&I loans I think in manufacturing and financial services. You had the three C&I loans that came into MPA’s this quarter. So kind of a couple of quarters back to back with a little bit of credit noise specifically in C&I. Are there any underlying trends that you're seeing that’s driving this C&I credit noise?
Brady, these are still diversified and we're not very idiosyncratic as it relates to the story that we are non-performing this quarter and the couple that you mentioned from last quarter. So the three this quarter, there was one healthcare credit, an ABL loan was equipment backed and an energy credit, all with, again not anything we are seeing relative to industry issues, just again specific to those credits and borrowers.
Okay a and then last question for me, you know Bryan with the currency trading how its trading, I’m guessing M&A with you guys as a buyer is completely off the table, is that the right way to think about it for you guys.
Yeah, I think that's very – you never say never, but in all likelihood you know the same trend that I talked about last year that we continue to execute on capitalizing on the opportunities that we now have in the Carolinas and South Florida continuing to build the business, continue to execute on controlling our cost base and reinvesting that and transforming our business. So in all likelihood, I expect it will continue to focus on delivering results day in and day out and M&A is likely off the table, yes.
Great thanks.
Our next question comes from Tyler Stafford from Stephens. Please go ahead with your question.
Hey, good morning guys and thanks for taking the question. I'm still a little confused on the expense outlook. BJ I was hoping you could just go over that one more time. Just the comments about the $30 million of run rate expenses and how much of that will be reinvested. Is the $30 million that you talked about on the deck net or gross of how much will be reinvested throughout the year?
$30 million is gross.
Okay.
And so like we talked about, I don't – we are not going to specifically say how much is going to be reinvested or not. I think that the point is that we are not investing in the business as we need to like Bryan said incrementally. We are trying to find costs that we can't afford anymore because we need to make strategic hires in Florida let's say or in some of our specialty businesses or invest in robotics or invest in customer facing technology that we need to compete as a $40 billion bank going forward.
So you know we think that these types of things are necessary and as Bryan said, you know we got $30 million of annualized costs this quarter. There could be another you know $40 million, $50 million, $60 million ongoing as well that we’ll continue to look for to again largely reinvest, but hopefully not totally reinvest.
Yeah, we firmly believe that we have room to bring our overhead efficiency ratio down over time, and as we've demonstrated in the past several years, we have the ability to get positive operating leverage. We think there are opportunities for us to continue to invest in South Florida for example or in the Carolinas and so we look to make investments in people where we can grow our business, and at the same time we think that the pace of change in technology is going to require additional spending.
The but is, but we believe we need to pay for that out of our existing expense base and so as BJ has described, we look for opportunities to reallocate resources from less productive areas to more productive areas and that's always difficult because it impacts people in the organization, but we think it's an important part of making sure that one, we remain competitive, two, that we continue to grow our business and then finally that we bring our overhead efficiency ratio down over time.
So I think it's – what we're signaling is we are looking to get out ahead of the cost pressures in the industry and making sure that we have the ability to remain competitive to grow the business and to deliver better results to shareholders.
Got it, thank you Bryan, that's very helpful; thanks for clarifying that. BJ on the fixed income expenses, the $51.2 million, do you know how much of that was variable versus fixed offhand?
I don’t. Let me think for a second. Our fixed cost base in that business is about $75 million. So let’s say $80 million is fixed and the rest is variable.
Okay. So 75%, not $75 million.
$75 million in total expense for any given year is fixed expense, say $80 million a quarter, something like that.
Got it. How much on the margin shift in there, how much more opportunities do you see this year to reduce the index deposits?
Fairly material. So you see that at period end they were down 19% from the prior quarter. You know if we continue to see the deposit growth that we saw in the first quarter and expect to see the rest of the year, we could let go another several hundred million is my expectation.
So we are continuing to manage that down, not just because you know we're getting great deposit growth, which is the primary reason, but also we have alternative funding sources like Federal Home Loan Bank that are more just in time funding that we think might be more appropriate to use than holding contractual market index deposits as well. So we’ll continue to remix it, but there's certainly an opportunity to continue to bring it down really meaningfully.
Our next question comes from Rob Placet from Deutsche Bank. Please go ahead with your question.
Hi, good morning. If I could ask one more follow up on your NIM outlook and what this means for NIM to sink on the dollars. For the full year where do you think Net Interest Income shakes out? Do you think you can grow net interest income year-over-year at least on a core basis ex-accretion?
So right, if take out accretion, right, based on you know starting with 1Q ‘19 and looking at the positive loan and deposit growth that we are seeing and that the pricing discipline that we have, I would expect that we could grow NII over the course of the year. Now what that – what you're seeing there though is that rates like we said are stable, one month LIBOR is stable, those types of things. But the things that we can control around pricing, discipline and growth, we think that we can continue to grow NII.
Got it, thanks and then just separately on commercial real-estate, you continue to see elevated payoffs in this portfolio, but just curious if you could talk to your outlook for your commercial real-estate portfolio from here?
Bob we have, as you’ve seen in the last couple of quarters, it’s going to be higher than expected pay-off and I believe Bryan said this last quarter. I actually view that really as a positive related to what the economy is doing.
So the fact that some of our customers are choosing to sell properties when they get to the point when their fully leased up, they are getting good prices for those. We’ve had a handful where we've passed them to either put in equity or refinance those that they’ll need to be refinanced by others. So just from a pure credit perspective, when I see good pay offs like that, I think that indicates that we've got good underwriting and we are dealing with good borrowers.
All that being said, we do see good continued good opportunities within commercial real-estate really across all of our major markets, and we've seen good opportunity, well underwritten, good sponsors, good up front equity, Charlotte, Raleigh, Houston, Memphis, Chattanooga, Nashville South Florida. So there are opportunities there with good clients and we again seeing equity still hold very well really; pricing coming under pressure in some category, but I feel very, very good about the commercial real estate book that we've built. It’s well diversified by project type and by geography. So I think the outlook’s good.
Okay, thanks.
Our next question comes from Garrett Holland from Baird. Please go ahead with your question.
Thanks for taking the question. Just a question on positive operating leverage. What is a reasonable level to expect over the intermediate term given the challenge in spread income outlook with elevated investments spending?
Yeah, so Garrett its BJ. We always targeted at least two comps. Positive operating leverage is what we look to do quarter in and quartet out or year in and year out. So as we see opportunity to do that, we will make sure that we manage our expense base to be able to do that given the uncertain interest rate outlook, but we feel really good about what we are putting on the balance sheet, what kind of growth that that’s going to give us going forward in terms of margin, growth, our expenses are good, so we expect to be able to do that over time.
Thanks and then just to follow up on the technology investments. Just maybe the percentage of revenue, where are technology costs now and how do you expect that level to trend over the next few years? It seems like you are already spending pretty heavily on technology, but any insight on what new customer facing applications are at, it would be helpful.
Sure. So doing some quick math here. We spent about 10% of our revenue on technology today. That’s everything from customer facing technology to back office technology, to telecom and everything in between. That benchmarks fairly well with others, particularly in our peer group or even bigger than our peer group.
I think the difference is over time as Bryan alluded to, is that we've got a shift the mix of how we spend technology more towards customer facing technology and more towards you know you want to call it machine learning or robotics or artificial intelligence or things that will make us more efficient in the back office versus what I might call traditional technology or other things and those are the types of things that we are investing in.
If you remember back to Investor Day, we had a specific section on transforming our customer experience and a lot of what we're doing right now internally is looking at where those opportunities are to improve the customer experience, particularly from a digital perspective and so we are continuing to spend money on our online banking, our mobile platforms, our treasury services on the commercial side in our onboarding and product offering set that we have there. I mentioned earlier robotics. Particularly in our operations group we're expanding our use of robotics to take out automated process or automate processes that are currently manual.
All those things over time will make us a much more efficient company and our technology expenses may grow, but as Bryan said, the way that we're looking to harvest existing expenses even within technology that we don't necessarily need and put it into more useful technology going forward will also benefit us for the long term.
We think that the trends in technology are gone accelerated and it's going to be new feature functionality required in existing programs and applications. If you think about small businesses for example and even consumers, the likelihood that the industry will be expected to provide real time payments for example and technologies around that is an example.
The other thing that we expect to happen is that the pace of change in technology is going to mean that you don't put in a website or a mobile app and that it’s there 10 years from now, that the cycle times get shorter. The way I think about it is when I bought my first iPhone in 2007 or 2008 or whatever it was and paid $500, $600 for that phone, I thought it my last forever and I'm on my fifth version of the smartphone since then. The pace of change is going to accelerate.
So we preparing ourselves to be in a position to the face the competitive demand for table stakes technology and make sure that we're delivering that in the context of our community banking look and feel. And as BJ said, we have to reorganize our expense base over time to help accomplish that.
Our next question comes from Christopher Marinac from FIG Partners. Please go ahead with your question.
Thanks. Good morning. As you look at the opportunities from other bank mergers, large and small in your footprint, do you see this year as one of heavy recruitment of additional lenders in other customer facing folks or do you just see this simply taking your existing team and winning the business.
Hey Chris, it's Bryan. If you give me an option and say and take both, I’ll take both. I think it’s an opportunity to do a little bit of both. Whenever you have a lot of change in the industry, it does present opportunities from a customer perspective and from a people perspective and as we have been in the past and as we will be in the future, we're always going to be opportunistic looking for talented bankers who want to do business the way we do business, to bring them on to our platform and to grow aggressively through that.
I mentioned South Florida, we’ve added a number of bankers in the past six months in South Florida. For those of you that were at our Investor Day you’ll remember Jeff Jackson. He got up and talked about what we are gone do there and he's doing a great job of investing and executing on that.
But if we also think that there'll be customer opportunities as well and not that we wouldn't be equally aggressive in any environment trying to win new customer business. I think when you have a lot of change in the industry it does facilitate more customer transition and so we will take option C, which is I think we can do both.
Great! That’s helpful and does the expense that we see this year again from the outlook, does that anticipate additional hires as well?
Yes, yes right.
Thanks Bryan.
Sure thing.
Our next question comes from Matthew Keating form Barclays. Please go ahead with your question.
Great, thank you. I just had a follow up on the sort of the pace of the magnitude of the market index, deposit remixing. BJ if I heard you correctly, I thought you said several hundred million across the balance of this year. So just wondering, was there anything special about Q1 that you are close to $1 billion there and why is that moderating as we look at the balance of 2019? Thanks.
Yes, we were very pleasantly surprised by how much deposit growth we got from customers in the first quarter and I think as we’ve talked about what market index deposits are, they are contractual right, which helps us when we need it and it also helps the provider as well to know where they are going to place the deposits. And so even if we make a decision today that we're going to release those deposits, it will take anywhere from three to six months for them to actually go away.
And so we had a plan coming into the first quarter. We were going to let go some of those contracts and we talked about that in the fourth quarter. I think we said something like 200 million to 400 million of contracts that we were letting go, but because of the great deposit growth that we got, we started to let go more and more contracts and try to get them out as quickly as we could and it just takes a little bit of time.
So again, average market index deposits for the quarter were only down 4%, period end was down 19% and so we expect that 19% to continue into the second quarter and we’ll let go more contracts after that, such that we are managing it down further. So I think it’s a great problem to have. I don't like having a negative margin impact from excess cash, but its – liquidity is always a good problem to have for a bank and we’ll manage it down appropriately.
And then maybe more broadly on the deposit pricing front, you mentioned that the change in through the yield curve and the rate outlook right has impacted the bank's overall, and then there is margin expectations. But what is the expectation in terms of deposit costs? Are you seeing your competitors sort of bringing in deposit pricing pressures or how are you guys thinking about ex maybe mix shifts in deposits around deposit pressure across the balance of this year. Thanks.
Yeah, so I think deposit competition remains high, but with the fed seemingly pausing on rates, we are not seeing to continue much higher in terms of deposit rates that are being offered out there. It’s kind of flat lined at what was existing maybe a couple of months ago and so competition is still very high. But I think the incremental increases have hopefully moderated. So that should be incrementally helpful.
There is always obviously a lag of what you are bringing in verses what's on the books now, so that doesn't mean that deposit rates paid will immediately flatten, but I think that should certainly help.
One other thing that I would mention is, you know we’ve got the market index deposit portfolio and that has had an outsized impact on our deposit rate paid in our deposit beta since the beginning of the rate cycle, but now we're having an opportunity to let those go.
If you look at our consumer deposit beta since the beginning of the cycle, it is only a 25% beta and on the commercial side ex the market deposits, it's only about a 40% beta. So combined in the Regional Bank we've got about a 29% beta ex those market deposits, which is very attractive. So I think our bankers even in the face of competition on both sides of the balance sheet have done a really, really good job of managing pricing and being very disciplined over time while being able to be competitive and grow business like they have, so that's excellent.
My team's job and our job is to then use that opportunity that the bankers have given us to reduce those higher costs market index deposits as quickly as possible and we're working to do that and again, as we've talked about strategically, that will remix our deposit portfolio, bring the deposit costs and the funding costs down and help us flatten that grows in deposit rate paid, maybe even a little bit more than others have an opportunity to do so. So that’s exactly what we're focused on, executing on and believe that we're doing a good job on it.
Our next question comes from Jared Shaw from Wells Fargo Securities. Please go ahead with your question.
Hi, good morning. This is actually Timur Braziler filling in for Jared. I guess my first question is do you have the period end balance for loans to mortgage companies?
Yes, it is in the back of our presentation. It is $2.3 billion and 4Q ’18 was $2.0 billion.
Okay, and then maybe looking more broadly at what's going on in South Florida, obviously there's been a good deal of consolidation. Just wondering if you can speak generally to what the competitive landscape is looking like there and where you are seeing most success in either gaining market share or hiring?
I've been fortunate to meet and interview many of the people that we are hiring in South Florida, and largely the opportunities that we are seeing are coming from hiring strong season bankers who’s been in those markets for many years, in terms of knowing the companies and individuals who have been around, who made it through different cycles and we've got – I think we've assembled a very good leadership team. They are continuing into approved and higher relationship managers.
We are seeing opportunities in C&I, we are seeing opportunities in municipals, private clients and selectively on commercial real-estate. So I think we’ve got a really, really good opportunity there to build a book of business that’s sustainable through the cycle.
I’ll pick up with that. It would be a disservice to all our markets to say that everything's not competitive and South Florida is equally competitive in both, the pursuit of talent, as well as the pursuit of customer relationships. And while there's a lot of change going on across the industry, we see it as a very good growth market for us. We start with relatively small shares there and we see the ability to build out the toe holder, the footprint that Capital Bank had pre acquisition and while it'll be of a competitive landscape, we do think with the with the right people added to the team, the right base that we have there, from an existing standpoint. We think we have a nice opportunity for growth.
And our last question today comes from John Pancari from Evercore. Please go ahead with your question.
Good morning.
Good morning John.
Alright, thanks for taking my question, because I know the call is going on long. Just a question again on the efficiency side. Regarding your longer term targets, I know BJ you indicated your goals is still to get the overhead efficiency lower and then I heard Bryan you said that. My question is around the medium term expectation for below 60% and then longer term below 59%. Have they changed at all, just given the fed and given the curve or is there a reason to move them from where you currently, where you last provided. Thanks.
No, there's no reason to move them over the medium term or the long term. I mean you know quarter-to-quarter you are going to be impacted by things like rate and you can't move this quickly in a 90 day period as you can in a 12, 24, 36 month period. And so we’ll adapt and we’ll adjust and we'll figure out a way to continue to grow and provide positive operating leverage such that we can be at sub-59 efficiency over time. And so that hasn't changed at all and we’ll manage the company to do that.
And in terms of how you view the medium term, can you give us an idea or even the longer term, the time frame that you consider when you say that?
The next couple years, three years, two years.
That would be for the long term?
Thank would be our goal, yes.
Okay, alright. Got it, thanks BJ.
Thanks John.
And ladies and gentleman that will conclude today's question-and-answer session. I would like to turn the conference call back over to Mr. Jordan for any closing remarks.
Thank you, Jamie. Thank you all for taking time to join us this morning. We're very pleased with the results of the first quarter and encouraged about the momentum we see in 2019. Thank you again to all our First Horizon colleagues.
If you have any follow up questions or you need any additional information please reach out to Aarti, BJ, me, Susan or Brian Mellone. We’d be happy to try to fill in any gaps.
Thank you again. Hope you all have a great day.
Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending. You may now disconnect your lines.