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FNB Corp
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Welcome to the F.N.B. Corporation Second Quarter 2018 Quarterly 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 today's event is being recorded.
I'd now like to turn the conference over to Mr. Matt Lazzaro. Mr. Lazzaro, please go ahead.
Thank you. Good morning, everyone, and welcome to our earnings call. This conference call of F.N.B. Corporation and the reports it files with the Securities and Exchange Commission often contain forward-looking statements and non-GAAP financial measures. Non-GAAP financial measures should be viewed in addition to and not as an alternative for our reported results prepared in accordance with GAAP.
Reconciliations of GAAP to non-GAAP operating measures to the most directly comparable GAAP financial measures are included in our presentation materials and in our earnings release. Please refer to these non-GAAP and forward-looking statement disclosures contained in our earnings release, related presentation materials and in our reports and registration statements filed with the Securities and Exchange Commission and available on our corporate website. A replay of this call will be available until July 31, and the webcast link will be posted to the About Us, Investor Relations & Shareholder Services section of our corporate website.
I will now turn the call over to Vince Delie, Chairman, President and Chief Executive Officer.
Good morning, and welcome to today's earnings call. Joining me are Vince Calabrese, our Chief Financial Officer; and Gary Guerrieri, our Chief Credit Officer. Gary will discuss asset quality, and Vince will review the financial results.
Today, I'll highlight the quarter’s performance and cover some recent strategic actions, namely our planned divestiture of Regency Finance Company, the acceleration of our branch optimization strategy, plans to leverage our digital account opening capabilities to accelerate deposit growth. And F.N.B.’s plans to expand our business prospects in Charleston, South Carolina.
Looking at the quarter, we had strong results achieving operating earnings per share of $0.27 and record total revenue that surpassed $300 million for the first time. The growth in earnings per share represents a year-over-year increase of 17%. The efficiency ratio of 55.6% improved from the first quarter, even with the impact of several non-run rate expense items that Vince will cover in his comments.
Average total loans and total deposits both increased 6% on a linked-quarter basis, driven primarily by new household acquisition as well as some seasonal inflows in business deposit account balances, which we noted last quarter. Our fee-based businesses saw a growth across the board and continue to track in line with our full year expectations with very positive results in capital markets, wealth management, mortgage banking, SBA and insurance.
Looking at the wholesale bank, commercial loan growth was driven by 6% growth for average C&I loans as we had strong contributions from our Cleveland, Baltimore-Washington D.C. and Pennsylvania markets. As mentioned in our earnings release, we continued to improve the overall commercial loan portfolio mix and our growth is gaining momentum.
Regarding our Carolina markets, we are seeing increases in both the number of new middle market relationship opportunities, as well as the overall size of relationships. Carolina commercial 90-day pipelines are at record levels and these strong near-term pipelines bode well for our average balance sheet growth in the coming quarters.
Our equipment finance group had another strong quarter as we have seen robust activity footprint-wide, commercial leases increased more than 20%, compared to March. We expect this business to continue to grow as we move into the second half of the year. Demand for this product continues to accelerate and is benefiting from a strong pipeline of opportunities as well as organic growth in our Carolina markets.
Turning to non-interest income, almost every fee-based business is trending positively across our footprint. And have gained traction in the Southeast markets. Our fee income categories continue to track in line with our expectations, with capital markets up 12% linked-quarter and wealth management and SBA building from first quarter levels. The mortgage and SBA banking sales teams are fully built out and are increasingly adding fee contribution. F.N.B. will continue to invest in our senior management and underwriting support areas for both SBA and mortgage.
The SBA group in particular has benefited under a newly appointed executive of specialty finance and capital markets. For wholesale bank overall in North and South Carolina is nearly fully staffed and we continue to receive inquiries from commercial bankers seeking opportunities to work for F.N.B. from both larger and smaller institutions.
Earlier this year, we received national recognition from the U.S. Department of Commerce for our international banking unit. Our international banking specialists were honored with the President's E Award for Export Service. We are proud of our dedicated international banking services group for the global opportunities they have made possible for our clients and communities.
We launched this business in 2013 and the group has provided international banking services of more than 300 million in transaction volume since inception and achievement we are all very proud of.
Wealth management delivered strong results led primarily by an increase in securities commissions and a slight increase in trust income. On the brokerage side, our Carolina markets are performing above our expectations, as they build on the early momentum established in the first quarter.
Mortgage banking had a record quarter with growth of 7% linked-quarter. Contributions from the Carolinas have begun to kick in, with production volume up more than 30% compared to the prior quarter. We are encouraged by this upward trajectory and the strength of the current mortgage pipeline. These leading indicators give us confidence that mortgage banking will continue to experience revenue growth during the second half of the year.
In the consumer bank, residential mortgage and indirect auto grew meaningfully, partially offset by a decline in HELOC balances. On the deposit side, F.N.B.’s growth was led by non-interest demand deposits and time deposits. We continue to focus on gathering new households and deepening relationships.
During the second half of the year, we plan to leverage our previous investment in technology to generate new deposit households through opening accounts in adjacent underpenetrated markets where F.N.B. may not have a physical branch or critical mass. Many of our larger competitors have revealed the roll-out of digital-only deposit strategies. F.N.B. currently offers this service enabling customers to open accounts digitally from application to funding from a variety of mobile and online devices.
Leveraging the online deposit gathering capabilities is a key part of our clicks-to-bricks platform as well as our current three-year strategic plan. We expect to step up our efforts in new markets with our existing online deposit gathering capabilities by the fourth quarter of 2018.
Last month, we announced our plans to divest our consumer finance subsidiary, Regency Finance Company with the sale expected to close during the second quarter or second half – I’m sorry, of 2018. Additionally, we are consolidating 20 branches of First National Bank, most of which is already complete. We expect the branch consolidations to produce annual cost savings of $6 million. The majority of these cost savings will be reflected in the run rate by the fourth quarter of 2018.
The most recent consolidations are an acceleration of the branch optimization program. We have had in place for nearly a decade, which is resulted in the closure of nearly 100 locations. F.N.B.’s Ready program is a continuous process designed to increase efficiency and improve growth prospects for the bank as customer preferences for mobile and other technology based services evolve.
In addition to our focus on efficiency, our optimization approach includes opening new locations in areas identified as key markets to foster relationship growth and to serve clients and community needs. One key market we identified was Charleston, South Carolina. We announced last month that we will be expanding our retail, commercial and wealth management teams in Charleston and the surrounding area with three new retail banking locations and a downtown regional hub.
These locations will enable us to better penetrate one of the southeast fastest growing markets. The Charleston area is projected to have the six-state regions, top population growth rate through 2021 at 9.6%. We look forward to serving customers where we have existing, local, commercial, small business and mortgage relationships. The region continues to grow and attract advanced manufacturing plants for companies such as Boeing, Volvo and Mercedes. These large manufacturing facilities encourage business formation and will bring regional supply chains with them.
We're excited to expand our team into Charleston and increase our commitment to the region. When looking at the quarter’s performance, our earnings trajectory has begun to accelerate and we are very pleased with the position of the company and our strengthened risk profile moving forward.
Now I’ll ask Gary to comment on asset quality and our overall credit strategy. Gary?
Thank you, Vince and good morning everyone. We finished the first half of 2018 with our credit portfolio well positioned, marked by the quarter's continued consistent results, which were highlighted by improvements across our portfolio. Our GAAP credit results improved during the second quarter as we were successful in exiting some underperforming and non-strategic assets at better than marked positions.
Delinquency improved by 24 basis points to end the quarter at a very solid 1.09%, while NPLs and OREO improved to 61 basis points, down six bps linked-quarter. Net charge-offs were 34 basis points annualized with a quarterly provision up slightly at $15.6 million. I would now like to walk you through our originated portfolio and provide some added color on our credit results for the quarter, followed by some key highlights around the acquired portfolio.
Looking now at the originated portfolio, delinquency ended June at a very favorable level at 68 basis points, which represents an 11 basis point improvement linked-quarter and 31 basis points year-over-year. The level of NPLs and OREO improved as well to 71 basis points, down 11 basis points from the prior quarter and 37 bps from the year-ago period.
Net charge-offs were 36 basis points annualized during the quarter as we were able to move a small pool of nonperforming small business loans off the books at levels equal to their reserve position. The originated provision at $15 million covered net charge-offs and organic loan growth, reflecting an ending originated reserve position of 1.02%.
As reflected in our results, we continue to actively and aggressively manage risk in the portfolio, notwithstanding its already favorable position, which we are pleased with at the end of the quarter.
Let's shift over to the acquired portfolio, which totaled $4.8 billion at quarter-end. Credit quality was favorable with much of the activity attributable to the positive execution around removing select underperforming and non-strategic assets from the portfolio. Contractual delinquency came down significantly, totaling $120 million, reflecting a $37 million or nearly 24% reduction on a linked-quarter basis.
Net charge-offs of $3.4 million reflected the resolution of problem assets from the balance sheet, bringing the ending reserve position for the acquired book down to $4 million. Inclusive of the credit mark, our total loan portfolio remains adequately covered with combined ending reserve coverage at 1.67%. In summary, we had a successful second quarter, which was marked by consistent credit results and our ability to move non-strategic assets off the books to further reduce our risk profile.
Pipelines continued to be solid and growing with good traction across the Carolina markets. As we entered the second half of the year, we are very pleased with the position of our portfolio, which is due in large part, to the focused and attentive approach we take to proactively manage risk. That along with our consistent and prudent underwriting and our ability to maintain a diverse book has served us very well throughout a variety of economic cycles and we'll continue to do so going forward.
I will now turn the call over to Vince Calabrese, our Chief Financial Officer, for his remarks.
Thanks, Gary. Good morning, everyone. Today, I will discuss our financial results for the second quarter, provide some color on the outlook for the rest of the year. As you can see on Slide 4 of the presentation, operating earnings for the quarter were $0.27 per share, a 17% increase from $0.23 in the second quarter of last year.
Let's start with the balance sheet for the quarter, starting on Slide 6. As Vince mentioned, linked-quarter average loan growth was $289 million or 6% annualized. Including annualized growth of 10% for consumer loans and 3% for commercial loans with underlying C&I growth of 6%.
On the consumer side, we had strong growth in residential mortgage of $91 million and indirect auto of $151 million, which was partially offset by declines in home equity lending. And looking at the acquired portfolio, runoff continued at a similar level to last quarter at $415 million and we continue to see a strong level of originations across the footprint. As Vince and Gary mentioned, our short-term pipelines have grown to very encouraging level, which gives us confidence for a very good third quarter on the commercial side.
Average deposits increased $314 million during the quarter or 6% annualized which included 11% annualized growth in non-interest bearing deposits and continued solid growth in time deposits, partially offset by declines in interest bearing transaction balances. We continue to focus on growing deposits across all categories, and during the second quarter, we were able to grow deposits faster than loans. We are focused on growing deposits in the second half of 2018 through a variety of strategies and initiatives to attract deposits in a way that should benefit us over the rate cycle.
Turning to the income statement. Net interest income increased $13.3 million or 5.9% due to solid loan and deposit growth and additional day in the quarter and higher levels of scheduled accretion and excess recoveries. As Gary noted, we benefited this quarter from moving loans off the books in values better than where they were marked while taking risk off the table.
Total purchase accounting increased $10.1 million with an increase in scheduled accretion of $900,000 and a $9.1 million increase in excess recoveries. In terms of margin impact, purchase accounting added 23 basis points in the second quarter, up 9 basis points from the first quarter. Looking at the margin, excluding purchase accounting, it decreased three basis points through a combination of repricing short-term borrowings in response to the March and June Fed moves and the impact of an isolated interest reversal on purchased mortgage loans.
That being said, we would expect the margin, excluding purchase accounting, to increase next quarter. And then on the funding side, you can see that our cost of funds increased 10 basis points on a linked-quarter basis, with the repricing of short-term borrowings being a key driver. On the deposit side, the cost of interest bearing demand deposits and time deposits both increased 10 basis points.
Change in funding costs is mostly offset by upward repricing on the loan portfolio as 57% of the loan portfolio is variable or adjustable with about 46% of total loans tied to prime or one month LIBOR. Excluding purchase accounting, loan yields increased about six basis points during the quarter. Going forward, we will continue to see repricing in the loan book although I'll note the mix of loans that came onto the books this quarter was more weighted towards consumer loans, which combined with the increases in the securities portfolio, affects the overall yield on average earning assets.
Let's look now at noninterest income and expense on Slides 8 and 9. Excluding charges incurred on fixed assets related to branch consolidation, noninterest income increased $1.1 million or 1.6% linked-quarter with increased contributions in every category, except insurance, which was seasonally lower. Wealth management benefited from increased contributions from the Carolinas.
Capital markets revenue increased 12.3%, primarily due to growth in swap income. Mortgage banking income set a new record of $5.9 million, increasing 7.4% linked-quarter. Volumes in that space were strong more than offsetting competitive pressures on gain on sale margins from the first quarter. Total SBA revenue was $1.6 million, representing a slight increase from first quarter levels. Insurance revenue came in $600,000 lower, primarily reflecting seasonal highs in the first quarter when we received the bulk of our contingent revenue for the prior year's performance.
Turning to Slide 9. Expenses increased $11.9 million linked-quarter. The increase includes $2.9 million of branch consolidation costs, $3.6 million of non-run rate personnel expense and $2.2 million of previously announced employee compensation initiatives in response to the benefits provided by tax reform. The non-run rate items included a $2.6 million charge related to a large medical insurance claim and $1 million payroll tax rate adjustment. The remainder of the increase in personnel expense is largely related to normal merit increases and annual restricted stock awards.
Even with these non-run rate personnel expense items, the efficiency ratio improved to 55.6% from 55.8%. As you know, we announced the sale of the Regency Finance Company in June. We chose to divest that business as it had become a smaller portion of the balance sheet over time as F.N.B. has grown. We expect the transaction to close near the end of the third quarter. We also announced the consolidation of 20 branch locations, most of which have already been completed. Together, these actions are expected to be essentially neutral to capital and earnings in 2018.
Going forward, these actions will be accretive as the combination of rising funding costs and the implementation of CECL, beginning in 2020 would impact historical performance and provide diminishing returns to F.N.B. Finally, I would like to close the loop on guidance for the remainder of the year. Through the second quarter, we are on track to be within our ranges for all elements of our guidance and we reaffirm all of our 2018 expectations, excluding the sale of Regency.
Once the sale of Regency closes, it will obviously have an impact on the elements of our guidance, particularly given the higher risk and higher coupon nature of that $165 million loan portfolio. Using the first quarter 2018 segment reporting data as a starting point, the sale of Regency on a pro forma basis would reduce first quarter 2018 net interest income, noninterest income, provision for loan losses and noninterest expense by approximately $8 million, $1 million, $2 million and $5 million, respectively, or $1.5 million in pretax income.
This reduction in pro forma pretax income would be fully offset by the benefit of consolidating 20 branches that Vincent discussed earlier and should have a neutral effect on fourth quarter earnings.
With that, I'll turn the call back over to Vince.
Thank you, Vince. We are pleased with the results of the second quarter and our teams are motivated by our performance during the first half of the year. We covered a lot today, and I want to emphasize that the prudent strategic actions we've taken better position F.N.B. from a long-term growth perspective and further enhance our overall credit risk profile. When looking at our accomplishments so far in 2018, the earnings trajectory has begun to accelerate, and we look to build on these levels moving forward.
By leveraging our previous investments and geographic expansion, technology and risk management infrastructure, we are in a better position to maintain positive operating leverage and grow earnings per share moving forward. Across the F.N.B. footprint, we continue to strive to achieve and exceed our long-term objectives. On behalf of the management team, I would like to thank our employees for their continuous efforts to create value for our customers and to drive long-term shareholder value.
Now I'll ask the operator to open the call for questions.
Yes, thank you. We will now begin the question-and-answer session. [Operator Instructions] And this morning's first question comes from Jared Shaw with Wells Fargo.
Hi, good morning.
Hi Jared.
Good morning, Jared.
Maybe just looking at the loan growth first, can you give a little detail on the growth you saw in the auto, was that expecting the geography of dealers into the new markets? And then sort of a corollary with that, last quarter, you gave a little highlight on the pipeline coming out of the Carolinas. Can you talk about how that ended up actually closing and should we expect to see a similar closing rate on the pipeline in the Carolinas today?
Well, I'll take the pipeline question. I'll let Gary answer the indirect auto question because it reports up through him. From a pipeline perspective, we've seen – again, we're seeing very, very strong pipelines, in North Carolina we have a number of transactions that are going to close shortly. So we – I think, like Gary mentioned, what has been coming through committee because he's closer to it than I am, but there's a significant surge in activity, which is very positive for us.
Pipelines are up overall, 15% over the last quarter and last quarter was a record level. North Carolina is up 70% from Q1 and 100% over Q2 of 2017. So fairly robust pipelines, we're still experiencing the pull through. We expect the benefits of that pipeline to impact the portfolio balances in the third quarter, really providing us good support going into the fourth quarter. So we're very excited about that. And we've had some great cross-sells in North Carolina. Fee income in a number of categories has surged. Derivative fee income, capital markets fee income, international, insurance, all have performed pretty well in the Carolinas, some great wealth opportunities as well.
So the teams have really stabilized and really have adopted the culture and are pushing the product. So that's working very well for us. It's reflected in the numbers. I know there's a lot of noise in the quarter so it's kind of difficult to really gain clarity on the performance. But we're very excited about the performance. I feel there is a disconnect between the stock price performance and our actual performance when you look at the underlying metrics. We had really strong loan growth in this particular quarter. That was really helped by efforts in Maryland and D.C. and the Pennsylvania markets really pulling through, particularly the eastern part of the state, where we acquired Metro, some really good production, great opportunities have rolled in.
From a deposit perspective, we've had a great run with deposits. The average balance was up. Non-interest bearing deposits were up. I've looked at a lot of the earnings releases and the reports and we're an outlier in terms of our strategy to secure new households and grow those deposit categories. And the odd thing is that there was an outage. Comcast had a national telephony and Internet outage that impacted the transfer of hundreds of millions of dollars of deposits for us. It actually delayed it into the next quarter.
So the spot balance would have shown better this quarter. Anyway, that's the answer on the pipelines. Again, very excited about what's happening and we are very optimistic about the remainder of the year. Gary, you want to comment on indirect auto?
Yes, just a follow-up on the North Carolina activity. We're seeing fairly brisk activity coming through our approval process. A couple of weeks back, we had three transactions, all very solid transactions come in one day through North Carolina, right at about $50 million in total. So really good, solid activity, the teams are moving forward. The pipelines are solid and growing and we feel good about the progress being made there.
In terms of indirect, the activity that we saw was strong during the quarter and it was essentially with our really long-term group of dealers. No expansion of the markets. We've really just had good activity with our core dealer group. We do expect that to slow in the coming quarters. And as I've mentioned to each and every one of you in the past, our focus is on high-quality paper. Average FICO scores during the quarter were 7/75. We're also enhancing our pricing over the last month and also making some changes at this point to strengthen the margins there.
So we're very focused on that portfolio and the quality in it. Just a couple of touch points around that portfolio. At the end of the quarter, delinquency came in at 57 basis points. That's a very solid number. Charge-offs were 30 basis points for the quarter and again, reflecting very solid performance. We're pleased with where that book is positioned and how it's continued to perform.
Thanks. And actually just following up on the charge-offs. When you look at the increase in charge-offs this quarter, you say that was a cleanup of an SBA portfolio? And was that tied in at all with some of the interest recoveries, outsized interest recoveries as we saw this quarter?
Yes. During the quarter, we actually had two loan sales of underperforming and one non-strategic asset pool, Jared. The small business loan sale was $54 million. It was about $16 million of old originated loans and $38 million of acquired assets, primarily what was left of the Yadkin portfolio that we still wanted to get off the books. The originated assets were moved equal to their reserves.
So there was no P&L impact there and the acquired assets were moved at better than marked positions. So that did benefit the accretion income that you see. The other pool was a $56 million pool of serviced by others mortgages that we acquired in 2012. It was a nonstrategic pull and we were just looking to move it off of the books. That also generated positive impact for the quarter from an economic standpoint as well.
And I would also comment that the accretive yield benefit that we reported collectively when you look at year-to-date and as we see – relative to Vince's guidance, were within the range of what we guided everyone at the beginning of the year. So I just wanted to point that out because the two acquisitions that we did were fairly large. So it's very lumpy as Vince Calabrese always says, but still within the range that we guided.
Yes. One thing I would add, Jared. In reference to – you had a question about the charge-offs. That did elevate charge-offs during the quarter. Charge-offs related to the reserved positions regarding those loan sales was just a touch over $6 million – right at about $6.2 million. So absent that, GAAP charge-offs would have been 22 bps and the originated – I just want to make sure I got this correctly for you. It would've been 21, absent those, moving those assets.
Great, thanks.
Thank you.
Thanks Jared.
Thank you. And the next question comes from Michael Young with SunTrust.
Hey, good morning.
Hey, Michael. How are you?
How are you?
Doing well. Can we start may be on the expense side? I think, obviously, a lot of noise this quarter with some one timers but just kind of a go forward run rate in understanding what that is going to look like. And then also any color you can provide around – you mentioned of kind of accelerating the Ready branch program and what that can mean either additionally this year or going into next year?
Sure. I can start with the expenses. I guess, if you look at the overall levels of noninterest expense, $183 million, it was up $12 million from the first quarter. $8 million of that is what I would call, kind of non-run rate items and I'll just go through the list for you. So we had the branch consolidation cost that run through expense was $2.9 million. We had $0.9 million related to the discretionary 401(k) contribution that we had announced last quarter that we were doing in response to the tax reform.
We had a large medical claim that we mentioned in the earnings release, $2.6 million. Then we had a Pennsylvania state unemployment tax, where they came back to us after a few years and said, they charged us the wrong rate so we owed them $1 million. So nothing, no error on our part, just a change in their perspective in what they charged us and then we have our annual stock grants for the directors that run through this quarter, which was $700,000.
So in total, eight of the 12 is kind of what I would call non-run rate that you're not going to see next quarter. So I think that's important. I think the guidance that we gave overall for expenses is still intact. It's before Regency. So I think it's important to note that. Regency hasn't closed yet. They're still going through the regulatory approval process, but I gave those figures as far as the impacts. Just so everybody could understand kind of what rolls through when Regency comes out. We are retaining a small mortgage portfolio that's part of that as well as the note program that we have that we've used to fund that, that's an F.N.B. Corp. notes, sub-notes and we keep those, those are good funding for us.
So those pieces we keep. The figures I gave is kind of essentially which pieces will be going away. And I guess when you step back and you look at the actions that we're taking between the Regency as well as the branch consolidation. We're basically taking out $26 million from annualized expenses out of the expense base between the Regency, $5 million a quarter and then the $6 million from the branch consolidations. So I think that's important, too to kind of keep that in mind for the go forward. That benefit is still to be realized.
And then any additional color on kind of the branch strategy, obviously, you've expanded some in Charleston. Do you look to kind of offset expenses related to new branch expansions through branch rationalization, other parts of the footprint or should we see kind of net expense reductions coming from occupancy going forward? Just any kind of big picture color there?
Yes, I think typically what you see from us is a net benefit. We’ve closed an average of 10 branches per year, I mentioned that. We've closed 100 branches. We've been doing this for a long time. We've opened about 15 or 20 over that period of time. So we're very selective about where we go. The whole program was designed to do exactly what you said 10 years ago. We look at a variety of metrics. We look at the low performing locations. We take into consideration community need and our desire to serve certain communities.
And then we look at the delivery channel and track transaction volumes and activity and market potential. And where we have opportunities to take cost out, we take cost out. We close branches. We've been very aggressive at doing it over time. But we also open branches in markets that provide us with a higher growth trajectory. The game, if it works, is to cut branch locations and not suffer from attrition and get an economic benefit by doing that, by reducing expense.
And then investing some of that into higher growth areas, where we have a better growth trajectory. That's what we do. We do it every year. It's an ongoing process. I say every year because it's reviewed quarterly and it takes time to execute the closures. So you have to kind of have a strategic plan each year that you adopt, that we follow through on. So we've done a good job of optimizing our delivery channel. The other area that's important to note here is that the investment in technology was significant over the last few years and we've mentioned that. We've had the ability to open an account digitally, fully digitally online from application to funding for almost three years.
So a lot of banks have announced, hey, they're coming out with a digital-only platform and they're going to expand in other markets to try to capture deposit share. We can do that very easily with a run rate expense already baked into our numbers. So the only incremental expense would be marketing expense. And you can be very targeted in terms of what you do with digital advertising because you can open accounts on iPhones with our system. So I think that all bodes well for us.
That's why I'm mentioned it in my comments. And I think we've been very diligent about taking costs out of that delivery channel that's becoming somewhat archaic over time. Still need branch locations, but probably fewer and fewer of them. So we have to have a program to continuously reduce those branch locations. Anyway, that's the plan. So I would expect to see the same moving forward.
Okay, thanks. Can I sneak in one last one just on the size of the interest reversal on purchase mortgage loans this quarter?
Yes, I would say, if you look at the – in terms of basis points, it was about 4.5 basis points impact to the margin.
Okay.
And one other comment, I'm not sure if it was in your flash note or somebody else's. I think it may have been in yours. But noninterest income for us is actually grown. There's – if you go to Page 8 in our deck, there was a $3.7 million item that reduced the optics. So I think that when you look at it overall, it’s actually expanded quarter-over-quarter. Anyway, I just thought I'd point that out. I don't know if it was your flash report or somebody else's. I saw so many of them – so quickly…
Yes, in our operating base, it was up $1.1 million.
Yes, exactly. Yes. That’s it. Thank you.
And I guess just one other point on that that interest reversal. So just to explain a little bit about what that is. It was just related to a nonstrategic pool of loans service by others that we had. It was acquired home equity loans from the mid-2000s and as we were going through our reviewed exit certain kind of nonstrategic pools, discovered we needed to make an interest reversal there. It's just a onetime item. It's not that big in dollar amounts, but it's about a basis point – half of the margin as I mentioned and that won’t reoccur next quarter so you kind of get that back as you go forward.
Thank you. And the next question comes from Russell Gunther with D.A. Davidson.
Hey, good morning, guys.
Good morning, Russell
Good morning, Russell
I appreciate all the color on the loan growth, particularly commercial out of the Carolinas. Wondering if you could just pay particular attention to the commercial real estate opportunity down there and help me understand kind of what the growth outlook for CRE, in particular, is in the back half of the year.
Yes. Go ahead, Gary, you can cover that.
Yes. In terms of CRE, I mean, our bankers are very active in the CRE markets. We are looking at much more sizable and larger opportunities each and every day. I think the teams are well positioned. I will say on the CRE space, the competition from a structure standpoint continues to put pressure on structures across the board and we're seeing a lot of extremely and overly aggressive structures across the space. A lot of that pressure is coming on the smaller side of the equation. We're also seeing some pricing pressure there. And we compete on price everyday. But one thing we will not chase is structure that's unacceptable. So that continues to be in each and every opportunity that we're seeing.
Okay, great. Thanks Gary. And then last question for me. Just given the kind of thoughtful exit of Regency ahead of the implementation of the CECL, do you guys have a preliminary impact you could share on CECL for the remainder of the overwhelming majority of the portfolio?
We talked about this. If you look at it on an earn-back basis, it was about – it was over three years of earnings basically is what would happen. At the time the CECL would get implemented for that company. So it's a significant number. It's in the tens of millions of dollars, let's put it that way.
Yes, and then so exactly. Sorry, Vince. Given that the guys are well down the road in thinking about this, do you have any preliminary results to share on CECL as you implement it for the core portfolio?
The only observation I will give you. I don't think we're ready to say anything relative to CECL, but I will tell you that if you look at the size of our acquired portfolio. And the fact that we have reserves, life of loan within that portfolio, we probably have a considerable advantage over non-acquisitive companies, right, because they're going to have to cover…
Yes, that’s a benefit for us…
That will be a benefit. But I don't think we're prepared to comment any further.
We have a team of 40 people working on that, we're into the projects and it's a little early to make any comments on the whole process.
A lot of work there.
Okay, great. Thanks. Understood. Thanks guys.
All right, thank you.
Good question, thank you.
Thank you. And the next question comes from Casey Haire with Jefferies.
Thanks. Good morning, guys.
Hey, Casey.
Vince Calabrese, just question for you on the NII guide. Does that still assume $25 million to $35 million in purchase accounting on the year given that you're running a little bit ahead of that year-to-date?
Yes. That range is still good. Obviously, we'd be at the higher end of that range with where we are first half of the year. We are not going to have another 15 basis points going forward. So at this point, we'll have more of the normal kind of scheduled accretion that's been pretty stable in that seven to eight basis points. I mean, we'll probably have some recovery. We always have. I mean, it's been anywhere from one to kind of 15, it's kind of the new high watermark that we've had for that, but it's been one to six, seven, eight, kind of normally.
So some level of that going forward, but the scheduled accretion, kind of in-line with that we were eight basis points this quarter so the range still is our range overall, but obviously, we'd be at the higher end with the success we had this quarter and moving assets off the books.
Okay, got you. And then the core NIM, you expected it to be up this quarter. I understand – I get the 1.5 basis point drag from the NPL reversal, but what is – what are some of the core NIM drivers going forward? Is it more moderate deposit betas? Just some color on what's giving you the confidence to drive NIM expansion in 3Q?
Yes, I would say a couple of things. Obviously 1.5 basis point on the interest reversal is part of it. We had another kind of 1.5 basis point related to the short-term borrowings. Our overnight position was essentially the same at about $3 billion at the end of June, within $100 million of where it was at the end of March. But obviously, you have that repriced up some. So you had the impact of the Fed move. So that was about 1.5 basis point so the margin if we exclude all the purchase accounting was down three and its just those two items.
I mean, as you go look ahead to the third quarter, I think as we commented on in our remarks, we expect strong loan and deposit growth in the third quarter. That clearly helps. The more we have on the deposit funding, the less we have in the short-term borrowings. So that's a benefit so – and we like the position as we're entering in the third quarter here. We should see a benefit from the mix of the earning assets put on the books. I think as I commented on this quarter, there's a higher proportion of the consumer loans. The spreads are higher on the commercial book. And as we said, we're teed up for a good quarter – a very good quarter in commercial growth in the third quarter. That will help and then the mix of the funding liabilities overall, clearly will help.
Another factor that's important is that the – I typically comment on the low yields and where they are. So the rates for maids or new loans that we're putting on the book exceeded the starting portfolio yield by 22 basis points this quarter. That was a push in the first quarter. In the last two quarters of 2017 that was a 15 to 20 basis point kind of detriment to the starting portfolio yield. So that's encouraging, too. So that helps you for this quarter and helps you kind of going forward as you're putting on new loans. And the mix obviously, matters, too.
So I think if we see some benefit on the deposit side, you'll see more of the benefit – the repricing of the loans to 45%, 46% that's tied to prime and LIBOR. I mean, that's happening. It's been getting masked a little bit by the short-term borrowing overall cost. But I think with that being less, going forward, you'll see the loan repricing come through as well as the new loans being higher than the starting portfolio yield. All of those things kind of help us as we look ahead to the third quarter.
Okay, great. And just to clarify on that. The core loan – when you talk about loan yields, are you talking about core or ex accretion? Or are you – is that GAAP loan yields?
Just talking pure coupon, basically, so excluding purchase accounting and everything.
Okay, got you. Great. Okay. And just one last one for me. One more try at the expense front. Year-to-date, you guys are tracking up 6% versus the fourth quarter annualized rate. I appreciate there was some specials this quarter. But to hit that guidance, and if we assume 6% is mid-single digits, the expense run rate is going to have to average about – by my math, 1.75 per quarter in the back half year. Does that jive with what you guys are thinking would come out?
Well, the guidance is the guidance. I mean, your math seems pretty reasonable. So I mean, the non-run rate stuff clearly was elevated this quarter, and I guess, the range is big enough that it's encompassed in the range. So I think that, excluding the Regency impact, plus the branch consolidation timing gets phased-in in that kind of the $21 million that I mentioned – or $26 million that I mentioned, going forward, will come in over time. So I mean, your number sounds reasonable.
Great, thank you.
Okay, thanks.
Thanks Casey.
Thank you. And the next question comes from Frank Schiraldi with Sandler O'Neill & Partners.
Good morning.
Good morning.
Hey, Frank.
Hey, Frank.
Just a couple of questions, I just want to make sure I understand. On the guidance, so we're talking about – on the NII, I'm kind of having an issue in the model just getting to that mid-single-digit guidance. So I just want to make sure I'm thinking about this right. And I know we've talked about it in the past, so I think I am. But the – so you start with the 230 on 4Q, right. You just annualize that for a $920 million number. And then you're basically just saying the guidance is mid-single digits from there, right. So what, 4% to 6% growth from that $920 million, is that still what makes sense for – excluding Regency, when that comes off, I guess.
Yes. No, you have it. That's exactly the way we built the guidance, Frank. You have it.
And when you talk about NIM in the third quarter, you're talking about the core NIM. You're seeing some expansion, right. I mean, I think you made a point about the cash recoveries. That's at the high end of the range. So it could – I would assume very well see a reported NIM that would be lower than Q2, just given more normalized income there?
Yes. That's a good point. It's the core margin that I'm referring to.
Okay. And then I wondered if you, Vince, if you have – you talked about scheduled accretable yield being rather stable. How does that runoff? Like, for example, 2019, do you have that per quarter in 2019?
I'll be happy to give you some color in January, Frank. How about that? I mean, obviously, the number changes. The dollar amount changes as the portfolio get smaller. But no, we could build that into our guidance in January.
Okay. And then, just want to make I understand the Regency versus the branch closures. So I think you said Regency was like $1.5 million pretax income and then you lose that. But then the branches save you about the same amount in expense per quarter. Is that the gist of it?
Yes, you got it exactly right.
Okay, great. All right, thank you.
And going forward – and then, Frank, when you get into – going forward, when in you're into CECL environment, 2020, it's accretive. It's not just a push because you have the CECL impact, and then you also have impact of rising rates on that business. I mean, the rates on the loan side are pretty much capped where they are, and then you have…
Assuming the portfolio doesn't grow. Yes, we haven't been growing the portfolio.
Yes. Right. No, it's a good point, too. And the funding costs would kind of compress your margin over time. So it becomes accretive as you go out. But in the short run, it's a push.
Okay, thanks.
Okay, thank you.
Thank you. And the next question comes from Collyn Gilbert with KBW.
Thanks. Good morning, guys.
Good morning, Collyn.
I just wanted to clarify. I know we've gone through a lot of this. But just want to clarify on the comp line of expenses linked-quarter. So it was up $8.5 million, and it looks like – so $2.6 million was that medical and then roughly $1 million was that 401(k) contribution. Is that correct?
Yes, and then you had the payroll tax was $1 million.
Okay, so then – so $4.6 million of that $8.5 million was what you would – what you're kind of saying non-run rate going forward, right.
Correct.
Okay. So can you just explain the other – it's still a meaningful increase just on the core comp expenses. Just trying to understand what drove that.
Remember, we talked about increasing the minimum wages, so that was like another $1.5 million or so increase related to the – move into the two-step process that gets to $15 an hour by the end of next year. So that went into effect on April 1, Collyn. And then we also have – April 1 is when we have our normal kind of 2.5% merit increase that goes into effect as of April 1.
Okay, okay. Board comp also in the second quarter.
There's board comp there's – I think so, no?
Yes, the directors' compensation goes through there, too. I was thinking that was in other so…
You have annual stock…
$700,000 for their annual stock grant.
Yes.
Okay, all right.
Outside of those numbers, there's nothing unusual in the expense base…
Okay, that’s helpful. Okay. And then just trying to think about the funding side a little bit here. So Vince, in your guide for the core NIM expansion in the third quarter, so do we assume that you are projecting an absolute decline in borrowings and then being offset by deposits? Is that correct? Because you did see on a period year-end basis, a big jump in borrowings but I assume you expect that go back down, reverse, and then you're going to offset that with a big increase in deposits.
The overnight borrowings were literally up $100 million. They're about $3 billion at the end of June. So the pure overnight pieces, it was very stable from March to June. What I'm saying is that the expected activity overall, as you look to the third quarter between the strong loan growth and funding with strong deposit growth, we should have a higher proportion of the funding liabilities being on the deposit side. I'm not specifically saying that borrowings are going to be down, but more funding the overall balance sheet, more deposit base as opposed to on the borrowing side is what I would expect. And if we get the strong deposit growth that we're going after, that would help to reduce the borrowings, too. But I wasn't specifically stating anything on the borrowings in dollar amount.
Okay, so just to understand. So the incremental dollar of borrowings that you're adding, what's the cost differential for that versus what you're adding on the deposit side? Or what you're kind of anticipating to come on in the third quarter?
Well, you have to look at over time, Collyn. I mean, where we're borrowing overnight is in the low 2s, I would say right now. And we have – like we did last year, we had a variety of initiatives to bring in the deposit funding, bring in time deposit funding that maybe in the very first quarter is a little bit above that. But then with the expected Fed movements going forward, it's quickly in the black. So it's really a matter of just balancing the overall pricing on the deposit portfolio.
Okay. Are you – so are you extending at all on the duration of borrowings? Just trying to reconcile your indication that only $100 million of short-term borrowings were added in the low 2s, but yet borrowing costs were up pretty significantly. So are you extending some duration then on the other borrowings?
No, what I said is at the $100 million – the overnight position, which is – short-term borrowings are anything inside of 12 months. But the pure overnight piece, which is the piece that prices immediately whenever the Fed moves, is $3 billion so that's $3 billion of that. I think it's $4 billion-ish figure. That's all I was commenting on there.
Yes, okay.
And on the deposit side, we definitely have some initiatives to bring in some longer-term deposits. We're focusing on 19, 25, 52 month type products to lengthen on that side.
Okay, okay. And then just rounding out the discussion on the funding. Vince Delie, what – can you just – what was it that you said about the Comcast? What happened with Comcast that impacted the deposits? And how should we think about that going forward?
Yes, I don't know how you should think about it going forward. Switch to Verizon. I would tell you that at the end of the quarter, there was an outage that caused some of the entities in Pennsylvania to have problems wiring funds. So we ended up not posting those balance increases until after the end of the quarter. And it was a glitch caused by – this was a massive outage that occurred. It was in the media with Comcast. That's all I was saying, is that the spot balance looks lower than it should at the end of the quarter. So it should help us in the next quarter, right. That's all. Just optically, it looked lower. But – and I'm not endorsing Verizon or Comcast on this call.
Okay, all right. Thank you. Just wanting to clarify, okay. Very good, I’ll leave it there. Thank you.
Thank you.
I should clarify, too, that I misspoke. The $700,000, $800,000 that I was talking about was actually restricted stock expense for normal grants. That also goes into effect on April 1. So that was figure. The director's fees that I discussed are in other noninterest expense, just to clarify that.
Thank you. And the next question comes from William Wallace with Raymond James.
Thanks. Good morning, guys.
Hey, Will.
I'll be – I'll try to be brief. Just to get clarity on the comment about Regency. I believe you said capital neutral. So we should anticipate roughly a $6 million gain when that sale closes.
Yes, around that level. It's not exactly that figure, but it's pretty close to that.
Okay. And I believe at that end of the first quarter, the balance of loans was about $165 million. Can you update us where that ended the second quarter?
It was right around that same level, $164 million, $165 million right about that same level.
Okay. And then just kind of bigger picture. When you guys enter a new market, like you're doing with Charleston now, how is that expansion led? Do you have a market leader for the Carolinas? Is it led by somebody out of Pittsburgh? I'm just curious how you're leading it? How you're doing the recruiting, et cetera?
Well, it's a combination. I mean, we have on the commercial side, the leadership out of Charlotte is in the process of interviewing people. By the way, we already have 20 candidates to interview, and we just started on the commercial side. We have an existing portfolio there. Yadkin had operations there. So there's about $100 million in commitments already in that market. We were just managing it outside of the market.
When we go into a market like that, there are a variety of people that are involved in assessing the opportunities in staffing. And basically, the people that run the wealth shop or private banking, insurance, they're functionalized. So they're looking at the opportunities within the market and deciding whether they allocate resources or not. From a commercial and retail perspective, it would roll up under the leadership, really, in the Charlotte market, where we have very strong leadership. So we're very excited about the opportunity and have a tremendous group of people working to get people in the seats there.
Okay. And when you say Yadkin, was there – I thought they had exited that market. Are you saying they still had customer relationships there? Or had they not actually...
They had one REIT location on Daniel Island that was not optimal. And when we did the deal, they were in the process of closing it. They came to us and said, do you want us to proceed? We reviewed it and said yes. The rest of the business activity, their mortgage loan originators, we have in the market. We have a real estate portfolio that's fairly sizable. There's builder finance commitments of about $40 million with active borrowers in the market.
So the decision to go in there was pretty easy, particularly given the opportunities for us in terms of sourcing locations. So we felt we could go into that market with a very small footprint and do well there to gather deposits and lend in other areas, private banking, provide wealth services, a whole host of areas
We were studying it for a while before…
Yes, that was on the list before that all came down. But we did not feel that their location, we agreed with them. Their location was not optimal.
Okay, thanks for that clarity. Appreciate the time, guys.
Thank you.
Thank you. And the next question comes from Brian Martin with FIG Partners.
Hey, guys.
Hey, Brian.
Hey, Brian.
Most stuff's been answered, but just a couple of last things. But just the – Vince, the North Carolina pipeline, just – can you just go back what you said with that. I missed the commentary, whether it was up or how it's changed.
Yes, I mean, it's up fairly significantly over last year. So if you look at the end of Q1 and Q2 last year, it's up 70% and 100% over those levels. The pipeline overall is at a record level, and the global pipeline is up about 50% over the first quarter. So it's experienced a sizable increase. And then there's a number of areas within the North Carolina, as we monitor fee income in North Carolina.
We've had some fairly significant increases in areas, like capital markets, leasing. Leasing's up huge. Leasing produced about $120 million in new transactions, and a big chunk of them came out of North Carolina. So we're seeing some very positive things. And then Gary mentioned that there's $50 million in approved credit that will fund early in the third quarter that was coming out of that pipeline from a pull-through perspective. Anyway, that's the commentary around it.
Okay, got you. And then you talked about the runoff in the acquired portfolio. Just, I guess, to extent it's been, I guess, a bit higher. I guess, any thoughts that, that – see that declining a bit? I guess, is that the thought at this point? Or any color on just kind of that rate of change in that acquired portfolio.
Yes, I would just give a few comments on that, Brian. I mean, as we've said in the past, there's a lot of volatility kind of overall within the portfolio. And the runoff that we were experiencing in the second half of last year was high, right. It was $0.5 billion. They both had $500 million plus handle to it. And last quarter, as we had predicted, we had said it was going to moderate, and it did. It came down from 509 in the fourth quarter to 379 in the first quarter. It was 415 this quarter. So definitely a good amount lower than where it had been running in the second half of the year and about 70% of that is Yadkin, and that's kind of been consistent.
I guess, when you step back, part of it is just the sheer size of the portfolio we brought in with Yadkin. Day one, the average life that was kind of implied in those number was around four to five years. And that number will just kind of come down, just from normal activity as well as some of the exits that we mentioned. So I think the number will continue to be closer to the lower end of this range than – I don't see it going back into that kind of $500-plus million area.
Yes, okay. And then maybe, can you just – the deposit strategy you guys talked about, kind of going back to one of the early questions. I mean, if you just talk about – if the margin resets a bit in the third quarter based on kind of what you guys have outlined, I guess, as you think going forward, given – if you execute on this deposit strategy or maybe you do pay up a bit for some CDs and the like, then it changes bit of the black. Just as you kind of think about the core margin going out a bit longer, I mean, I guess, in the expected rate increases you guys are thinking about, I guess, is the outlook on the core margin, just kind of bigger picture, flattish to slightly up? Is that how you're kind of thinking about it with the strategy you're going to execute here?
Yes. I think a key part of the strategy, too, is the DDA growth. In this quarter, we had 11% growth in DDA. So I mean, we're going after all the categories. The CDs are one area that we had been running off a couple of years ago and now have been more aggressive there to bring in the funding to support the loan growth. But the DDA growth is a big focus by our commercial bankers in the field and we'll continue to go after that. So it's a – as you know, it's always a function of the mix you put on, but it – the CDs help to supplement, and if it's, like I said, a little bit in the red for a couple of months, and then you get that benefit as you go forward, particularly as we're pushing out the terms.
Right. And the new markets you mentioned or kind of the underpenetrated markets, is that more in the Carolinas? Is it more in the – across the footprint?
It's really across the footprint. There – obviously, as we move into Charleston, we could lead with our digital capability, right. It's those types of markets across our footprint where we are underpenetrated relative to the opportunity. And we looked at it and said, hey, this is a lower-cost way for us to go in and secure good deposit balances. In some instances, we may expand through de novo expansion into those, like Charleston.
But we can lead with digital campaign to get customers and slightly different than what some of the other large banks are doing. They're going in wholesale into other markets. And I'm not disparaging that strategy. But for us, it makes more sense to go into adjacent markets, where we're already calling commercially, where we're underpenetrated from a consumer depository standpoint.
Understood. Okay, I appreciate the color, guys. Thanks.
Okay, all right. Thank you.
Thank you.
Thank you. And that concludes the question-and-answer session. I would like to return the call over to Vince Delie for any closing comments.
Yes, I'd like to thank everybody for their questions. I know, I apologize for the noisy quarter. There was a lot of activity, a lot of things going on. I think once we were able to have dialogue, hopefully, you found that it is a solid quarter, that it's a great quarter to build upon. There's a tremendous amount of momentum, and we're very optimistic about the rest of the year, as evidenced in our guidance. So thank you for calling in and I appreciate the time and the good questions. Take care.
Thank you. The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines.