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.’s Third Quarter 2018 Earnings Conference Call. All participants will be in a listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded.
I would now like to turn the conference over to Aarti Bowman of Investor Relations. Please go ahead.
Thank you, Cole. 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 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 us. I’m pleased with our third quarter results. We delivered strong returns and improved efficiency. We demonstrated positive operating leverage with solid earnings, continued cost saves and excellent credit trends. We showed growth in our specialty areas and in our new markets, and we effectively deployed capital.
Our returns continue to be strong. Adjusted ROTCE was about 18% and adjusted ROA was at 1.21%. we are on track with our merger-related cost saves, and our adjusted efficiency ratio was at 64% in the third quarter of 2018, and we expect it to continue to trend down as we realized additional efficiencies.
We strengthened our capital ratios with the sale of our Visa B Shares. Our tangible book value per share increased from net income, as well as from the gain on the sale of the Visa Shares to $8.58. Loan and deposit growth were steady. We had good pipelines and we’re expecting continued commitments to fund up over the remainder of the year.
It’s important to note in our slide, you will see that we did some repositioning in the balance sheet and reduced outstanding low spread, low value of single product relationships by over $350 million in the quarter. We’re seeing good momentum from our specialty areas and I’m encouraged by the trends in our new markets in the mid-Atlantic and South Florida.
We’re focused on capitalizing on the organic growth opportunities in our new markets that have strong economies and attractive demographics. We see very good opportunities there. We do have a good platform to serve our customers as differentiated and we think we can continue to build our specialty areas on a broader basis.
With that, I’ll turn it over to BJ, and let him walk you through the quarter, and then I’ll have some closing comments before we open up for questions.
Great. Thanks Bryan. Good morning everybody. I’ll start on Slide 5 with our financial results. In the third quarter, our reported EPS was at $0.83, which included our previously announced Visa sale gain. Excluding that gain and the acquisition-related expenses, adjusted EPS was at $0.36. Third quarter reflected solid performance with adjusted pre-tax income driven by positive operating leverage with adjusted revenues up 1%, and adjusted expenses down 1%.
On the revenue side, NII declined around 5 million linked quarter, driven primarily by two factors that totaled about 7 million. Number one, lower loan accretion quarter to quarter, which was about 4 million as a change, and about 3 million of impact from the auto loan sale we announced in the second quarter. This was offset by a gain that we had on the sale of some trust preferred loans, as well as higher fixed income revenue.
Fixed income ADR was up about 75,000 a day from second and third quarter to 544,000. The expense decline was driven by continued incremental realization of merger cost saves. We did, however, make some incremental marketing-related investments in the quarter, which we expect will help generate momentum heading into the fourth quarter and 2019.
Turning to Slide 6, as we previously announced in early September, we sold our remaining Visa B Shares in the quarter for an after-tax gain of 161 million, which was a positive $0.49 impact to both EPS and tangible book value per share. And as you can see on the slide, this gain along with our earnings growth in the quarter meaningfully increased our tangible book value per share and our capital ratios.
Linked quarter tangible book value per share was 8% higher than in the second quarter, up $0.64 to $8.58 with $0.49 from the Visa B gain and an additional net increase of $0.15 from retained earnings. TCE to TA increased 58 basis points to 7.12, and our CET1 ratio rose almost 90 basis points to about 9.9%.
Turning to net interest income and net interest margin trends on Slide 7, you see the linked quarter ins and outs with NII and NIM down mostly from lower accretion in the third quarter and the expected impact is a 2Q18 sale of the subprime auto portfolio.
On the liability side, although total deposit costs were up from 2Q to 3Q as deposit competition continues to be high, we did see a moderation in our deposit cost increase as expected. Our cumulative deposit beta since the start of rate hikes in 3Q15 is at 36%. For that same time period, loan betas were at 66% far outpacing the deposit beta movement.
As we have discussed before, we are continually managing our balance sheet in totality with an intentional focus on optimizing the mix and growth of our loan and deposit portfolios over time, along with appropriately pricing our loans and deposits to deepen relationships and improve the performance of our margin.
To that end, we will continue to press our advantage in our attractive specialty lending businesses, deepen our deposit customer relationships, and take advantage of the floating rate nature of our loan portfolio to maintain and improve our margin over time.
Taking a look at loan growth dynamics on Slide 8, we see that our specialty banking areas continue to demonstrate strong growth with linked quarter annualized growth across those aggregate businesses of about 12%. Loans to mortgage companies were up 11% linked quarter, and although industry mortgage origination volumes are down, we have been able to grow the business by increasing market share.
As usual, we expect fourth quarter to be down from the seasonally strong home purchasing month of the summer and fall, but believe we have opportunity to further increase market share gains over time. Asset based lending was up 3% linked quarter, primarily driven by existing customer expansion of line utilization.
In our growth markets, we’re seeing ongoing success with our strategic efforts in Middle Tennessee where we posted 2% loan growth linked quarter. As you know, we are continually focused on maximizing the economic profitability of our businesses, and while the regional bank has seen some net growth over the course of the year in the range of 3% to 4% annualized from a loan perspective, it has come while we have been optimizing the balance sheet by exiting lower spread relationships as Bryan mentioned.
Over the course of this year, we have reduced our low spread loan balances by about 360 million. This has cut our regional bank loan growth by roughly half of what it could have been. This is the right thing for the balance sheet long-term and has improved loan yields by 73 basis points in those portfolios alone. Over time, replacing these loans will have a nice impact on our overall yields and free up balance sheet for higher return lending.
As you can see on Slide 9, credit trends remain excellent. Net charge-offs were at 2 million in the third quarter, flat from the second quarter. Provision was also at 2 million and the allowance to loans remained steady at 68 basis points.
Turning to Slide 10, I’ll quickly give an update on the Capital Bank merger. Our cost savings remain on track with 16 million of cost saves achieved as expected in the third quarter, and that means about 75% of the costs are now in the run rate and should be substantially in the run rate fully by the end of this year.
Revenue synergies increased again with 31 million of annualized year to date deals closed were in process. And as Bryan and I have both mentioned, we have started to see some promising signs of growth from our newer markets in the Carolinas what we call mid-Atlantic and South Florida. Our retail deposits in those markets were up 5% and 3% linked quarter respectively. And as we’ve discussed before, now that our merger integration activities are behind us, we’re confident in our ability to profitably grow both loan and deposit relationships in these markets and we expect those positive trends to continue.
Wrapping up on Slide 11, we are very pleased with where we sit with our return profile and that profile that we’ve built for sustainable returns going forward with a return on tangible common equity at almost 18%, our return on equity at 10.7% and a return on assets at 1.21%. With these results, we’re already right at or exceeding our medium-term return targets we laid out in May and continue our improvement towards our efficiency ratio goal of 60% or below, which will drive continued improvement in our return to the shareholders.
So, with that, I’ll turn it back over to Bryan.
Thank you, BJ. In summary, I am really pleased with the third quarter results and excited about the opportunities that we have ahead of us. We are optimistic about the fourth quarter in 2019 and feel very good about our ability to continue to drive strong returns in the business. The economy continues to be stable. Customer sentiment continues to be good. Loan pipelines have strengthened into the fourth quarter. So, we’re optimistic as we look into the remainder of this year and into 2019.
Word of thanks to all of our employees for all of their hard work, not only wrapping up the integration late in the second quarter and into the third quarter, but also the hard work to serve the customers and appreciate that. As a reminder, we’re holding our Investor Day on November 6 in Nashville. We’ll be providing more information about not only our strategy, but our execution plans with our executive team in attendance. If you need details, please reach out to us directly.
With that Cole, we’ll now open it up for any questions.
Thank you. [Operator Instructions] And the first question comes from Steven Alexopoulos from JPMorgan. Please go ahead.
Hi, good morning everybody.
Hi Steve.
I want to start on the deposit side, and looking at the increase in deposit costs, I was surprised to see the degree of increase in the commercial interest, which were up 25 bips quarter-over-quarter, can you give some color on why we saw such a big increase there? Was it all related to the prior increase you had done in larger account balances?
Hi Steve, good morning it is BJ. I think on the commercial deposit side, the competition has really since the beginning of the cycle been much more heated than the consumer deposit side. So, there is not really a material change in what the competition looks like there. There is high competition both on earnings credit rates, as well as the business interest-bearing account. So, there wasn't anything that was out of the ordinary in the quarter, it’s just continued increased competition.
Okay. BJ, as you're calling out pretty good growth in Florida and the Carolinas on the deposit side, do you have some perspective what types of deposits are you raising and what’s the cost of those in those markets?
Yes. So, it’s our normal mix. We are getting – obviously we’re leaning in those markets to establish ourselves a little bit more strongly coming out of the integration, and we’ve gone out as you might expect with the money market and CD offers that we thought were attractive, but then it’s also bringing in core checking account relationships as well, and I would tell you that the deposit betas that we saw in the mid-Atlantic and Carolinas in terms of those retail deposits are actually in line with what we saw across the rest of the footprint and then in Tennessee. So, in aggregate, our portfolio mix isn't materially different than what we’re seeing elsewhere nor are our betas, which is highly encouraging to us.
So, we expect to be able to continue to drive positive momentum and deposit growth in those markets. We’re putting some of that marketing-related investments that I mentioned earlier to work in those markets to again establish a foothold, establish a brand and grow core deposits over time. And as we’ve talked about previously, what we love to see is those markets further establish with meaningful deposit growth there over time such that we could replace our market index deposits from a funding perspective and continue to enhance relationships and improve our margin.
Okay. That’s helpful. And how are you thinking about the core margin here in 4Q?
I would characterize my view as stable going into the fourth quarter. I’d say that the margin was largely in line with what we would have thought and maybe a hair less than what we would have thought, and so, I see it as relatively stable.
And our next question comes from Ebrahim Poonawala from Bank of America Merrill Lynch. Please go ahead.
Good morning guys.
Good morning.
I guess just first question around capital management strategy, I’m not sure if BJ or Bryan who wants to take it, but I get, I think you recently again reiterated your focus on the 8% to 9% CET1, we’ve got a bump from the Visa gain as you mentioned earlier, I'm just trying to understand your appetite to buy back stock given that it felt like a quarter ago in July you felt that the stock was cheap, we’re down about 10% to 15% since then, and I'm just trying to gauge the management's urgency in being able to deploy about $230 million in remaining buyback authorization.
Hi Ebrahim, this is Bryan. I’ll start and if BJ wants to add on. We do think that there will be opportunities and now maybe one of those to be opportunistic in repurchased stock. We monetized the Visa again, we bolster the capital ratios, we had ascent from a lot of feedback that we were screening low on our book – price to book, as well as high on price-to-book and low on tangible capital to total asset ratios, and that created our bump with the hidden capital we knew that was there. But as we look into the future, we think our capital ratios were sufficient.
We have given a great deal of information about our stress testing. We published it in the third quarter. So, you have got that out there, and we think that with priorities for loan growth, organic growth being number one, managing capital is probably our number two priority as we look into the remainder of this year and into 2019. So, we do think that there will be attractive opportunities to buy stock and we do have the authorization to do it and we fully intend to use it as appropriate.
Got it.
I would add Ebrahim. I mean, if you look at where our return profile is and we’re confident that we can continue to maintain and improve that into 2019, and then you juxtapose that with what our forward earnings look like, what our price-to-book, what our price tangible book looks like, and we’re very bullish on where we’re taking the company and this could very well be a great opportune time to buy back some of our shares.
So, is it fair to assume that we still think that 8% to 9% CET1 is where we are targeting capital ratios or is the TCE 7% also something that you're going to triangulate too when thinking about capital management?
Ebrahim, this is Bryan. We still – we primarily focus on the CET1 ratio, the 8% to 9% is what’s in the bump. The reason we focus on that is our balance sheets are not created equally and a 7% ratio is an even more blunt instrument and when you look at the risk weighting of our assets, particularly the [2.5 to $2.5 billion] of average assets associated with our fixed income business has very, very little risk in that and it shouldn't and it doesn't draw very much capital. So, we manage more around CET1. We think that’s a good framework. We think that’s adequate capital and we will use those ratios to manage our capital allocation going forward.
And our next question comes from John Pancari from Evercore. Please go ahead.
Good morning.
Hi John.
First, on the credit quality side, I noticed you flagged a credit that moved on to nonperformers in the quarter, that contributed to the – looks like $20 million increase in MPAs, how – can you give us a little bit of color on that or what was the size of the credit, what’s the industry, did you put aside any incremental reserves against it or take any charge-offs? Thanks.
Hi John, it’s Susan. Yes, it was a $24 million credit from the financial services industry. We did – it had previously been a classified credit, I believe it was in the non-performing in the third quarter, and we did not take any charge-offs, but we have reserved some against it.
Okay. And you said it was financial services credit?
Yes.
Okay. Alright and then on that topic, any incremental – any indicative of any incremental inflows you expect on that front?
No, actually that one was really an isolated incident. I’m really pleased with what I’m seeing as it relates to asset quality, kind of the average PD grade actually improved quarter-over-quarter, which is our probably default grade rating for commercial portfolio, so we’re continuing to see strong asset quality and that was just an isolated downgrade.
Okay, thank you. And then separately on the margin, I know you give us some expectation for relatively stable for the fourth quarter, how are you thinking about it in terms of a general trajectory through for 2019. I know it’s a little bit further off and you’re going to probably talk about at your Investor Day, but how should we think about it. I mean, are we going to see some incremental expansion as we get some additional moves by the fed or are we still looking at relatively stable as we move through 2019?
Hi John it’s BJ. Yes, we will talk a little bit more about it at Investor Day as well, but we are continually trying to position our balance sheet to improve the margin over time. If you start with our continued asset sensitivity and our outlook for fed increases, we would think there is probably one late this year and at least one more next year, and with our asset sensitive balance sheet that provides a tailwind, number one.
Number two, our loans to mortgage company business continues to perform well. So, even though industry mortgage originations are starting to moderate as the long-end of the curve is moving higher we think their ability to take market share is going to provide us tailwind as well. And so, we expect that to continue.
Number three, we are very, very focused in our banking business on DVA growth. It’s DVA growth in consumer and it’s DVA growth in our commercial businesses, including our specialty businesses, and we have confidence in our execution plans to be able to do that and as you well know our ability to drive DVA is our most profitable way to improve the funding side of our balance sheet and so we're going to be very, very intently focused on that and those three things we think will help continue to support the margin.
And the last will be, as our loan growth continues into 2019, based on what we're seeing on the balance sheet and how disciplined who you are, we think that that can continue to help us incrementally improve the margin as we’ve taken out these lower spread relationship loans as well. So, we’ve got several levers that over time we think that we can continue to help them prove the margin.
And the next question comes from Casey Haire with Jefferies. Please go ahead.
Hi, thanks. Good morning guys.
Good morning.
Wanted to touch on the loan growth outlook. How do you guys, you know how are pipelines here at the end of the quarter, and then specifically the 360 million of run-off year-to-date, is that still – have you worked through most of that or is that still a headwind that we’re going to have to adjust in coming quarters?
Yes, I’ll start with the run-off that we have. There were a couple of different areas of the business and it wasn’t by the way to be clear simply capital bank-related portfolios that we were repositioning, it was also first Tennessee-related portfolios. In aggregate, we were repositioning our balance sheet to be able to take advantage of other things that we saw, but it was loan portfolios that had yields in the 2% to low 3% ranges at the beginning of the year, which we just felt like we’re not accretive to as Bryan said, really single product relationships that we didn’t have an opportunity to deepen.
So, we took the opportunity to take those out and move ahead. We’re always optimizing our balance sheet like this, but I would tell you that in terms of the magnitude of the repositioning that we’ve done over the first three quarters that magnitude of change will not continue to occur or we’ve largely repositioned most of what we wanted to do with some of the larger buckets. And so, going forward, it would not be nearly as visible.
And then on the pipeline and production side, we’ve actually seen a significant increase in production in the specialty businesses core commercial, commercial real estate of about 13% quarter-over-quarter, so third quarter production was strong, and that’s even excluding mortgage warehouse. If you include mortgage warehouse, our production quarter-over-quarter was up about – new production was up about 30%. So, we feel well-positioned as we go into the fourth quarter and then the pipelines really across multiple areas, including the capital bank market of Carolinas and Florida, many other specialty businesses are reporting strong pipelines for fourth quarter.
Casey, this is Bryan. September was our strongest month of the year in terms of production and Susan said, very good pipelines go on into the fourth quarter. I wouldn’t characterize personally the repositioning of the portfolio as a headwind. As BJ noted in his opening comments, our margins on that business that we replaced it with a 73-basis point higher. I think it’s important to note when you look at our balance sheet that we’re not driving just the cosmetics or the size of the balance sheet, we’re driving the profitability of the balance sheet and the return on the capital that we have deployed in it. So, while it may be what appears to be a headline to topline loan growth in terms of profitability is to right decision to position the balance sheet from a more profitable relationship-oriented perspective. So, I just want to finetune and I wouldn't characterize that as a headwind.
And then one additional point about optimizing these exit kind of single-product relationships and we’ve looked at this over time, asset quality performs better with customers where you have deeper relationships, and you have insight into treasury management cash flows, et cetera. So, in addition to improved margins, we also believe that over time that improves asset quality.
Okay, understood. I guess in keeping with the profitability, BJ, I’m following up on your comments on perhaps optimizing the market index funding side, is that something that you guys are actively prioritizing higher and is there a loan-to-deposit ratio at 91% or so is okay, what’s the appetite to take that higher to paydowns, to optimize the higher cost market index deposits?
Yes. It’s obviously a high priority for us. As we’ve talked about the last couple quarters, we would like to replace as much as that market index over time as we possibly can. It’s going to take a while, right, because we’ve got to build our portfolios, particularly in the newer markets to be able to replace it, but personally I would love to see deposit growth outpace loan growth, because I think that we would improve our margins and our net interest income by doing that, but we’re comfortable with a 90-ish percent loan-to-deposit ratio that does not make us uncomfortable, now would sometime a couple of basis points higher if we saw good profitable loan growth. So, you would probably hear more from us on Investor Day around that topic, but we continue to focus very intently on trying to optimize our finding mix and that’s one way to do it.
And our next question comes from Ken Zerbe from Morgan Stanley. Please go ahead.
Great, thanks, good morning.
Good morning.
I guess maybe starting up with loan growth, if we cut it, I guess, Slide 8, it looks like the idea of you do certainly have pockets where you are seeing some strong growth, but I guess average loans in total up 0.2%, again I understand that the run-off portfolio that we were talking about earlier, like what is the biggest headwind to growth at this point, and also kind of as you look out over the next year, like does that accelerate, like what drives that meaningfully higher than where it is today? Thanks.
Ken, this is Bryan. I will start. I don’t see anything that is particularly ahead when to loan growth. We have very good call in activity, we see very good strength across all of our markets, and in some ways optimism or pipelines picked up in some of these markets right in the quarter. That said, we are thoughtful about what we put on the balance sheet, the risk and reward that we take when we enter into a relationship, there are pockets were structure and pricing have gotten to a point that we decide that we can't be competitive at those levels and so you might characterize that is a headwind, I would characterize that as just managing the balance sheet for one you're going to like long term and so I don't see anything that is particularly problematic area, I just think we’re trying to be smart about the business we book, we're managing it for profitability, we’re using the balance sheet to support relationships, and as we look into fourth quarter and we look into 2019 we think something in that mid-single-digit area is still a reasonable way to think about the growth potential of our balance sheet.
Got you. That helps. And then just a question back on the NIM being stable next quarter, what underlying assumptions you are making about the accretion income as part of that? And should we expect accretion income to continue to decline from here or is it just kind of remain volatile given sort of accelerated pay-offs?
Hi Ken, it’s BJ. I think our loan accretion in any given quarter, probably peaked in the second quarter where we had 18 million, and this quarter we had 14. I would expect that it continues to step down by a couple of $2 million, $3 million a quarter over the next several quarters. And so that would certainly be a headwind to the margin.
And our next question comes from Brady Gailey from KBW. Please go ahead.
Hi, good morning guys.
Good morning, Brady.
So, if you look at the efficiency ratio, you saw some improvement as data on the 64%, I know you have kind of a longer-term goal of sub-60, you still have some cost saves coming from CBF in the fourth quarter of this year and then into next year. Do you think that you can get the efficiency ratio at that 60% or better level as you exit 2019?
That’s our goal. That’s what we’re driving for. And again, it will be a combination of overall positive operating leverage. Both Bryan and Susan both talked about some of the momentum we’ve got, we believe going into the fourth quarter. I talked a little bit about what we're trying to do to drive profitability out of the funding side of the balance sheet. We’re continuing to take cost out of the organization from the merger saves, and we’ll be very disciplined as we have been about what we spend money on going into 2019 such that we’re continuing to improve that efficiency ratio. As you’ve seen over the last five, six quarter we even proved it by 700 basis points or more. And that’s clearly one of our main priority to continue to improve the profit margin in the company.
All right. And then on the M&A side, CBS has been closed for a few quarters now, you’ve got almost all the cost saves realized a little more to come, but Bryan are you ready to start thinking about another potential acquisition?
Brady, this is Bryan. Short answer is, no. We're focused on execution on organic opportunities. We think that we have tremendous opportunities and momentum and the footprint that we have and we want to capitalize that and continue to build our business model and focus on those markets. So, in short no.
Got it. Thanks guys.
And our next question comes from Jared Shaw with Wells Fargo Securities. Please go ahead.
Hi, good morning.
Good morning.
I guess just following up on the loan transition comments from earlier, how are the markets, the new CBF markets transitioning? Are they on track with what you wanted to in terms of moving away from CRE and into the C&I side and should we expect to see the pipeline in those markets increasing?
Yes, Jared we are seeing very good shift in terms of additional focus on core C&I. From the existing teams that we have that are very strong in addition we’re recruiting new bankers in both Carolina and in Florida, who is focused on C&I core commercial real relationship building and as we mentioned earlier, the pipelines in the Carolinas and in South Florida are strong going into the fourth quarter, and we had particularly good production in mid-Atlantic, which is a Carolinas capital by market in the third quarter. So, we're pleased with where we are and opportunities in those markets that are dynamic and vibrant and growing. We’re also pleased with our ability to attract strong bankers from many different institutions that have potential clients that they could bring over, over time.
Okay. Thanks, and then on the fixed income business it was good to see the growth in the ADR’s there, how did that play out so within the quarter and as we saw the 10-year started moving at the end of the quarter was that, did that ramp up moving through the quarter and is that sustaining itself so far through fourth quarter?
It bounced around throughout the quarter. Third quarter and the fixed income businesses is, in any year volatile just because of the month of August and everything that’s happening around holidays and vacations. So, it bounced around. Activity was a little better probably on average in September, but it was up and down throughout and we have seen the same trends continue a little bit a year even into the start of the fourth quarter.
Thank you.
And our next question comes from Rob Placet from Deutsche Bank. Please go ahead.
Hi, good morning.
Good morning.
Middle Tennessee, Nashville is a market you’ve seen a growth in over the last number of years, I was just curious if you could talk about the success you’ve had there, and how translatable that is, that strategy is in your new markets in the Carolinas and then any differences in strategy, say Nashville versus the Carolinas?
Yes. This is Bryan. I think that’s an important point and we articulate optimism about the opportunities in mid-Atlantic and South Florida for example. We firmly believe that the model that’s been executed in middle Tennessee over the last handful of years is a really good example of how we're going to continue to grow and gain share in those markets mid-Atlantic, South Florida.
In addition to the demographic similarities, it is a model that we know works, it’s proven and we fully intend to deploy it. So, the lessons that we use to grow in middle Tennessee are going to be the same thing. We are going to deploy in the growth markets in mid-Atlantic and South Florida and it does give us that optimism.
Okay. Thanks.
One final point on that, which is, that will be one of the topics that we talk about in the Investor Day, so, I’ll tease the Investor Day a little bit.
And our next question comes from Jon Arfstrom from RBC Capital Markets. Please go ahead.
H, thanks good morning.
Hi, Jon.
Question on the synergies. You called out $31 million in annualized revenue and 471 deals closed or in process. Can you maybe give us an example of what one of those deals might be, one or two of those deals might be? And then curious how much more potential you see?
We have several different types of synergy opportunities Jon. Let me give you a couple of different ones that we are already executing on and we believe there are more out there. For existing clients, either in legacy First Tennessee or Capital Bank, in terms of hold limits and where we like to be. Obviously, it is a bigger balance sheet when there are opportunities to take on additional exposure on the lending side against the set opportunity to do that without going over the limit. That’s one example.
The opportunity to broaden relationships and we touched on this earlier about how important it is from a return standpoint, but even performance. The opportunity to offer Treasury management products to clients, so as an example I know there’s opportunity with a lock box for an existing customer in Capital Bank franchise and we had other products but we didn’t have an opportunity to expand there.
And then the third one I would bring up and all these are opportunities within synergies would be the opportunity to private client banking where we offer wealth management and private client lending to customers, executives, and owners of businesses. And then last, but not least would be our specialty lending verticals that we’ve had in the core First Tennessee franchise for a while, the opportunity we're seeing referrals into those specialty businesses from our bankers in the Carolinas in Florida. So, asset-based lending, franchise finance, mortgage warehouse lending, so we're seeing opportunities for referrals as well.
Okay, good. And more to come, you expect more to come from these opportunities?
Jon, this is Bryan. I think we just scratched the tip of the iceberg here. I think, we have a tremendous amount of opportunity as Susan articulated across a broad number of fronts, whether it be treasury management and P card to expanded balance sheet and referrals to specialty businesses. You take the ABL business, for example. Capital Bank's credit profile was much like ours. The ABL capabilities and the tools we have there will give us greater opportunities to call in these markets and expand our growth opportunities. So, we think there are quite a few opportunities left and we will continue to build on them.
Okay. And then a quick one for BJ. I don't know if you mentioned this, I may have missed it, but the reduction of low spread loan balances for the quarter, was that about a $200 million headwind? I’m just looking back through some of my notes, is that about right for the quarter?
No. It was [316 million] in total year-to-date. I would say that it was probably little less than 100 million for those low spread low value and then remember, we sold the subprime auto, which was about $100 million. So, in aggregate those were couple hundred million in the quarter.
Okay. Yes, good, thank you.
Thanks John.
And our next question comes from Michael Rose with Raymond James. Please go ahead.
Thanks for taking my questions. Just wanted to follow-up on the specialty lending growth, you know Susan you mentioned some of the areas, can you kind of size some of those opportunities for us, where you stand in the build out some of those different businesses and may be where you are looking to hire both in those businesses and the core franchise. There’s a bank in Nashville that obviously put out a lot of press releases about hires, just wanted to get the outlook for you guys? Thanks.
Yes, I’ll start, it is BJ. So, really our most profitable lending business is our loans to mortgage company business. And we continue to look for ways to expand that and that’s one of our top priorities, but across asset-based lending, loans to mortgage companies, our franchise finance business in particular those businesses in aggregate have less than 5% national market share. And so, we have huge opportunity over time to continue to build out teams, different specific sub niches within those lines of business and we’re very optimistic that we can do that and as we’ve talked about that before the reason that we like those businesses is that we see higher risk adjusted returns on those.
They have excellent efficiency ratios within those businesses. There is fewer more focused competitors in those areas because you have to know how to lend to those specific clients. So, not all banks can do it, and so we feel a little bit more rationality that we might see in some other lending areas. So, all of that really pushes us towards trying to allocate more resources to that growth and if you look over the last five years, our specialty lending businesses have grown 150% in terms of balance sheet growth over $6 billion and that’s excellent growth and it’s been growth that’s been very profitable and we expect that we will continue to grow those types of business, double-digits, and make less out of the balance sheet even more profitable.
That’s great color. Maybe just following up on that, excluding the run-off of the non-strategic. You guys still think of the core bank that mid-single-digit growth rate is kind of in the cards as we think about next year?
Yes, we certainly think so. So, some of the repositioning of the balance sheet that we have talked about this year has need some of that growth. I think if you look at the regional bank itself, I think we're seeing may be 3% to 4% annualized growth, but that was roughly cut in half by some of the repositioning portfolios and so going into next year our total balance sheet growth in the mid-single digits is very reasonable for what we think.
That’s helpful. Maybe just one final one from me. So, couple of quarters out, but any initial thoughts on the impact of seasonal for you guys? Thanks.
Yes, it’s number one a very frustrating thing and if any of you are knowledgeable on why we would want to change this and had total capacity there, I would love to hear it because I think it can be very disruptive, but nevertheless we will be prepared for going in. We don't have any specific impacts to share with you in terms of the magnitude of the change in our day one reserves or we're going to look like on our P&L, but we are in line, just slightly ahead with our planning of being prepared for seasonal, but hopefully something does change in the dialogue and it does continue to happen such that we can maybe landed in a more helpful place where both investors and banks before it’s actually implemented.
Michael this is Bryan. I would add to what BJ said. I strongly agree with the comments I read that Jamie Dimon made last week, I think, that it will be procyclical. I think this is an accounting convention that will be procyclical. I don't think it’s going to be particularly helpful to understanding financial statements and to sort of reiterate BJ's point of a minute or so ago.
To the extent that investors have strong views on the validity of whether this makes sense or not you need to express it to the accounting standard writers. They keep saying when we talk to investors who are demanding this and it doesn’t. I keep finding that groundswell of support. I just think it’s not good for the economy. I don't think it’s good for customers long-term, and I think ultimately, it’s not going to give investors any better understanding of financial statements.
And the next question comes from Geoffrey Elliott with Autonomous Research. Please go ahead.
Good morning. Thank you for taking the question. First just a little clarification. When you are talking about the NIM staying stable in the fourth quarter, that was the core NIM, I just wanted to clarify on that?
That’s right.
Thank you. So, just in terms of asset sensitivity, you kind of mentioned that a few times as a positive on the conference call, but I guess given the discussion about the stable core NIM into year-end and given the Slide 7 shows a negative impact from rates, days and other in the slide deck. Can you kind of help us by quantifying that asset sensitivity that used to be a useful chart in the slide deck, but it seems to be gone the last couple of quarters, just how much of a benefit is there still from rising rates?
Aarti is sitting here pointing and laughing at me because I thought that we didn't need that anymore. Now that we need it – the asset sensitivity hasn’t much changed from when we had that graph in there. There has been modest mix shifts as we would have expected, particularly in the deposit portfolio as rates have started to rise a little bit more of a shift into money market and money marketing into CDs which dampen asset sensitivity, but in terms of the lending that we’re continuing to do it is predominantly floating rate and so in aggregate our asset sensitivity has meaningfully changed and so we would expect the same types of net increases that we had seen before maybe, I think I’m trying to recall, I think it may be $8 million annualized for 25 basis point move, something like that, it’s roughly the same.
I guess the reason for asking is, it doesn’t really feel like it’s been coming through the last couple of quarters and the comments on 4Q stable core NIM kind of suggest there is not much benefit there in 4Q, so William what’s the piece that are missing there?
Yes, so I would tell you that the last two quarters have really – the difference has been the deposit beta. So, the deposit beta of course from 3Q 2015 to the first quarter of 2018, let’s say was very, very low, and if you actually go back we would have beat those asset sensitivity metrics that we put out on that graph before.
We would have been ahead of them. Last couple of quarters because we were active defending our deposit base, deposit betas where higher which dampened the sensitivity, but over time particularly when rates, short rates ultimately and stop increasing. We think that that again will help us in terms of our net asset sensitivity. And so, I Geoffrey it’s a question of timing, but over time and through a cycle we think our asset sensitivity is intact.
And our next question comes from Tyler Stafford from Stephens Inc. Please go ahead.
Hi, good morning guys.
Good morning.
I wanted to start just on the mortgage warehouse and obviously a good quarter there and the deck talked about market share gains driving that volume, I was just wondering if you can talk about the pricing or the yields in that business today, and just curious if you are seeing any spread degradation at all, just given that market share gains?
Yes, so it is still our highest yielding portfolio on the commercial side. Do you have that…
Yes, the yield is 546 [ph] for the quarter.
Yes, so it’s almost 550 [ph] in terms of yield and so very healthy. I would generally say though that as we continue to build market share, of course there are certain instances where we’ve leaned in and gotten a little bit more aggressive than the portfolio yields to try to acquire balances, but that rate volume trade-off has been a net positive for us of course and so we would expect that type of momentum to continue.
We will always look to increase our share at a profitable rate and I will tell you that Bob Garrett and our loan-to-mortgage company team and business out there do a phenomenal job of managing economic profit and managing returns on individual relationships such that we’re giving fair pricing to our clients, but also making sure that the bank gets paid for using our balance sheet as well. So, we expect those yields to continue to go up, particularly as when rates do rise because if they vary short-term oriented rate business and so we're very pleased with how it’s performing.
In addition to that, we’ve seen some really good deposit opportunity within the mortgage warehouse lending business and so calling on those customers and talking with them about deposits and then one last thing as it relates to market share, growth in mortgage, warehouse, it’s been a combination of an increase in client count, but client count mortgage warehouse, even just quarter-over-quarter was up about 5% year-over-year we were up about 15% in terms of numbers of clients. And then, in select cases, we’re increasing some lines to existing customers. So, we like the business and we like on both the winning side and the deposit opportunity that are there as well.
Very helpful. And do you have what the 546 comparable yield would have been in 2Q?
544.
Okay. And then, just lastly, BJ you mentioned the stock looks attractive based on your forward earnings profile, you guys just reported on 128 annualized EPS quarter, you’ve got 75% of the CBS cost savings now on the run rate and at some point, next year I would imagine the headwind of normalizing higher credit costs and then some margin – GAAP margin at least, headwinds from declining accretion and funding pressures. So, I'm just curious, what’s the biggest driver or drivers that you see internally from an earnings inflection that will be the biggest driver to it and improved forward earnings trajectory that you see?
Hey Tyler, just to clarify, $0.36 times four is $1.44.
Yes. I took out some of the onetime items in there, the drops and some other items.
That doesn't drop at $0.20, but regardless I will stay with what we got, which is $0.36 run rate right now. We talked about loan growth and what we thought the outlook was for there on this call. So, we feel pretty good about what we can do going into next year, we’ve repositioned the balance sheet for stronger profitability going forward. We still got asset sensitivity that we believe can come through. We're starting to see good deposit growth, particularly out of the newer markets, which will certainly help us in terms of our funding mix.
And again overall, we’re very, very focused on positive operating leverage and those things I just said, will drive the top line while we continue to get a full-years’ worth of benefit next year in expenses and sitting here today our expectation would be that expenses would be down next year, primarily due to the cost saves, while we continue to move the top line up. So, we’ll be very focused on making sure that that happens going into next year and that should obviously be helpful to expanding the earnings side. On the denominator of the EPS, as we talked about earlier, given where our valuations are, we think it’s a very attractive time for us to look at share buybacks and so what we will be looking at both sides of that equation continue to improve our earnings per share profile.
Tyler, this is Bryan. I would just add to BJ's comments. We have a lot of clarity about where our calling efforts are, we recognize – and our bankers did a great job through the integration, but when you're doing the integration in the first half first, really three quarters of the year, our focus goes on to the blocking and tackling in the short-term and not the calling efforts and growing the business. We see that turning, we see the momentum pick up. And as we see the business unfolding in 20 [ph], fourth quarter and 2019, we’re significantly confident that we have a pretty good outlook for the remainder of this year and the turn of next year.
And our next question comes from Brock Vandervliet from EPS. Please go ahead.
Hi, thanks, good morning. I guess just probably following up on the question, Bryan you touched on FTN securities and didn't sound like a resounding endorsement in terms of the business volume and cadence you're seeing there. You’ve got a bit of a long march ahead in terms of more rate hikes until you get to more favorable tailwind for that business, and I mean parting with that would certainly give you a leg up on efficiency ratio and another metrics, and how does that kind of fit in?
Well Brock that’s a business that we like and we had a slide in a deck for a presentation made early mid-September and it shows that business is counter cyclical. So, if you look at it from our perspective, one it is a business that has done very well and returns on capital for many, many years. We're comfortable with it and we’ve been in the business close to 100 years than not. And so, we understand it well, it is counter cyclical and when credit does start to deteriorate in the industry we will see a pickup in that and we have seen it historically, we will see a pickup there, it will be a countercyclical offset and in many ways I think an advantage for us and that while credit cost going up across the industry and ours will as well we have not have an offset to that. Given that, we’re not particularly panicked about the outlook for the next two or three or six quarter. We feel good about the business, we feel good about the team, and what they’re doing to control cost and to drive profitability in the business and so it’s a business that we’re comfortable with, we like the capital allocation we think it’s so counter cyclical balance and we’re committed to driving.
Okay. Separately as a follow-up on the provisioning and the provisioning tempo that’s kind of oscillated from small negatives or small positive, when do we, when should we, how should we think about that normalizing?
At this point Brock, we continue to see asset quality remains excellent and we continue to have run-off in the non-strategic portfolios, so we’ll see obviously some opportunities to relate non-strategic, use the models and they believe that we’ve got good coverage as it relates to the allowance. If the economy were to turn, credit quality started deteriorating, obviously you would see that available at this point. I see the provision remains rather stable across the next few quarters, based on what we know today.
And our next question comes from Christopher Marinac from FIG Partners. Please go ahead.
Thanks, good morning. Bryan you had mentioned a while ago about the repositioning not being a headwind. So, just kind of tacking onto looking at ROA and ROTCE, particularly as you have outlined on Slide 11, do we get to catch up coming soon just as a timing that sort of gets the ROA, a little bit strong stronger then obviously as you play out in 2019 to see where that can go? It just seems that you are earning in your zone on the return on tangible common but just a little bit below on the ROA, just want to reconcile the timing of that.
I think you will start to see it improving in the fourth quarter and then the 2019, particularly as you realize the additional cost save, which also affect your rate of efficiency ratio, but you should see both of those ratios continue to improve the capital. We did increase the capital buffer in the middle of this quarter. So, it is starting at a higher level of capital, but from a ROA perspective, we would expect that to continue to improve in 2019.
Okay great. And then, is it possible to compute a core loan yield, you may have mentioned that in the prior question, I just want to go back to that.
I don't have it in front of me, but we can get it to you.
Short answer is, yes. We can do that. Defining core may be the hard part. If you just excluded nonstrategic, we could probably do that fairly quickly.
Very well guys. Thank you so much for the time.
Alright Chris. Thank you.
And our next question comes from Matthew Keating from Barclays. Please go ahead.
Great, thank you. Just a quick follow-up on the company's asset sensitivity please. So, last quarter we talked about deposit betas moderating from 2Q levels in the back half of this year. As you think about deposit betas in Q4, do you think that what we saw in Q3 is our reasonable expectation? And then separately, perhaps you could quantify the impact at the more muted move in LIBOR this past quarter had on loan yields. Thanks.
Hi Matt, it’s BJ. So, on the deposit I think in terms of betas, I would venture to say that 2Q was probably our high-water mark. 3Q clearly moderated and I would open expect that 4Q would be flat to further moderate from the 3Q levels and so that will be helpful of course to the core margin in the fourth quarter. What was the other question Matt?
Thanks BJ. And the other question would be – obviously, LIBOR maybe was a bit muted in the third quarter, but it looks like it’s picking up from here, and so do you think you will see, obviously that beneficial flow through, I guess – so the question is really like, how big of an impact I guess to the more muted move have on loan yields if you are able to quantify that at all?
Yes. I think if you look at our reconciliation on the NIM slide, we had something I think called rate stage and others which was about 4 basis point decline, I’d say, a couple basis points of that was related to LIBOR ultimately.
Great. Thanks very much.
And 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, Cole. We appreciate you taking time to join with us this morning. Again, I’ll encourage you, if you have not already, please join us for our November 6, Investor Day in Nashville. Please reach out to Aarti and let us now. We have a lot of good information that we’ll cover. We’ll have our management team there going through the business, and we’ll spend more time talking about our outlook for the remainder of this year, but also for 2019 and beyond. Please feel free to reach out if you have any follow-up questions. I hope everybody has a great day. Thank you.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.