First Horizon Corp
NYSE:FHN
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First Horizon Corp
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Good morning and welcome to the First Horizon National Corp. Second Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded.
I would now like to turn the conference over to Ellen Taylor, Head of Investor Relations. Please go ahead.
Thanks so much. Good morning everybody and thanks very much for joining us.
We know it’s the end of what's been a really busy week. On our call today, are CEO, Bryan Jordan; and CFO, BJ Losch, who will provide an overview of our results and then we will be happy to take questions. We're really pleased to have Susan Springfield, our Chief Credit Officer with us to assist in that effort.
Our remarks today will reference earnings presentation which is available at ir.fhnc.com. I should note that we will make forward-looking statements that are subject to risks and uncertainties and you should review the factors on Page 2 of our presentation and on our SEC filings that may cause our results to differ from those expectations. Our statements reflect our views today and we aren't obligated to update them.
We will also address our adjusted results in our remarks which are non-GAAP measures and you should absolutely review the GAAP information in our supplement and on Page 3 of our presentation.
With that, I'm going to hand it over to Bryan.
Thank you, Ellen. Good morning, everyone. Thank you for joining us on the call.
In this most unusual environment, pandemic related economic slowdown, we've had a very good quarter, and I'm very proud of the work that our team has accomplished.
On July 1, we closed our MOE or Merger of Equals with IBERIABANK. This merger creates a leading southern franchise with strong demographics and the ability to drive efficiency and create significant shareholder value.
Given the disruption created by the COVID-19 pandemic, our associates across the expanded platform have been working to tirelessly support clients and communities by originating PPP loans, providing loan deferral assistance, waiving fees, all while effectively managing risk. At the same time, they have continued to ensure that execution on the IBERIA integration as well as the branch acquisition remain on track. Our expanded franchise strengthens our geographic reach and depth provides improved ability to better serve our customers and community, provides enhanced growth opportunities, and gives us scale to compete more efficiently.
This quarter, we delivered solid results with strong PPNR growth driven by strong fee income performance and good expense discipline, as our countercyclical businesses helped mitigate environmental headwinds. Our fixed income business delivered strong results and NII remained relatively stable as we grew average loans led by loans to mortgage companies and the PPP portfolio.
During the quarter, we built our loan loss reserve by $93 million, raising our allowance to loans coverage to ratio to 1.6% or 2% excluding lower risk loans to mortgage companies and the PPP portfolio.
We're continuing heightened monitoring and review of the loan portfolios in order to evaluate the impact of COVID-19 on our customer base and ensure that we are prudently managing risks, while helping support customers and the economy overall.
BJ will give you details about economic assumptions supporting our reserve level, but I believe that we're taking an appropriately cautiously view.
In the quarter, we further bolstered our capital with debt and preferred share issuances. As expected, our CET1 ratio increased over 70 basis points linked quarter to 9.3%, which positions us well as we look towards the second half of 2020.
While we acknowledge that the macroeconomic backdrop and industry landscape remain very challenging, we believe our combined company remains well positioned to drive enhanced shareholder value over the medium term.
With that, I'll turn it over to BJ to take you through the details. BJ?
Great. Thanks, Bryan. Good morning, everybody. Happy Friday.
As I'm sure you know, but as a reminder, our MOE with IBERIA closed on July 1. Therefore, the 2Q results I'll be discussing are for First Horizon standalone. Later, I'll give you some highlights of IBERIA standalone results for the quarter, as well as some key legal day one impacts from the merger closing that you should expect to see in our 3Q results.
With that, let's start with some highlights of our second quarter adjusted results. As Bryan mentioned, we delivered strong PPNR growth, which was up 13% linked quarter and 2% year-over-year.
Despite the challenging interest rate environment and macroeconomic backdrop, revenue was up 7% in the quarter and 11% year-over-year, driven by strong fee income growth with stable net interest income results. We think this quarter in particular really highlights the benefits of our countercyclical fixed income and mortgage warehouse lending platforms that are helping mitigate some of the headwinds that we're seeing across the banking industry. We generated nice balance sheet growth and continue to manage our deposit costs down, and given the environment we continue to be highly focused on expense discipline.
Of course, CECL is the factor driving provision costs higher for the banks overall. And as we updated our models for the further downdraft in the economic outlook compared to March, we built our loan loss reserves by an additional $93 million or $0.23 a share.
Moving to Slide 7, you can see that solid loan growth and disciplined deposit pricing helped us generate modest NII growth in the quarter despite a 26 basis point decline in the margin. As a reminder, our asset sensitivity is most highly correlated to one month LIBOR which was down 105 basis points on average during the quarter putting significant pressure on loan yields. In addition, because of strong customer liquidity, the NIM was pressured further by excess cash balances which created an additional nine basis point drag on the margin.
At the same time, we continued to lower our deposit costs overall, which were down 40 basis points in the quarter and the margin benefited from the addition of over $2 billion in PPP loans and the associated fees which helped offset some pressure from lower accretion.
As we look forward, while it will be challenging to offset the additional headwinds from the rate environment, we will continue to look for opportunities to bring deposit pricing down further and more efficiently manage the balance sheet, while still maintaining a prudent stance on liquidity given the uncertainty in the overall landscape.
Looking forward, we could see the NIM compress further, possibly in the mid-teens range, primarily due to the addition of the Truist branches. Those branches will provide about $2 billion of additional excess funding, which will further improve our liquidity profile, loan and deposit ratio, and profitability over time, but will temporarily depress the margin while we find ways to put the excess funding to work over the next few months.
Briefly on Slide 8, fee income was up 18% linked quarter and 31% year-over-year. The fee income growth was driven by strength in fixed income and deferred compensation, partially [ph]offset by lower deposit, card, and other bank fees given impacts from COVID. While more traditional banking fee income lines were challenged in the quarter as others have seen across the industry, given that some of our markets have begun reopening, we did start to see some improvement at the end of the quarter in debit card and ATM volumes as well as a pickup in wealth.
Fixed income revenue in particular was up 19% linked quarter and 77% year-over-year as we saw strong sales activities and a turnaround in trading results following the challenging conditions that occurred in March. As a result, the team delivered average daily revenue of $1.6 million during the quarter compared with $1.3 million in the first. Given the overall landscape, we believe the fixed income business remains very well positioned to capitalize on its extensive distribution platform and experienced salesforce to drive continued solid results.
On Slide 9, quickly cover expense trends, as we remain committed to a highly disciplined approach to managing the cost base, given the swing in market valuations, we saw an increase in employee compensation costs driven by a $20 million increase in deferred comp related to market changes which is offset by increases in other income. Outside of this, our results benefited from lower stock-based compensation, FAS 91 deferrals, and lower operating costs overall largely tied to the impact of the shutdown.
Importantly though we were able to take an additional $3 million of costs out in connection with our IBERIA merger during the quarter as was IBERIA. So overall, we have achieved a total of $10 million in merger savings between the two companies over the first half of this year meeting our expectations we set back in November when we announced the transaction. We continue to be very confident in our ability to generate the merger cost savings of $170 million over the next 18 months.
On Slide 10 and 11, we provide a view of our loan growth and funding profile. As I mentioned, we generated healthy average loan growth of 11% linked quarter and 18% year-over-year driven by loans to mortgage companies which were up on average $1.7 billion linked quarter reflecting strong refi volume due to low rates. We also picked up $2 billion in PPP loans as well. And the balance of the C&I portfolio saw declines tied to lower line utilizations from the peak that occurred in early April as commercial customers position started to improve in the wake of government programs and reopenings resulting in a reduction in the defensive draws that we saw in the end of the first quarter.
As Bryan mentioned, customer sentiment remains cautious and we do expect only modest loan growth at best for the second half of 2020.
At the same time, we've continued to work to further enhance our funding mix and capital stack; deposits were up 11% linked quarter driven by strength in DDA and savings. In the Regional Bank, we saw customer deposit rates paid decrease to 24 basis points from 59 basis points.
Overall, we lowered our interest bearing deposit cost 52 basis points in the quarter to 38 basis points. And while the mix of our deposit base will be a little different going forward than in the last rate cycle with the addition of IBERIA and the Truist branches, we do think it's helpful to note that in the third quarter of 2015, our interest bearing deposit costs ended at 15 basis points.
We also felt that in the face of continued economic uncertainty, it was important to continue to augment our capital and liquidity stacks. Since April, we've issued $1.25 billion of senior sub debt and preferred securities. We issued $800 million of holdco senior debt, prefunding a $500 million maturity coming due in December, $450 million of bank sub debt, and $150 million of holding company preferred.
On Slide 12, you'll see that as expected, we had a nice bounce back in our capital position from unusually low first quarter levels that were driven by outsized period end loan growth primarily from loans to mortgage companies. The CET1 ratio was up over 70 basis points to end the quarter at 9.3%, while total capital increased 170 basis points to 12.5%.
Our strong PPNR sub debt and preferred issuances and a reduction in risk weighted assets drove our capital levels higher and give us sample cushion as we prepare for the future.
While there will be many moving parts next quarter obviously as we close both the IBERIA transaction and the Truist branch acquisition sitting here today we would expect our CET1 ratio to be in the low nines in the third quarter.
Additionally, on Slide 13, you can see we ended the quarter with really healthy levels of reserves, allowance for loan losses totaled $538 million or over eight times annualized net charge-offs. We built the reserve by $93 million entirely attributable to anticipated further deterioration in overall macro trends.
We think it's important to note that while our models most heavily weighted the Moody's May 27th baseline scenario; we supplemented it with alternative scenarios and did very detailed portfolio reviews of industries currently affected by the pandemic. We also incorporated additional factors such as the re-emergence of COVID cases, additional geographic data, impact of stimulus programs, and overall economic uncertainty.
For your reference, we have a detailed table in the Appendix that shows reserve coverage by portfolio. Our coverage again excluding PPP and loans to mortgage companies which have exceptionally low to no loss content and stands at around 2% on a standalone basis.
Moving to Slide 14, you can see that overall the asset quality picture still remains relatively benign. While we continue to monitor our loan portfolios carefully, the net charge-off to average loans ratio came in at 20 basis points, with the losses this quarter driven primarily by two credits, one loan in energy and the other in the franchise finance portfolio.
We've given some details on deferrals at the bottom of the page and as you can see total deferrals of both commercial and consumer portfolios were $3.8 billion representing low percentages of customer accounts overall. Interestingly, more than 40% of customers that asked and received deferrals have made at least one payment seen since being on deferral status. We will continue to work proactively with these and all of our customers and monitor the portfolios carefully.
Let's shift now to Slide 15 and look at IBERIA results and expected impacts from the closing of our MOE. First we provide IBERIABANK standalone second quarter financial highlights on Slide 15. We plan to file pro forma financials for the combined company later in the quarter, but thought it was important to provide some information to continue to illustrate the power of the new expanded and more diversified franchise.
IBERIABANK also delivered solid PPNR which was up 7% linked quarter. Net interest income was relatively stable as loan growth of 7% linked quarter was more than matched by 8% deposit growth helping to mitigate some of the interest rate headwinds. IBERIA generated record fee income up over 30% in the first quarter and over 45% year-over-year fueled by strong momentum in mortgage origination income with a healthy mortgage pipeline at the end of the quarter. Of course, provision expense in the quarter was up significantly as well given the impact of the updated outlook in the macro environment.
But now let's move on to cover our expectations for the impact of the merger accounting on Slide 16 and 17.
As of July 1, we updated our estimates for the marks on the portfolio based on the current landscape and a detailed review of those portfolios. You can see on Slide 16 that we expect to record a total of $720 million or 3% of loans, including total marks of $560 million for credit and interest rates/liquidity, and $160 million of non-PCD double count. The $720 million of total initial marks will show up as follows: approximately $460 million of it will go into the allowance for loan losses; approximately $260 million, $160 million related to the non-PCD discount and the $100 million of interest in liquidity mark will be an initial reduction of capital but will retreat back through net interest income over time. And at the bottom of the slide we have laid out for you our current estimate of the timing of that accretion coming back into income and capital.
In the table at the top of the page, you can see that we now currently estimate of the total credit marks that a little over half or about $12.6 billion of the portfolio will be considered purchase credit deteriorated PCD with the remainder of the portfolio designated as non-PCD. It's important to note that the PCD designation as defined by CECL does not mean that the loans are bad, and it's not intended to be an indication of perceived loss content associated with the portfolio. So the initial marks will reduce our CET capital by about 20 basis points at close.
On Page 17, you can see the current estimate of the merger accounting adjustments which will result in a roughly $500 million non-taxable gain that will be recognized through the income statement in our third quarter results with a roughly $2.8 billion addition to tangible common equity.
On Page 18, we provide a reminder of the $170 million in expense savings that we're targeting for the combined company in connection with the merger. And as I mentioned earlier, we have achieved around $10 million so far in the first half of the year with $6 million in this quarter alone.
We expect to have an exit run rate at the end of 2020 of 25% of our targeted cost saves and we are well on our way to achieving that. Our integration efforts are on track and we are confident in our ability to deliver on the savings and the benefits of the merger with a strong belief that we will be able to exceed our targets.
So with that, Bryan, I'll hand it back over to you.
Thanks, BJ.
With our strong balance sheet, business mix, including our countercyclical businesses, our strong capital base and liquidity, they will all serve us well in this difficult environment. We have maintained underwriting standards that are very strong and built a diversified portfolio focused on profitability. Despite the economic headwinds, we're uniquely positioned to capture merger opportunities with enhanced scale, better efficiency, and improved earnings power to create shareholder value. We will continue to assist our associates' communities and client's efforts to overcome COVID-19's impact and revitalize the economy.
Thank you to all of our associates for your outstanding commitment and efforts in dealing with these unprecedented times.
With that, Andrea, we will now take questions.
We will now begin the question-and-answer session. [Operator Instructions].
And our first question will come from Brady Gailey of KBW. Please go ahead.
If you look at loan growth, excluding the mortgage warehouse and excluding PPP, I think period end balances were down a little linked quarter. Maybe just comment on I saw utilization went down, but maybe just comment on 2Qs loan growth kind of ex-warehouse and ex-PPP? And then BJ, I heard you say you expect modest loan growth at best for the back half of the year, but maybe just a little more color on how you're thinking about loan growth going forward?
Hey, Brady, this is Bryan, I'll start and then Susan or BJ can pick up. The loan growth on an absolute basis outside of PPP and mortgage warehouse was down a little bit. Most of that was driven by what you saw in the significant line draws that occurred late in the first quarter in the March timeframe when the economy started shutting down more broadly, those lines paid down. If you look at the loan growth through the second quarter, you could characterize it as BJ did earlier is reasonably modest. Most of the new loans were to existing customers and tended to be at levels that would be very low relative to say the last 18 months or two years.
So, our expectation is that we will have some activity that the line draws have sort of worked their way through the system and will continue to support customers both existing and opportunities to take on customers in the marketplace, but we don't expect a tremendous amount of loan growth throughout the rest of this year at least until we get to the other side of this pandemic.
Only thing I would really add Brady is, we remain very focused as we always have on full relationships and so continuing to work with our clients and some prospects that we brought in through the PPP program, but we remain as you can imagine very prudent in our underwriting, have a higher level of review for new extensions of credit. But we do believe on that there could be some limited opportunities, but as Bryan said would expect loan growth would remain in the lower range, certainly compared to the last 18 to 24 months.
Yes. I would just add one more thing. I mean, Brady, we're definitely open for business. It's not that question. It's just lower activity from clients looking to extend credit because of like Bryan talked about the pandemic. There's just -- it's just obvious caution across portfolios, but we'll look -- we'll continue to look for good opportunities to continue to grow customer relationships.
All right, that's helpful. Then, next on your common dividend. I think there's been some investor focus on your dividend post when we saw the CCAR results, but you didn't earn the dividend last quarter, you earned it this quarter, but the payout ratio was pretty high. If you include the $500 million gain next quarter, you will earn it by multiples, but how are you thinking about the stability of your dividend going forward?
Hey, Brady, this is Bryan again. The board considers the dividend every quarter. And we’ve looked at the rules as at least been publicly made available from the Fed and our modeling and our outlook indicates to us that we will be in a position to continue to recommend our dividend to the Board of Directors.
I would say that as a backdrop, while we are confident in it, we don't know what we don't know about this economy, and it's important that the board not only looks at dividend, but looks at capital and capital adequacy long-term. So that could change but based on our modeling, based on our outlook, based on our understanding of the rules in the Fed framework, we feel very confident that we will be recommending to our board that they consider continuing the dividend at current levels.
Okay. And then finally a quick one. Yes, BJ it was helpful to have the forecast for the yield accretion for the next few years. But that is just probably the scheduled yield accretion right, that doesn't include any unscheduled, so reality is with some payoffs, you'll probably see numbers a little higher than that. Is that the right way to think about that?
Yes, that's correct. Yes, it's going to be based on this -- this is based on our assumed timing and you're right. If there's an acceleration, then there could be a change much like we've seen in other transactions, Brady.
Our next question comes from John Pancari of Evercore. Please go ahead.
Hi, this is Rahul Patil on behalf of John. I just had a question around the loan mark. So I know in mid-April, you had provided an update around the loan mark. And I believe the total mark around that time was around $500 million to $550 million. And one could argue that the macro has kind of worsened since mid-April through the deal close in July. How come that did influence the credit mark? I'm looking at the total mark at $560 million right now? How come that did influence the credit mark? And then also, it looks like the rate mark of 40 bps is sort of consistent with the level that you had announced back in November 2019, and obviously rates have come down quite a lot since then. And I'm just wondering like how did that not influence your rate mark because it looks like that also stayed at 40 bps, so just a couple of clarification questions around that?
Sure. So it's BJ. So, it's been a wild ride on trying to estimate marks between November of last year and today. And so, like you said, we gave interim updates during the course of that.
So, if you recall back in November, we would have had credit marks assumed that announcement of 1.2% and interest rate mark of about 40 basis points. So that would have been 1.6%. The interim that you're referring to would have captured a little bit more of a credit mark, but a substantially higher interest rate/liquidity mark, and I would put more emphasis on the liquidity mark.
So when we put out that disclosure back a couple months ago, it was at the height of the liquidity crisis and the fear in the markets before the Fed programs had fully been rolled out. So the assumption was much higher on the liquidity and interest rate mark. Subsequently, markets have gotten a lot more liquid that liquidity in interest rate mark has come back down, but our expectations around the future outlook on credit has deteriorated.
So all in all, our credit mark is higher by probably 40% than what we would have thought back in November. Interest rate/liquidity mark interestingly enough, kind of landed in the same place. But as you can see in the table, the mix of the PCD and non-PCD has changed materially as well. So, lots of moving parts in here.
But the bottom line is we feel very comfortable that our teams have done great extensive work on evaluation that we're building very healthy reserves that go into the allowance. And we've got additional loss absorption capacity that will accrete back through income over time to the tune of about $260 million. So we're very comfortable with the estimates that we've got.
Okay. And then just question on the First Horizon's standalone expense base. So I believe it was like six months ago, your expectations for First Horizon's expense base was around $280 million, $285 million per quarter. And I'm looking at 2Q numbers on a core basis; it came in around at $318 million. So that $30 million differential obviously partly driven by this stronger fixed income business performance, but how much of that differential in your expense base do you expect to normalize in coming quarters? Or should we kind of expect like that $320 million is like the normal sort of run rate for First Horizon assuming fixed income kind of stays strong?
Yes so how I'll describe it is the increase that you're talking about is all related to two things. One is, as you mentioned, fixed income variable compensation which comes with additional revenue that we gain, so there's a 50% net positive benefit to our pretax income from that additional expense. And this quarter, we had deferred compensation expenses that were up quite materially in the quarter as well. We don't expect those to continue. That's that will certainly moderate.
So we still believe that we'd like to see fixed income remain strong which we think it will. So I would, if I were you take out the deferred compensation impact in this quarter. And then once we start to look at our companies on a combined basis start to layer in the merger-related cost saves and we expect to see meaningful declines over time in our expense base.
BJ, one more that that I would add to that list is the provision for unfunded credit, which was $11 million this quarter, $9 million last quarter vis-à-vis a year-ago was essentially zero.
Thank you. Yes.
Those two are fairly significant. They're pandemic related in the sense that they're related to credit -- potential credit losses for unfunded commitments it just happens to flow through our expense base.
Yes, that is a great point. I just want to bottom line reiterate we have done an excellent job of managing our expenses. And so the increases here are all related to either support of additional revenue and pretax income were the two things that Bryan and I discussed and we are continuing to focus very, very strongly on expense discipline.
Our next question comes from Jared Shaw of Wells Fargo. Please go ahead.
Yes, just looking at the margin I guess to start and the growth in cash and with the expectation for additional cash growth from the Truist deal and the IBKC deal. What -- how should we be thinking about sort of the deployment of that cash into either securities or I guess securities or the -- your expectation for customers deposit use. So as we go forward through the next few quarters, how should we be looking at that sort of net cash position?
Yes. So as I said in my earlier comments, we think that initially in the third quarter, the addition of the net $3 billion of funding from Truist is going to depress the margin maybe in the mid-teens range. And over the next few to several months, we're going to figure out ways to deploy that in terms of either securities, loan growth, managing down other higher cost deposits, et cetera. So we expect that to be a temporary type depression of the margin.
And so said a different way, if the Truist acquisition was not being completed in the quarter, we would think the margin would be relatively stable to just down modestly as opposed to down in the mid-teens because of the addition of the excess cash.
Okay, great. And then can you talk a little bit about the deferral extension processing as that initial 90-day period hence how are you approaching extension there? And do you expect to be able to get either additional credit enhancements or any type of beneficial term restructuring as those go forward?
Hi, Jared. Related to the deferrals we are really getting to the end of the first round of 90-day deferrals requested by our customers and we're really on a case-by-case basis with our commercial customers asking questions about other sources of cash, sponsor guarantor support, et cetera. And oftentimes, we are getting some additional whether it's the guarantee, asking guarantor owner to put in more equity potentially looking at other structural elements.
At this point and we've had deep portfolio reviews, as BJ mentioned, in his remarks on our slides, with a number of related to specific loans in a number of portfolios. In fact, we covered over 70% of some of the higher risk portfolios, and we were talking with our bankers about what their clients are telling them.
We don't -- at this point we're not anticipating nearly the number of second round deferrals as we had in the first round. Really only in two real industry pockets do we expect potentially second round deferrals to be maybe near what they were in first round and that would be some of the restaurant franchise finance companies and some of our hotel borrowers. Otherwise, based on feedback we've received over the last really 30 to 45 days, we're not hearing of a big increase. Obviously, we're watching that closely as things continue to be very dynamic around the COVID situation related to various states but many of our customers are reporting good liquidity, good cash reserves, a combination of their operating at lower expenses, the benefits of the government programs including the PPP program, the idle program, the CARES grant programs.
So again, we're glad to be able to assist customers during this time. But right now the second round of deferrals appears to be a much lighter request than we had on the first round.
That's great color. Thanks. And just finally for me, as we look at going forward, if we do see additional macro deterioration based on the Moody's models, should we assume that you're all are more willing to use qualitative overlays with the additional credit protection from the MOE or should we expect to see that the macro impact from any future deterioration would be a similar impact?
So actually for the second quarter and we did it in the first quarter, but even more in the second quarter, in addition to the Moody's baseline, we actually did apply a good bit of qualitative overlay on a number of portfolios that either or have the potential to have some effect from COVID. So as an example, some of the portfolios that where we had an additional qualitative overlay included not for profit, senior living like nursing homes assisted living, healthcare and then even a more significant qualitative on some other areas which you would expect things like restaurants, entertainment, hospitality, retail, and then energy we even -- we took a very, very strong look and did a type a great deal of the clients there as we went through borrowing base redeterminations, with the hedge strategies, et cetera. And so we did deploy a good qualitative overlay in the second quarter and we'll continue to do that as we evaluate CECL.
At this point, we feel like we're well reserved for the portfolios that we have and we'll continue obviously to evaluate that next quarter, I guess for this quarter, third quarter as we get near the end of the quarter, but we feel like we've got a good robust process and have taken both as I said the Moody's process, but then the subject matter expertise in it. That qualitative overlay based on information we gleaned from the deep dives that we did.
And I would add to what Susan said that as we evaluated the loan marks on the IBERIA portfolio, we did the same thing. We used qualitative overlays where we need to do, particularly around stress sectors as Susan outlined. So we feel like we had fulsome marks and we have very healthy reserves on the First Horizon standalone so.
This is Bryan. It's an interesting -- it's an interesting time to be estimating loan loss reserves and we're all trying to figure out how CECL works in the real world and in many ways it is -- yes, I'll stick with ill time and overly burdensome. But if you sort of step back from the loan portfolios and then you look at the various components, you're seeing some places where they're trouble emerging. And Susan did a good job enumerating those places. But there's a disconnect between call it $17 million in net charge-offs and $540 million in round numbers of loan loss reserves.
And we fully expect while borrowers are doing today that there are a lot of places that this economy can go and what happens if we have more shutdown or re-shutdown? What happens if the Congress and the administration don't put together a fully helpful another round of stimulus? What happens if Fed liquidity programs change?
Right now, the economy is doing better than you might think and borrowers are doing better than you might think. Given that the economic environment we're in, we attribute a lot of that to the great work that the Treasury and the Fed have done with programs like Main Street Lending, which has not really been used but in place liquidity programs, PPP, the stimulus payments, consumers are still relatively strong, credit card volume has been picking up since the economy started reopening.
So all in all, we've got a sober and cautious outlook on what happens over the remainder of the year. But when you talk to individual borrowers and you go through individual elements of the portfolio, things are doing much better than you might expect at this point in time.
And you take the restaurant business, if you're in the quick serve restaurant business; you're back to where you were pre-pandemic largely speaking. And in some cases, your comps are up 10%, 20% depending on the business you're in.
So it is a tale of many stories out there right now. And it's just an odd time to be trying to flyspeck what loan loss reserves and life of loan losses might look like.
Our next question comes from Steven Alexopoulos of JPMorgan. Please go ahead.
Bryan, does it stay with the reserve conversation this being an odd time based on everything you're looking at now, do you think the majority of the reserve building under CECL is now behind you?
Well, clearly from an accounting perspective, we take the information we have and we book what we think are life of loan losses. And so if the economy plays out consistent with that set of assumptions, yes I think so. But as I said earlier in talking about the dividend, we don't know what we don't know about how this virus plays out. It's a medically driven crisis. And until we get a solution to that, it's hard to know how it plays through the economy. But I think we have based on all the information we have available to us, book sufficient reserves to cover losses in the portfolio as it stands today.
And as we get to the second half and some of these deferrals are transitioning into default. Is it likely you'll then need to establish a specific reserve? Or is the plan to start using these qualitative overlays that you're building into the reserve today?
Well, I think clearly that we built some of these reserves in the qualitative reserves in anticipation of specific problem. So our intent would be to use those as they evolve, yes.
Okay. And then thank you -- and then shifting direction to fixed income. It was nice to see ADR above the prior range. It's been a while, I'm curious, how did ADR trend through the quarter? And do you think it's sustainable at these levels? Thanks.
Yes, ADR transition or trended positively throughout the quarter, we finished the quarter very strong and I would say a very good start to the third quarter as well. We do think it is sustainable. And some of it is sort of the extension of the comments we made about loan growth to the extent macro loan growth is not good across the industry, there are more opportunity for securities and securities portfolios and financial institutions and the question came up about cash on balance sheet that's happening across the industry.
So that's good for the business. The average daily revenue this quarter was impacted a little bit by the reversal of what we call negative splits and the end of the third excuse me end of the first quarter being reversed. Another name would be portfolio gains or trading gains and losses that occurred. But average daily revenue has looked good, the trends look good. And our outlook for the remainder of the year is that our fixed income business will continue to serve as a or the countercyclical buffer that we’ve always believed it to be.
Our next question comes from Brock Vandervliet of UBS. Please go ahead.
Hey, good morning. Nice to see some of the clouds begin to part here. Following on Steve's question; I do worry about in securities because the performance has been so good. It's repeatedly beaten our expectations and wanted to just go back to your comments, Bryan, and I mean is this more of a kind of flat from here sort of set up into the back half which would still be very, very strong or do you think you could actually climb it out from here?
I think my outlook would be that, that you sort of, if you were going to forecast it out, you wouldn't show a lot of growth and you wouldn't show a decline in a whole lot, it will be sort of in the area sort of the average where it's been the last couple of quarters.
Okay. And BJ, one of the areas where the clouds kind of remain is around the net interest margin. I know you've taken a crack at defining that a bit. You've got PPP; you've got the branch sale or the branch purchase coming in. As you look and IBKC of course maybe as you look at year-end Q4, what kind of a core NIM should we be looking at?
Yes. So by the way, I don't know why Bryan gets the good question on strong fixed income and I get the tough question on NIM.
So I would expect that the core NIM continues to be pressured through the back half of the year. I mean that we've got hopefully loan yields stabilizing a bit. We still have some room as I talked about earlier on deposits and deposit rates paid; we still think that we can bring those down. But the reality is we're going to continue to have a high class problem of excess liquidity that we're going to have to work through. So that's going to be the depression in the margin.
I wouldn't translate that into material declines in overall NII because we've got accretion coming through, even if the margin is compressed by excess liquidity, it goes into excess balances at the Fed and it's largely a wash. So it's again continued, it's going to be challenged, but we've got opportunities to mitigate it, both in the net interest income line as well as what Bryan just talked about the countercyclical businesses that we've got a fixed income, loans to mortgage companies and as a combined company, the mortgage origination platform that IBERIA has which had a record quarter in the first quarter and then soundly beat that record quarter in the second quarter. So we have multiple levers that we think can offset some of these headwinds. And we'll work hard to mitigate as much as we can.
Our next question comes from Ebrahim Poonawala of Bank of America Securities. Please go ahead.
Just wanted to follow-up on the NIM, BJ you earlier mentioned that ex Truist you expect the NIM would be relatively stable to just going down modestly. So just wanted to put some numbers around to make sure we get this correct. The com 284, you expect a mid-teens decline, so let's call it about 270. Is that a decent place when we reflect Truist, reflect IBERIA, we reflect PPP for now in terms of where the core NIM should be around that 270. And then maybe it might have some upside as we deploy that liquidity as PPP runs off, or is there more downside to that core NIM relative to a 270 number?
Yes, so I had said mid-teens and our core NIM is 280 in the quarter. And when I've been speaking about what I thought the second half of the year look like, I'm obviously contemplating not just standalone. I'm contemplating the IBERIA merger, the Truist acquisition, and the puts and takes it goes. So yes, I think it's mid-teens primarily from the liquidity, the excess liquidity that we will see from Truist.
Sorry [indiscernible] about 265 in actual spending. And then what's your view on PPP running off, do you expect most of this to be forgiven by the end of the year?
Yes, we do.
Okay, got it. And would you have like what pro forma earning assets or what the quarter end earning assets were for both the balance sheets, just trying to get a sense of what we should expect in terms of the size of their balance sheet looking out into 3Q with all these things added?
So pro forma earning assets at June 30.
So pro forma loans for both First Horizon, IBERIA together if you look at 6/30 without PPP is about $55 billion. And so I know you asked for all earning assets. But I thought I'd go and give you the loans, obviously that's without PPP. We had a combined PPP portfolio of about $4 billion, little over $4.1 billion. So if you include PPP total loans on a pro forma basis at the end of June are about $59 million.
Yes, I've got, even I've got earning assets of just roughly $74 billion.
That's helpful. And just one separate question I guess for Susan. So you've talked a lot about credit and what you've done and the uncertainty of the macro. At this point like when you looked at the loan portfolio, are you still making decisions based on portfolio level details as you mentioned the restaurant, finance hotel? Or would you say you have a good handle on granularly looking at these loans customer by customer, I think Bryan alluded too, just to get a sense of is this still a model based exercise, or do you have a good sense around and comfort around customers' ability to withstand if things don't get materially worse which would imply a decent drop off in terms of credit provisioning relative to what we've seen in the first half?
So in addition to portfolio level that we're looking at, and we're looking at information loan by loan, our bankers are updating loan by loan information based on customer feedback, we're also looking at a lot of market information around what's going on with various franchises in the franchise finance space, what's going on with hotel occupancies and ADRs but then again looking at that on a customer-by-customer basis. So we will continue to do that.
Just as a reminder, we talked about this last quarter, but we feel very good about the disciplined underwriting that we've had since the last financial crisis and I would say this applies to both Legacy First Horizon and Legacy IBERIA as it relates to things like in the commercial real estate book, hospitality, average equities in the 40% range. And so it gives us a lot of cushion, our customers a lot of cushion, when you have something unprecedented like the COVID pandemic.
Maybe a data point that some customers saw this was when things were starting to open back up Bryan alluded to do this on the restaurant side, we clearly saw it on the restaurant side, but also in the hotel portfolio because our hotel portfolios tend to be smaller driving distance type hotels that cater to family travel, some business travel, we have very limited exposure to convention large hotel business and we've heard from clients that Memorial Day in the June through July 4, some of them had -- were fully occupied. We also saw, as Bryan said, average restaurant checks went up as more people did take out, they were buying more than they would, if they went in because they were thinking about, I might want some later. So we did, we are seeing that both in the market data that we get on all of our industries and studies but also talking with individual customers about what they're seeing.
So we will continue to look at both. But again, I was pleased with the resiliency that I saw out of our clients when you have the complete shutdown and then things open back up. We saw dramatic increases pretty quickly. But as Bryan and BJ said, we're also watching really there's some additional shutdowns that have occurred. But again resilient customers, prudent underwriting and so we believe we've got a reserve for what our lifetime losses will be based on what we know today.
I would add to the resiliency. Customers have been very creative in the way they've adapted to an unusual set of circumstances and you see customers adapting their business, our customers adapting their business model to meet changing circumstances. And it really is amazing. And if nothing else, it is a testament, an overall testament to the strength and creativity of the economy in the U.S.
Our next question comes from Garrett Holland of Baird. Please go ahead.
Good morning, thanks for taking the question. Just had a near-term one on expenses. What's a good range for core expenses, as you think about Q3 over the back half of the year?
Standalone or combined or --?
The combined will be great.
Yes. I think -- I think I'll defer and have our IR folks follow-up with you on that because there's so many moving parts to what we got in terms of merger-related one-times and those types of things that I think it would be better to give you that in a different format.
Understand. I guess just bigger picture, I know the deal just closed, but you sound very positive on its potential. And clearly, the environment has changed though since you announced the transaction, just how would you recast earnings power or advise thinking about the return potential for the combined company in this type of environment?
Well, I think the way I would characterize it is short-term. I think we and everybody else are focused on safety and soundness right healthy reserves, strong capital levels, strong liquidity and funding profiles. Beyond that it's controlling what we can control. And what we can control is, particularly in this environment, our support of our countercyclical businesses, our deposit pricing discipline, and huge lever of course for us is taking costs out of our combined organization in a very material way over the next several quarters.
So, I think those things will position us very well in terms of our ability to maintain profitability over the next several quarters. Beyond that we’re very convicted and optimistic about the opportunity we have long-term as a combined organization. We've got the cost saves that will come in; we are in very attractive markets. We're continuing to build diversified business mix with countercyclical businesses, our enhanced scale will help.
So over the medium and long-term, we still feel like we can generate top tier profitability over the long-term and we're building a company to position us well to do that.
Hi Garrett this is Bryan. I think this is -- it's hard to sort of model what was in the numbers in November and what's in the numbers today because CECL changes everything. But as we talked about today, both businesses were seeing strong PPNR. We're seeing very good activity in our franchise. We think that there is a great deal of leverage. In fact, we're seeing in the first couple weeks of merger, post-merger timeframe referrals of business that go into our asset based lending business.
So we haven't modeled in any of the synergies, but those synergies will be there on the revenue side.
One thing I'm certain of, is we have the ability to hit our commitments $170 million plus. I think we have the opportunity to upsize that over time. And I can't understate how important a lever that is in an environment like this. These are costs that we couldn't get at on an individual basis by combining the two organizations in a no premium Merger of Equals. We have the ability to create $170 million pretax plus of run rate savings on an annual basis that you can annuitize. And so that's a big deal and that that will be a big driver over the next 18 months.
So, as BJ said, longer-term, I think we're going to be in a position with the markets that we're in, with the bankers that we have on the playing field, the team that's out there covering our customer base and our strength of balance sheet, we're going to have superior growth opportunities. And in the short run, we're going to have levers to pull with our countercyclical businesses and our cost savings that are going to be meaningful in terms of creating shareholder value.
Our next question comes from Jennifer Demba of SunTrust. Please go ahead.
Hi, Jennifer.
Good morning, Jennifer.
Good morning. Just talk about your criticized loan trend from sequentially and where you're seeing the most increase. And then can you also talk about what you're expecting in terms of near-term net charge-off levels over the next six months. I know that they stayed quite low in the second quarter. Thank you.
Jennifer, as it relates to criticized loans and we talk about First Horizon standalone and then I've got some information on a combined basis as well. If you look at --
Operator, could you mute that please.
Apologies. Jennifer seems to have placed us on hold. Would you like to move to the next questioner?
Why don't you go ahead?
I will go and answer the question. Yes. So Jennifer asked about criticized loan changes. And so for First Horizon standalone, we saw about $100 million added to criticized lines quarter-over-quarter, IBERIA added just under $200 million. So we had about $290 million added quarter-over-quarter in the criticized loans of which about $190 million was energy-related across the two portfolios. I would say that both companies took a very conservative approach as we look through our energy portfolios and took the appropriate action we needed to on grading those.
So on a percentage basis of criticized loans, First Horizon standalone went from about 2.8% of the portfolio to 3.5%. By the way, these numbers exclude PPP loans on the percentage of loans.
And then on a combined basis, again pro forma, ended the quarter criticized loans are about 3.2% of the portfolio up from about 2.4% if you'd looked at it at the end of the first quarter. So we did see some increase in criticized loans.
So I don't have a specific forecast for net charge-off. We are obviously looking at some increase in the criticized loans. Based on what we know today in the economy, I would expect that we would have the net charge-offs in the third and fourth quarter. At this point, though I don't really have a forecast because there's a good bit of uncertainty. But as we mentioned earlier because of how CECL works, we believe that we've got -- we're well reserved for the lifetime losses in the portfolio based on what we know today and to complete really the deep dives that we did on the portfolio and specifically the higher risk portfolio.
Yes. And I would say just to add; Susan talked about that the majority of the increase being energy and energy being one of the near-term portfolios that we would obviously be most focused on. Our coverage of the combined energy portfolio will be around 8%. So we significantly increased the reserves on those portfolios through both the marks and on the standalone side. So, that's one of the places that we leaned in along with the other sectors that Susan talked about earlier.
Our next question will come from Casey Haire of Jefferies. Please go ahead.
Yes, thanks. Good morning guys. So you guys give us an update on the fixed income business but the mortgage warehouse unless I missed it, what's the outlook there? It seems like it could have legs given where mortgage rates are going and any color on the split between refi and purchase as well as where deals are today?
So mortgage warehouse refi purchase is about 65% refi in the second quarter, which is kind of what you would expect with rates, we keep thinking they've hit their low point and they go down again. So there's been good activity there.
Yields in the second quarter were about 3.61% for that mortgage warehouse portfolio. So as we have over the last three years added customers to the customer count in mortgage warehouse. But I'll let BJ talk maybe about the outlook for mortgage warehouse.
Yes, Casey, I would -- I think if you remember in the first quarter, we had a very significant run up in the last five weeks of the quarter and period end balances top ticked at around $5.8 billion. They stayed pretty elevated because of strong activity through the quarter and you'll see -- you saw average balances actually up pretty materially in loans to mortgage companies first to second. The period end balances were down more than the $4 billion range, right. So the business does ebb and flow based on the flow of mortgage originations and the mix of purchase and refi.
Going into the third quarter, we see continued strength in the business. And so we expect it to grow from the period end balances of $4 billion and likely be in the range of the average balances that we saw in the second quarter.
Great, thank you. Bryan, just big picture question for you. When you guys announced this deal in early November obviously it was a much, much different world. Things seem to be tracking at least from a capital perspective and cost save perspective plans. But is there anything strategically either on First Horizon or the IBERIA side of the house loan vertical or is portfolio strategy change that you guys are thinking about just given how -- how different the world is today versus November?
Well, there are not any significant changes, no. We're still equally convicted about the merits of the transaction. And I'm extraordinarily pleased with the way the team has come together. It has been remarkable and while we had the first four months to bring people together in a face-to-face environment since March, we've been doing it by WebEx and Zoom and all the other electronic virtual means that you can come up with, but the team has come together and doing very, very well.
And as I mentioned, we're seeing some opportunities to leverage portfolios or businesses across both organizations. I mentioned ABL, BJ mentioned the mortgage business and the title business that that IBERIABANK brings to the table. So we still see a lot of that. We'll fine tune some things. One of the -- if you look closely at the numbers, you'll see for example, the commitments in energy were down a little bit this quarter, it represents on a combined basis about 4% of the portfolio. So we're willing to trim our sales as the economy continues to adjust to the pandemic and then the post pandemic world.
On a macro basis, we're still equally convicted about the opportunities of bringing these two organizations together. And I'm glad we're beyond the starting line and the hard work is in place. So it's exciting time to get that done. And I think as I said earlier, we're going to see a lot of shareholder value created when we combine these two companies over the next 18 months.
Our next question will come from Christopher Marinac of Janney Montgomery Scott. Please go ahead.
Good morning. How are you? Just wanted to focus on the branch acquisition and sort of strategically, Bryan, does that -- do you look at it any differently than you did last fall, just given where we are in this and also the high liquidity that BJ had addressed earlier?
Well, I think you raised an accounting and an economic point; excess deposits today are sort of different in a zero rate environment. But from a strategic standpoint, I think it is a home run transaction for us and we're very, very pleased with that transaction. As BJ mentioned earlier that conversion and acquisition is going on this weekend. So those customers and those branches will be converted over the weekend.
And what it will do is overnight we'll do 30 years of branch building in the Carolinas in terms of average branches would call it $80 million in deposits and give us meaningful share in the middle part of North Carolina. And back to what we said in 2017, when we merged with Capital Bank, it was we wanted to have a meaningful presence in the Carolinas and to pick up a top five presence in the triangle, excuse me in the Triad area, Greensboro, Winston-Salem, High Point, and to pick up meaningful share in Durham and Chapel Hill, the Triangle area in North Carolina is significant.
And so from a strategic standpoint, if we started building these 30 branches, we couldn't create branches of this quality in 20, 25 years. This is just a quality franchise and we were lucky to partner with SunTrust, BB&T now Truist to acquire these branches. So we're proud of what we're building in Virginia, Carolinas and Georgia with this transaction.
Okay, great thanks for that. And I guess when you have the systems fully converted; you can do more with those branches too. Right, so we could start thinking about it in that context.
Yes, absolutely. But the systems will be converted Sunday morning. So everything will be done this weekend. So it's soup to nuts this weekend on a branch acquisition. So we'll hit the ground running. People have worked really, really hard over the last few months and it's one of the reasons we deferred, we wanted to be in a position to do adequate customer communication, adequate training, we've got ambassadors in all of these banking centers from the First Horizon perspective, who will be helping with systems and technology and things like that over the next couple of weeks. But we're going to hit the ground running and these branches, financial centers, banking centers will be part of the First Horizon franchise this weekend and we'll hit the ground running Monday morning.
It really does help. I mean obviously having additional banking centers improves our ability not only to reach additional consumers, but small businesses and middle market companies still like to see a branch presence and so it enhances the work that our bankers have already done in calling on and bringing in business from all the areas where we'll have expanded presence in a few situations presence that we didn't have before. So we look forward to that in addition to serving consumers, but also the business side.
This concludes our question-and-answer session. I would like to turn the conference back over to Bryan Jordan for any closing remarks.
Thank you, Andrea.
I appreciate all the hard work that our associates are doing. And as I mentioned, the branch conversion, but there's an awful lot of merger plan and integration, and most importantly taking care of our clients and our community. So thank you for your hard work. Thanks, everybody for joining us on the call this morning. We appreciate your interest in our company.
We're very well positioned and we're going to create a tremendous amount of shareholder value with the consummation of the branch transaction and our Merger of Equals.
If you need additional information or have any further questions, please feel free to reach out to any of us. Ellen Taylor, Aarti Bowman, and let us know. We'll be happy to help you.
I hope you all have a great and wonderful safe weekend. Thank you.
The conference is now concluded. Thank you for attending today's presentation and you may now disconnect.