First Horizon Corp
NYSE:FHN
If you don’t study any companies, you have the same success buying stocks as you do in a poker game if you bet without looking at your cards.
Utilize notes to systematically review your investment decisions. By reflecting on past outcomes, you can discern effective strategies and identify those that underperformed. This continuous feedback loop enables you to adapt and refine your approach, optimizing for future success.
Each note serves as a learning point, offering insights into your decision-making processes. Over time, you'll accumulate a personalized database of knowledge, enhancing your ability to make informed decisions quickly and effectively.
With a comprehensive record of your investment history at your fingertips, you can compare current opportunities against past experiences. This not only bolsters your confidence but also ensures that each decision is grounded in a well-documented rationale.
Do you really want to delete this note?
This action cannot be undone.
| 52 Week Range |
12.07
20.93
|
| Price Target |
|
We'll email you a reminder when the closing price reaches USD.
Choose the stock you wish to monitor with a price alert.
This alert will be permanently deleted.
First Horizon Corp
You don't have any saved screeners yet
Good day, and welcome to the First Horizon National Corp. Third Quarter 2020 Earnings Conference Call. All participants will be in listen-only mode. [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, Sara, and good morning, everyone. Thanks so much for joining us today.
To kick things off, our CEO, Bryan Jordan; and CFO, BJ Losch, will provide an overview of our results, and then we are going to open things up for questions. We're really pleased to have Susan Springfield, our Chief Credit Officer with us to help with that effort.
So, our remarks today will reference the earnings presentation which is available at ir.fhnc.com. And I should note that we will make forward-looking statements that are subject to risks and uncertainties and you should review the factors in our SEC filings that may cause our results to differ from our 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 absolutely should review the GAAP information in our supplement and on Page 2 of our presentation.
And with that, I am going to hand it over to Bryan.
Thank you, Ellen. Good morning, everybody. Thank you for joining us this morning.
This has been a very significant quarter for us. We closed our merger of equals with IBERIABANK. We acquired the 30 branches from SunTrust, Truist, really excited about that. That integration was done in mid-July. We’ve made significant progress during the quarter. We are very pleased with the performance of the organization.
The great work that our associates did to serve their customers and their communities in what has been a challenging and trying time. We see good momentum in our business. We proved out again the countercyclical benefit of our businesses, mortgage, mortgage warehouse lending and our fixed income business.
Our balance sheet continues to perform well. As we talked about over the last ten or 12 years, we have really significantly restructured the balance sheet and to focus it more on C&I. We had net charge-offs of 44 basis points during the quarter and we saw a slight tick up in non-performing assets, but we ended the period with about $1.3 billion of capacity for loss taking. So, very strong balance sheet.
Very good quarter in terms of deposit activity. We had good customer inflows and the balance sheet feels good and we saw some progress made in adjusting our pricing to compensate for the lower interest rate environment.
Also during the quarter, we made good progress on our expenses. We had captured another $8 million of run rate – excuse me – of run rate in our quest for $170 million-plus in expense savings. We feel very good about our progress in controlling cost and are planning for the integration. There is a couple of good slides in the investor deck, which you can reference, that lay out the expectations around expense efficiencies over the next couple of quarters and year.
Our capital base continues to be strong. Very, very pleased with the positioning we came in with the CET1 ratio of 9.15%. Our tangible book value dilution was very slight from the acquisition of the branches and the completion of the merger, largely offset by earnings during the quarter. Our planning around the integration continues to go well. We expect that the significant integration work will be completed by the fall – early fall of 2021. We are on target and on track for completing that integration.
We have a lot of work to do between now and then, and we have associates all over the organization who are working to make sure that we do it in a seamless fashion and minimize, absolutely minimize adverse impact on our customers and our communities.
Finally, before I turn it over to BJ, I feel very strongly that we are well positioned for this somewhat uncertain environment. Clearly, the progress of the PPP programs, the fiscal stimulus has been positive today on the economy, but there is still uncertainty. I feel like we are well positioned in terms of a strong balance sheet, strong loss taking capacity, strong capital. And also positioned with a tailwind in the sense we have our non – our countercyclical businesses and we also have the ability to realize a significant amount of cost savings over the next 18 to 24 months.
So, with that, I will stop. I’ll turn it over to BJ, and then, we’ll be happy to take questions later. BJ?
All right. Thanks, Bryan. Good morning, everybody.
If we could turn to Slide 5, our GAAP EPS totaled $0.95 and $0.35 on an adjusted basis, which excludes the pre-tax net notable items detailed here totaling $269 million – excuse me - or $0.60, which are largely tied to the IBERIA merger.
We think it’s important to note that the impact of merger accounting on our financials are overall in line with the estimates we provided you during the second quarter call and in the pro formas released during the quarter. We’ve provided the detail on the marks and other impacts related to the merger in the appendix for your review.
On Slide 6, we provide a summary of our adjusted financials for the quarter, compared with FHN’s standalone adjusted results in the prior quarters. So, obviously, the trends here largely reflect the net impact of the IBERIA merger and the branch acquisition.
Moving on to Slide 7 for a look at net interest income and net interest margin. We generated net interest income of $532 million in the quarter, up $227 million linked quarter, driven by the impact of the merger. NII remains fairly stable with second quarter combined levels, despite the impact of the challenging rate environment.
Third quarter results included a $44 million benefit from accretion or about 12 basis points on the NIM, which was modestly higher than we originally expected given higher prepayments. Reported NIM came in at 2.84% in the quarter, down 6 basis points, reflecting the impact of low rates and continued elevated levels of liquidity, somewhat offset by accretion.
We also continue to take action to improve our deposit pricing profile. Our deposit rate paid was down again this quarter with interest-bearing deposit cost down to 36 basis points. Our goal was to manage down interest-bearing deposit cost towards the levels we saw in the prior zero interest rate cycle back in 2015 of around 24 basis points.
This quarter, we plan to align our deposit pricing across the expanded franchise, which should provide additional benefit as we enter 2021. Our NIM also continued to reflect the impact of much higher levels of liquidity. We estimate excess cash lower the third quarter margin approximately 12 basis points. We averaged about $3 billion of excess cash, which grew to $4.5 billion at quarter-end.
As you know, while this excess cash position lowers the margin, it does not impact our net interest income. We continue to look opportunistically for more attractive reinvestment alternatives going forward and expect to put more of that money to work over time.
In the fourth quarter, we expect to see additional margin pressure likely in the high-single-digit to low-double-digit range, but expect that level to represent the bottom for NIM going forward.
Moving on to Slides 8 and 9, I would note that here, we have provided our results versus prior period combined results for FHN and IBERIA. We delivered solid performance in fee income again in the third quarter with relatively stable results on a linked-quarter basis and a 23% year-over-year increase as the benefit of our countercyclical businesses in fixed income and mortgage banking helped to mitigate COVID-related pressure in some of our more traditional banking fee income streams.
Fixed income results came in as expected with relatively stable results linked quarter and $33 million increase year-over-year, given average daily revenues of $1.5 million. Mortgage banking again delivered stand out results with a $13 million increase linked quarter and almost $40 million year-over-year.
Secondary originations of $1.2 billion were up 3% from strong second quarter levels, while gain on sale margins expanded over 100 basis points to 3.93%.
As we look into the fourth quarter, while we expect a seasonal slowdown in volumes for both of these businesses, we do expect overall market conditions to remain favorable for both for the foreseeable future.
As you can see on Slide 9, we continue on our commitment to expense discipline. Linked-quarter expenses were down $15 million as a reduction in personnel expense and other non-interest expense was partially offset by an expected increase in intangibles amortization from the merger and branch acquisition.
Salaries and benefits increased $7 million, driven by the alignment of benefits across the combined platform, the addition of personnel from the 30 acquired branches and an increase in healthcare cost following the pandemic-driven slowdown. This increase was more than offset by a reduction in revenue base incentives and commissions, as well as lower deferred comp cost.
Our results this quarter also reflects the benefit of $8 million in net merger cost saves, giving us a year-to-date total of $18 million. We understand the importance of remaining incredibly focused on utilizing cost control as a lever in this environment. We have unique advantages to be able to do so given our merger and we’ll continue to look for further expense reductions beyond our targeted merger savings.
Turning to Slide 13 and 14, you see a view of our loan growth and funding profiles relative to combined First Horizon IBERIA results. As expected, period-end loan growth was modest as customer demand remains muted, payoffs continue and utilization rates have returned to more normal levels. Bright spot in the quarter was continued strong mortgage warehouse demand, which drove loans to mortgage companies up $1.6 billion on a spot basis and approximately $430 million on average.
Similar to fixed income and mortgage banking originations, the loans to mortgage companies function as a countercyclical, high return specialty business for us and we expect continued strong performance.
On the liability side, period-end deposits were up $2.3 billion, driven by the branch acquisition primarily, as well as continued strong customer inflows, which enabled us to run-off higher cost non-customer balances giving current levels of excess liquidity and our enhanced market presence, we expect to continue to move our interest-bearing deposit cost lower, particularly as we move to align our pricing strategies across the footprint.
We also further improved our funding profile with $1.2 billion reduction in borrowings from Q2 combined levels, as we leveraged our excess liquidity to pay down legacy IBERIA Federal Home Loan Bank advances.
Turning on to Slide 12, we will cover asset quality over the next few slides. Clearly, our results this quarter reflect the impact of the merger with a lot of moving parts. But if we step back, broadly speaking, overall asset quality continues to remain fairly benign so far outside of energy, despite the impacts of COVID-19.
Net charge-offs came in at 44 basis points, up from 20 basis points for legacy FHN, driven by energy-related losses and we saw a relatively modest six basis point increase in NPLs to 75 basis points of total loans despite the impact of the merger.
On Slide 13, you see we continue to add reserves this quarter as the impact of the merger and branch acquisition added $475 million to the allowance for credit losses. Outside of merger map, we also built reserves by a modest $13 million. Therefore, we ended the quarter with reserves of $1.1 billion, which is equivalent to 2.15% of the loan portfolio, excluding the low risk PPP and loans to mortgage companies portfolios and about four times annualized net charge-offs.
When you also factor in the unrecognized discount on acquired loans, we have total loss absorbing capacity of $1.3 billion or over 2% of total loans.
On Slide 14, we provide an update of our view around the portfolios that investors have been most focused on in terms of impacts from the pandemic. We continue to do very detailed portfolio reviews of industries currently affected and in the quarter, we reviewed in detail $9 billion of loans in the commercial portfolio across the various sectors.
As a result of that, as well as other broader portfolio reviews, we believe that just 11% of our total loans should be and are subject to a heightened level of monitoring. We have shown the subsectors of the portfolio that maybe more stressed such as real estate lending, energy, retail, trade, and the non-fast food portion of our accommodation food service portfolio.
It’s important to note that other sectors such as the central services, recreational goods, manufacturing, and home improvement are continuing to perform well and additionally our higher quality consumer portfolio is performing well as well with a weighted average FICO score of 750 on a refresh basis.
As we’ve mentioned today, customers are proving to be more resilient than originally appeared and overall stress appears to be declining. We’ve provided data in the appendix on the reserve coverage across our portfolio, as well as on deferrals which have now declined meaningfully to around 2.4% of total loan balances from a peak of almost 13%.
Overall, we continue to feel very comfortable with our risk profile and reserve levels, particularly after going through the very detailed process of marking the IBERIA loan book, which represents about 45% of the portfolio.
Moving on to capital and tangible book value per share on Slide 15, as we mentioned, TBV per share of $9.92 remained relatively stable to second quarter as strong earnings were offset by the impact of the IBERIA Merger and the Truist branch acquisition and the CET1 ratio ended the quarter at 9.15%. Near-term, we expect to continue targeting a CET1 ratio in the 9% to 9.25% range.
Turning to Slide 16 for a merger integration update. We continue to be very energized as Bryan said by the opportunities ahead of us in connection with our merger of equals. In the year, since we announced the deal, we have established a strong merger integration framework to help ensure that we capitalize on the opportunities in a highly efficient manner even in the phase of the pandemic.
We’ve already done a great deal to align our cultures, processes and systems to ensure a successful integration. We completed much of HR-related integration by identifying leadership and converting payroll systems. And on the customer side, we’ve built out our go to market and organizational models, as well as finalizing our customer experience dashboard.
We are on track to convert various other platforms and are currently planning for the full systems conversion to occur in the fall of 2021.
Again, as Bryan said, in the third quarter, we delivered $8 million of cost savings bringing the year-to-date total to $18 million. And in the table on the right, we’ve provided a modestly updated view of our expected saves over time. We continue to be highly confident in our ability to deliver at least $170 million of annualized savings in 2022, but the past as the saves has shifted by a quarter or so.
This largely reflects the fact that we now believe it’s prudent to target a September, October system conversion versus the previous view of a late second quarter conversion. In the table on the right as well, we’ve provided the estimated timing of our merger savings on an annualized basis. In the third quarter 2020, our annualized expense base, excluding incentives and commissions totaled about $1.52 billion.
And based on our expectations for the timing of the merger saves, we believe that our 2021 expenses excluding incentives and commissions should reflect low-single-digit decrease.
Wrapping up on Slide 17, we believe we are well positioned to capitalize on the benefits of our more diversified business model over time and through our IBERIA merger and the branch acquisition, we now have an expanded franchise across some of the most attractive markets in the south. As we’ve demonstrated this quarter, we have a revenue mix that helps us offset NII pressure from the low rate environment.
We also have the advantage of merger cost saves and through prior acquisitions and efficiency initiatives, we’ve proven our commitment to expense controls. Our prudent approach to risk management should help us mitigate credit losses going forward and we have the benefit of the marked loan book and significant loss absorption capacity.
While the economic environment remains challenging and loan demand is muted, it gives us the ability to focus on merger integration for the next year and we believe our business model will result in outperformance and shareholder value creation in the quarters and years ahead.
Since I know they are listening, I want to give a quick shot out to all those on our various teams across IR, Accounting, Finance, Credit and Technology in particular, that have done extraordinary work and have spent long hours getting us to this point.
This is my 47th quarterly earnings call with First Horizon. And I’ve seen a lot over the years, but the complexity and uniqueness of this quarter and the year take the cake. Thanks to all of you for your efforts.
So with that, I will turn it back over to Bryan.
Thanks, BJ. We believe our strong balance sheet, capital and liquidity will serve us well in this difficult operating environment. We’ve maintained strong underwriting standards and built a diversified portfolio focused on profitability and performance in a downturn. Despite the economic headwinds, we are uniquely positioned to capture merger opportunities with enhanced scale, better efficiency and improved earning power to create significant shareholder value.
We are incredibly committed to continuing to assist our associates, communities and customers and efforts to overcome the impact of COVID-19 and revitalize the economy. Thank you to all of our associates for their outstanding commitment in helping us and helping our company and our community navigate this unprecedented landscape.
Again, we are very well positioned. I am very, very excited about the combination of IBERIABANK and First Horizon and we think we have unprecedented opportunities ahead of us.
With that, operator, we will be happy to take any questions.
Thank you. We will now begin the question-and-session. [Operator Instructions] Our first question comes from Jared Shaw with Wells Fargo. Please go ahead.
Hey, good morning, everybody.
Hey, Jared.
Morning.
Hey, maybe just starting on the – on credit, I guess, first, what’s the credit market specifically on the energy portfolio beyond just the provision?
Yes. If you – we’ve got about a 7 point – almost 7.5% coverage – allowance coverage for the energy portfolio. And that’s detailed on Page 19 in our deck.
I guess, in addition to the allowance, what’s the 141-hour mark on the acquired portfolio?
Mark, on the energy portfolio, I am not sure I have that in front of me in detail. But like Susan said, we had energy charge-offs in the quarter. We’ve replenished the reserve on a combined basis and the reserve on the energy portfolio remains at about 7.5%. So, still very healthy reserves.
Yes. For sure. Okay. Great. Thanks. And then, it looks like you used the August economic baseline in calculating the provision allowance this quarter. Given that September and October have improved, could we view this as a high watermark for the allowance ratio, assuming all else equal?
Yes. It’s a great question. I would hope so, but we are hoping for the best. But still pretty cautious about what could occur, particularly around the election and entering the fall and what could happen with COVID-19, et cetera. So, obviously, we feel very comfortable with our reserve levels. We feel very comfortable with the marks that we’ve made.
We continue to take a cautious approach to particularly releasing reserves. You’ll see we had just a very modest build on our reserves despite the fact that, like you said, that the outlook has certainly gotten better from second quarter and even from the August scenarios that we use. So, we are going to continue to be cautious about holding on to reserves for a while. But at some point, clearly, you are going to see that if the economy continues to improve, which we sure hope it does.
Hey, Jared, this is Bryan. If you had asked us six, eight months ago and say, how would you feel going into the second six months and maybe the next 12 months of pandemic, how would you feel about things? I don’t think we would have said, things would look as good as they do right now. And so, we are pleased with the progress. I pointed out earlier, the significant impact of the fiscal programs the Congress has put in place.
BJ mentioned some of the uncertainty that still exists in the environment. And we still believe, I believe very strongly personally that, in certain sectors of our economy, consumers and some of the more severely impacted industries associated with social distancing and the fallout of the pandemic needs some targeted fiscal support.
So I believe strongly that the next several weeks, they maybe, but weeks, months of how Congress deals with additional fiscal support is going to set the direction for the next several quarters. I am optimistic today, I think, they are making progress. But as BJ said, with the uncertainty, we think it was appropriate to maintain strong reserves going into the fourth quarter in the turn of 2021.
Okay. That’s great color. Thanks. And then, I guess, maybe just a bigger picture question, do you feel like you are able to maybe more immediately go on the offense and take advantage of some of the market disruption in your markets from either larger competitors or larger deals that have happened? Or are you still more focused on integration first and that more of an offensive stance would be end of the year, I am sorry, end of next year?
Well, depending on how you define offense, Jared, I would say, I think, we are very front footed in terms of taking opportunity in the market to pickup new relationships. And while I didn’t mention it earlier, we are seeing the beginnings of very nice revenue synergies between the two organizations, IBERIABANK and First Horizon.
It is very – it’s an environment that is somewhat unique and that you’ve got to be cautious as you look at what you put on the balance sheet and how you use the balance sheet. But we are looking for opportunities to take advantage of this dislocation and we are seeing benefits from the PPP program and we think there will be additional opportunities down the road.
If it relates to further M&A, that’s not really in our frame of reference today. We are focused on the merger and the integration that we have in front of us. I’ve said earlier, I’ll repeat, it’s a tremendous amount of work between now and early September of next year. As BJ said, our teams are working really, really hard and doing a great job and I am excited about what our associates are going to get accomplished. But that’s most important. And then, we’ll figure out what’s next after that.
One thing I would add to the question about opportunities for the offense. We are seeing what I would call some generational opportunities with prospects that our bankers have been calling on in various markets where, in some case, years that are really great opportunities to bring those into the fold to become clients.
So these are businesses that have survived through many cycles that we know well and opportunities to bring ourselves. But we are being selective, as you can imagine at this time. But we do remain open for business for the right profile, the right industry and the right client selection, which has been important, really the both legacy banks for many, many years.
Our next question comes from Ebrahim Poonawala with Bank of America. Please go ahead.
Hey, good morning guys.
Good morning.
Good morning.
Good morning.
BJ, I guess, if you can just start with less interest income, I think, you gave the – in the margin, one, in terms of your margin guidance for, I guess, down 10 basis points plus or minus. Is that on a – do you expect that decline in the core margin? And then when we look at the $454 million in core NII, do you expect that number to go higher or lower in fourth quarter and beyond?
Yes. So, let’s see. Let’s start. When I said, high single-digit, low double-digit, that was more on the reported NIM side. I think we can be a little bit better on the core NIM due to opportunities around further deposit rate pay reductions, some of the opportunities that we are seeing in higher yield portfolios like loans to mortgage companies putting excess cash to work and those types of things.
So I feel, feel pretty good about that. Clearly, as you know, in merger accounting, we had a higher level of accretion this quarter, which we expect to be modestly lower in the fourth, which is driving a lot of the decline in the reported NIM.
But as I’ve said, we expect the NIM to bottom out in the fourth quarter and then into next year be relatively stable to hopefully modestly improving as we view some of the things that I just mentioned.
And the core NII, $454 million, do you think that goes higher from here or lower?
Yes. So, like I said, if the margin is – if the core margin, I think is relatively stable, maybe down a little bit into the fourth, but bottoming out, then it’s going to be a question of how do we put the excess cash to work, improve the deposit rate paid and see what kind of loan growth that we can have in terms of opportunities into 2021. So, go – I guess, to your question, I see it kind of bottoming out and then being able to hopefully improve into 2021 as the economy gets better.
Got it. So, we should expect some decline in the fourth quarter in line with your sort of core NII – core NIM decline, but from there on, it should stabilize as we look into the first half of the next year or that develops?
Yes. Yes. So, I’d say, the core NII, we think could be flattish going into the fourth quarter and then, hopefully improving with opportunities going into next year.
That’s helpful. Sorry to ask so many questions on that. I think there is just a big divergence in terms of expectations around NII next year. So it’s helpful in terms of the color you provided. And just in terms of expenses, so, thanks for the update on what the cost savings tied to the integration both First Horizon and IBERIA, there is a pretty strong track record in terms of expense management.
You have seen banks kind of take another look at real estate costs, other expenses coming out of the lockdowns. Just talk to us in terms of what’s the opportunity like in terms of expense savings meaningfully exceeding the $170 million that you laid out?
Yes. So, I think, you heard Bryan use the term $170 million plus. I use the term at least $170 million. So, clearly, we are very confident in our ability to get the $170 million and that’s not even an issue for us. We are looking beyond that to find further cost reduction which we are highly confident that we can capture. We want to make sure that we get all the $170 million in the numbers, but we are working on things like, customer behavior changes, and the impacts on branches and how customers want to do business with us. We have 5.5 million square feet of office space and branch space that we certainly think that we can optimize further over time, given changes due to the pandemic.
And we are working very hard as we put our systems and processes together to find opportunities to use the systems upgrades and new systems that we are putting in place to find further process improvements and do a lot of work around RPAs and so on which Anthony and Randy and their teams have great expertise at. So, we are confident that the $170 million is going to happen.
It’s the question of how much higher. And so, we’ll come out further in the fourth quarter and into 2021 talking about further plans that we have to continue to get cost saves. But this is a journey, not a destination, particularly given this environment, we are highly confident we’ll be able to deliver as we have before.
Hey, Ebrahim, this is Bryan. To add to BJ’s comments, I think he is exactly right. You have to keep in mind that we have a lot of moving parts right now with the integration and we want to be thoughtful about how we put the two organizations together and not do things that damage the customer franchise while we integrate. So we are been thoughtful about expenses. That said, BJ is absolutely right.
We think we can do and will do more than $170 million and we don’t think we should try to pin the tail on that number today, but we will sometime in the not too distant future. It is clear to us that the effect of the COVID-19 experienced and the pandemic has changed customer behaviors probably for the long-term. It has changed our work habits. It has changed a lot of things.
Then, we believe very firmly that we need to factor all of that into how we put these two organizations together. How we look at expenses. What our branch, our banking center coverage looks like and BJ went through a lot of the important details that we are looking at. So it’s a work in progress. We are committing to doing more than $170 million. We’ll be back to you with how much down the road.
Got it. Thanks for taking the questions.
Our next question comes from Steven Alexopoulos with JPMorgan. Please go ahead.
Hey, good morning everyone.
Hey, Steve.
Good morning.
Hey, Steve.
So first, just a follow-up. BJ, in your comments for the core NIM to hold stable in the fourth quarter, it seems that excess cash is going to build, right? So you are going to have even more weight on the NIM in 4Q. So is the thought that, at least in the short run, you realign deposit cost, I don’t know if it’s a 4Q event that you get to the mid-20s and that’s the near-term support?
And then, from there, you deploy excess cash and that’s what provides further support to them, because it would appear that core NIM will go down in the fourth quarter based on just the cash phenomenon.
Yes. So, Steve, good question. Our current expectation is that, we are able to put more of the excess cash to work in the fourth quarter.
So, we did see it increase into the end of the period from some of the averages, but the strategies that we are contemplating now, including letting contracts expire on market index deposits, some of the things we are thinking about to soak up the excess cash around the loan portfolio, the securities portfolio and other things.
We think that we can move the excess cash position down. The other is, we still think that there is opportunity in loans to mortgage companies, as well, which is a very efficient use of our excess cash. And so, usually, seasonally, that business can be down. But given the very strong environment that we are seeing today in the mortgage space, we think that that – it could hold up in terms of balances in the fourth quarter.
That’s actually very helpful. And then, on the reserve, I hear the comments, right, you are still cautious given we are still in the middle of the pandemic, but when we look at the reserve, right, the $1 billion, it’s a 1.8% ex PPP and that’s on top of the credit mark, if – and if you have strong loan growth in mortgage warehouse, you really need reserves for those. So, if the rest of loan demand is somewhat muted, why would you need to provide any additional provision over the next few quarters?
I hope you are right. I think, as I said in the beginning, we are taking a pretty cautious stance at this point, right. It’s a lot easier to be conservative at this point and hold reserves and then release them as opposed to be too quick to let reserves go and then see a reversal of the improvement in the economy and have to build reserves again.
So, I am highly confident again in where our reserves are and our loss absorption capacity and I do think that eventually we will release reserves. But we think it’s a little too early to make that call at this point.
Thanks. And then, finally, you have announced that the three year plan is finalized or getting finalized in the fourth quarter, Bryan, should we expect anything material from that in terms of revenue, or additional expense initiatives? What should we get out of that? Thanks.
Well, yes, I don’t think that in the short run you should expect any significant shift in our business. This is really bringing together the combined organization the thing that’s done and Anthony Restel has done a good job leaning, but the team has done a great job pulling the strategy together and what’s – I think that you will see out of it is, where we are going to focus in markets, in product set, and it’s about how we have combined focus as an organization.
Then, as we said a couple of different ways, clearly, expense control will be an element of that. But what we are really trying to focus on is, beyond the integration, what is it that we need to be executing on to be on the ground running through the integration and then most occasionally to really pick up momentum when we get that completed in September of next year.
So, it’s got a strong focus on markets in where we invest, where we put people and the products, how we work on our cross-sell opportunities, the revenue synergies that exists are bringing the combined product set together.
Then, we believe, given what we’ve seen on a macro basis in the U.S., that the states that we do business and the markets that we do business in are going to be very positively impacted by the migration of people, and businesses and opportunity and we just want to be position to make sure that we take full advantage of that.
Great. Thanks for all the color.
Sure. Thank you.
Our next question comes from Brock Vandervliet with UBS. Please go ahead.
Thank you. Just I just piling on Steve’s question on the reserve, BJ. I mean, what do you need to see to tap that reserve? Because I think the point here is that, relative to peers you are very well set up. Is this something that a Moody’s outlook would reveal or you’d have the confidence or is it, hey, just double the size of the bank and give us a couple quarters, but we get it it’s coming down. And any further color there?
Yes. So, the way these models are built, as you know, is that the quantitative part of the models are driven largely by our historical lots, history, as well as what the forward view is, as informed by the Moody’s scenarios. We then create qualitative overlays, particularly in stressed portfolios and sectors where we have a little bit more concern or uncertainty around it.
And as you might imagine that, if the outlook continues to get better which we certainly hope it does, the quantitative models are going to tell us to release reserves. And at some point we are going to be comfortable that the qualitative that we have aren’t needed. So, again, I think, we are well reserved. I do think reserves will come down into next year.
It’s a question of timing and we just think at this point, given continued uncertainty that it’s better to hold it as opposed to release it. But we are confident that we are well reserved and we’ll be able to do so.
Okay. Thank you. And regarding the – I believe it’s 2.4% deferrals, what do you see is the end game there? Are most of these going to return to normal P&I payments and a chunk restructured with very little real breakage or something different? How does that – how do you think that plays?
Brock, thanks for leaving what we’ve saying of when it was at the higher level a couple quarters ago. Many are returning to making their payments. Some of them are cautious in the beginning and just said they are back and take a deferral, I will.
There will be some clearly that we will work with to restructure. But at this point, we are seeing very, very few clients ask for that – what I would call a third round of deferral which I think is very good, which is why the active deferrals have come down so dramatically.
But we are, as you saw on one of the pages where we talked about our proceeds, - on areas of the proceeds, I think that was Page 14, in addition to overlays that portfolios as a whole, we continue – we did a second quarter third quarter or in this quarter and as long as we need to with any sort of uncertainty around COVID, we are also doing deep dives with individual clients. So we’ve got really good insights.
And one of the things that I continue to feel very good about is the fact that our prudent on the writing in the beginning, the client selection and seeing our business owners and to our sponsors working with us during this time. We’ve seen a lot of – I think, positives around that. So, you’ll see – your question was what you are going to see?
I think we’ll see some of all of that. You’ll see some that will just return to normal, you’ll see some that we’ll have to work with on a longer-term dices. And so, we stand ready, client-by-client to make that happen.
Okay. Great. Thanks for the color.
Our next question comes from John Pancari with Evercore ISI. Please go ahead.
Good morning.
Good morning, John.
Hey, John.
If I could just kind of beat the dead horse little more here on the reserves if I could. Kind of go about at this way, and can you just maybe give us little bit of the granularity of your credit details behind what may have influenced your thoughts on reserve? Particularly, do you have your criticized in classified asset trends for the third quarter?
Yes, we do. John, this is Susan. So, overall, our criticized went from 2.7 to 3.3, now that’s on an, obviously combined basis for second quarter to third quarter with those things. So you did see some increase of about $400 million that moved into the criticized category.
We – in terms of the portfolios where we look at during a qualitative overlay, there is a portfolio as you would imagine that we would and if you look at the areas of proceed risk, we have an additional overlay for energy, additional overlay for hotels, for retail, and for some of the non-profit and also the casual dining full service.
So those are areas where I think Bryan and BJ have said that on many of these questions. We do – we are seeing some things loosen up our strings in terms that we like. But we just think it’s too early to be thinking about releasing reserves, but based on what we know now, we should be able to do that in a quarter or two if we continue to see good trends.
Hey, John. This is Bryan to use your pros, there are a lot of ways to come at beating this dead horse. At the end of the day, CECL implies a heck of a lot more precision than actually just in reality and we sort of look at this is bit of an art and we apply these overlays mainly because it is too early and it is a degree of uncertainty about what will happen in terms of fiscal stimulus and how the pandemic plays out. How far away are we from therapeutics.
How far away from a vaccination. There is no intended signaling whatsoever that we see something about the portfolio that calls us to just to keep them up other than we believe that we lean into the art. We remain conservative as it’s been our practice over many years. And we will continue to evaluate it. Whereas, as I said optimistic about how things are positioned today on October the 22nd or 23rd, whatever the day is. And we think this can play out very, very well and when it does, we will release these reserves and they’ll come back.
Okay. Okay. Thanks, Bryan. And then, separately on the expense side, BJ, are you – could you kind of – or just repeat the expense guidance for 2021? I think you had indicated, did you say a low-single-digit – did you say decrease including incentives and commissions?
Yes John. Thanks. So, what I said was that, our expense base excluding incentives and commissions, which as you obviously now are going to rise and fall with revenue-related fee income. We expect that expense base ex incentives and commissions to be down low-single-digits.
Okay. Got it. Got it. And that is on a full year 2021 versus full year 2020 basis?
Yes. Yes. I am sorry. Go ahead, John. Go ahead.
No, go ahead. I’ll ask after you.
I was just going to say it quickly if you look in our press release in the supplement, we did reorganize those – the expense line items a little bit to make it easier for you all to explicitly see the incentives and commissions broken out from the rest of the expense base, such that it’s easier for you to visibly see the expense discipline and the merger cost saves as they come through.
Got it.
And John – hey, John, and just one thing I want to clarify. So, if you – we gave you our third quarter expense base excluding incentives and commissions. That’s the 1.5 to 2, because remember, the first half of 2020 excluded fee. So, that utilized that third quarter annualized.
Right, right. Okay. And does the base also exclude the charitable contribution and the merger charges as well?
Yes. That’s an adjusted basis number. So I just – that we’ll just wrap on.
Yes, yes. Alright. That’s it. Thank you.
Thanks, John.
Thank you.
Our next question comes from Ken Zerbe with Morgan Stanley. Please go ahead.
Great. Thanks. Again, so thanks for pointing out. Hey, so thanks for pointing out all the one-time items. But aside from the forward through for notable items you guys called out, were there any other line items in the income statement that were impacted by – at least can you say volatility that might not recur in future quarters?
Well, I think we mentioned the true-up of the IBK seems – sorry, benefits, so, from a linked-quarter perspective, it was an initial step-up there that will persist. But you shouldn’t see a repeat of the step-up.
That’s right. Yes, Ken, I can think of anything that we would specifically call out for all of you, I think, broadly speaking what John just asked about our expense base from 3Q 2020 annualized versus 2021, it would all be captured in there, we wouldn’t call anything else out other than the notable items,
Got it. Okay. Perfect. Go ahead.
I was going to say, you’ll see over the course of coming quarters, we will see normal seasonal variability in certain line items, but….
Got it. Of course. No, no, I understood, I guess, I was just looking and so the next question is, if I was looking at the mortgage banking line which is obviously very strong this quarter, certainly well above sort of IBERIA’s runrate basis, just with mortgage banking, like how do you see that planning out? And obviously, it sounds like, fourth quarters generally remains strong, but where does that sort of normalize when we think about 2021?
Yes. Yes. Ken, we still think that for the foreseeable future, and I can’t exactly put a fine point on foreseeable future, but we think that the countercyclical businesses are going to remain strong. I mean, if you look at our mortgage origination volumes and home price demand, it is still very, very strong. And so, we are benefiting from that.
And so, we expect that that’s going to continue for both the mortgage origination side, as well as the loans mortgage company side. I would say that, we had, if you look in our information very strong gain on sale percentage this quarter, we still think that volumes are going to be high, gain on sale was probably higher than what it would normally be going forward.
We expect that to moderate a little bit, but in aggregate, we expect that these businesses will continue to drive outperformance and help us offset some of the NII headwinds that we see.
Alright. Great. Thank you.
Sure.
Our next question comes from Brady Gailey with KBW. Please go ahead.
Hey. Thanks. Good morning guys.
Hey, Brady.
Morning.
Morning.
I wanted to start with loan growth. I know, when we talked about it last quarter, you said you expect kind of modest loan growth at best. It seems like loan balances would be back off to acquisition noise were up a little bit organically in the third quarter from the mortgage warehouse.
But as you look forward, how do you think about loan growth? Lot of times, when you do big acquisitions like this, but there is some loans that tend to run-off. So, do you expect to see kind of some near-term loan shrinkage in 4Q? And then, just how do you think about loan growth as we look into 2021?
Yes, so, I’ll start and Bryan and Susan can jump in. But there are a few areas of growth that we think can certainly help us going into 2021. Loans to mortgage companies, of course, we continue to think could be strong. There are specialty businesses beyond loans to mortgage companies like asset-based lending, like equipment finance that are very strong today and we expect those to continue going into next year.
We don’t have any portfolios aside from what we are doing to manage our exposure to energy, of course. But more broadly speaking, we don’t have any other portfolios that we are actively managing down or managing off. So, I don’t expect any material step-downs in terms of other areas of the portfolio, but traditional loan demand, broadly across consumer and commercial portfolios is like we’ve said pretty needed at this point.
So, we do have pockets of opportunity that can offset some declines. So, we don’t have very high expectations for loan growth going into 2021, that’s not because we don’t want to look for new opportunities that Susan said earlier. We are and we will, but it’s just the nature of the environment right now that we’ve got to pick our spots.
Okay. So, not a ton of growth next year. And if you look at, I heard you guys say that common equity Tier-1, the targeted range is 9% to 9.25%. You are at 9.15% now. I think – do you say profitability and not a lot of growth that ratio, I am guessing is going to move higher pretty rapidly. So, how do you think about buybacks seeing off the table this year? But as we look into next year, 2021, how do you think about share buybacks as your common equity Tier-1 moves over the top-end of that targeted range?
Brady, this is Bryan. It’s clearly our desire to put capital to work in organic growth opportunities. And so, we are always looking for that as the first way to leverage our balance sheet and we’ll know a whole lot more about what 2021 loan growth looks like when we get past the turn of the year. We are very conscious of maintaining a strong capital base.
The dividend and the buyback are clearly vehicles for repatriating capital to shareholders that we think what the use in the balance sheet. So, I don’t want to get out in front of our Board and the discussions there. I feel very, very good about where our dividend is. I think it’s unlikely in the near-term that we start the repurchase program.
But we are constantly looking at how that capital ratio builds and how it fits into our expected usage in the balance sheet. This problem that we all sit here with today and it’s universally through the financial services industry there are more known unknowns than we’ve ever experienced. And we’ll all be smarter in 90 days. And so, we’ll have a more clear view of where we think that capital goes.
But to your basic point, we think that capital will accumulate that we will see growth in not only our Tier-1 or CET1, but we’ll also see growth in our tangible book value.
Okay. Great. Thanks guys.
Sure.
Our next question comes from Christopher Marinac with Janney. Please go ahead.
Hey, thanks. Susan, when you talk about the criticized assets being at 3.3%. Does that include the higher risk items that are on Slide 14?
Yes. That’s a total. That’s total criticized.
Okay. So all the…
That doesn’t - it’s 3.3%.
But not everything in the higher risk category is a criticized asset?
Yes, yes, yes.
Yes. It’s a subset of the 3.3%. Yes.
That’s only one.
The ones we highlighted for you on Page 14 are just ones that areas that we are paying very, very close attention to and are a big part of these portfolio reviews that we are doing. And I am going to say this, there are things on this page, as I think we are even being conservative calling as a higher risk, because of how we’ve underwritten and things we are hearing about from our clients.
So, we wanted to kind of give you the full list, but I would say within some of these things, I’ll give you an example. Our Cree retail is very much a value-oriented, many of grocery anchored or we’ve seen variable issues there with the most recent portfolio review we did or we saw very few problems in that portfolio.
So, I just wanted to tell you, I think even this list, this proceed risk is – we are on the conservative side. But I believe that’s how we want to be.
You’ve heard Bryan and BJ say that to another questions on this call, we just want to be prudent and cautious during this time until we kind of get through things like the election, potential vaccines, et cetera and see how the economy as it continues to open up. But we are pleased with what we are seeing even in some of these areas of proceed risks.
No, that’s helpful background. Thank you both for that. I was just curious if the trend would be to see more migrates on to criticize or could it possibly go the other way or perhaps it’s too soon to tell?
Yes. I think, I mean, again, we are – again facing these every quarter. Could you see a few of them go criticize, you could, but based on what we know now, we’ve got them graded the way we believe they need to be graded.
The other thing is, we are actually seeing some upgrades too. So, there are pockets of industries they are doing extremely well and there are players even within the higher risk industries that are performing very, very well.
We point out an example of that within the hotels, and we are in some of these markets – present in these markets a long time that are doing really, really well, it would be mountain areas, beach areas where people can drive. We’ve talked to clients who are having even within hotel portfolios their best year ever.
And it’s a combination of people wanting to just get away. They can still work from there and the hotel operators are able to do it with a lower expense base.
Same thing with quick serve restaurants. Many of them still are just drive-through only and their expense base is to what’s dropping to the bottom-line is even better than 2019. So, it’s – that’s what I think is so important and the fact that we’ve gone and done this portfolio review. We are talking to individual clients.
But again still being cautious and wanting to highlight for all of you the areas that we continue to look at quarter-over-quarter during this COVID situation.
Great. Thanks again. I appreciate it.
Thank you.
Thanks, Chris.
Our next question comes from Jennifer Demba with Truist Securities. Please go ahead.
Thank you. Good morning.
Good morning.
Good morning.
Is there any consideration to a bulk loan sale if any of these more at risk loans, particularly hotels? Thanks.
Jennifer, this is Bryan and a word, no. We feel good about the quality of the portfolio. We are very confident in what we know about it and it doesn’t seem to make any sense to me, to us to sell it at a significant discount to somebody else can profit on the performance of that portfolio.
So, we’ll have a few problems here and there. But overall, we feel good about it. We feel good about our reserve levels and we don’t have any interest in selling any of it.
Okay. Thank you.
Sure.
Bryan, this is a more longer term question. What are your thoughts about remote working for your employee base going forward? Is the new normal going to be some combination of in-office and remote working for almost everyone? And how do you maintain corporate culture with more remote working? Thanks.
That’s a – I think a fantastic topic. And I think you really framed it very well. We spend a lot of time talking about that very thing and BJ mentioned the five plus million square feet of space that we have and we think people are going to work differently. There is no doubt about that. Our customers are going to perform differently and it is going to be different.
I worry more about the downsides of managing corporate culture or the conversations that don’t happen, because you don’t get an elevator right with somebody you felt about, hey, I need to – next time I see, am I need to say this or have this conversation. I think it’s really a big downside in the sense that if you onboard new people, when you bring in new bankers, how do you bring them into the culture?
How do you mentor people? How do you develop people? So, I think we’ve got the fine sort of a balance and I think we’ll end up as you suggested in a bit of a hybrid environment where people work more remotely for a portion of their time and we see how we spend the time we have together in a more quality fashion. So that we don’t just assume everybody just see everybody every day.
So, I don’t think anybody on our side believes we’ve got it figured out the day. But we are paying a lot of attention to it. And I think, while we could go cut out a lot of office space and do things remotely, because we’ve proven with technology that it works, you really have a hard time as you say, maintaining corporate culture in a two-dimensional framework of a WebEx or a Zoom conference call. So, it’s something that we are clearly paying attention to.
This concludes our question and answer session. I would like to turn the conference back over to Bryan Jordan, CEO for any closing remarks.
Thank you, operator. Thank you everyone for joining us this morning. As we said a number of different times this morning, we are optimistic about how we are positioned. We are optimistic about what our combined organization is capable of doing.
We are optimistic about the opportunities we see in our markets with expanded customers, product set, as well as the ability to bring the full suite of products of the combined organization to bear on existing relationships.
If you have any questions, or any additional follow-up, please let any of us know. We are more than happy to provide you additional information. Thank you again for your interest in our company. And I hope everybody has a great weekend. Thank you.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.