FNB Corp
NYSE:FNB
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FNB Corp
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Good morning and welcome to the F.N.B. Corporation Fourth quarter Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note, this event is being recorded.
I'd now like to turn the conference over to Matthew Lazzaro, Investor Relations. 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 we filed 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 January 30th 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 CEO.
Good morning and welcome to our earnings call. Joining me this morning are Vince Calabrese, our Chief Financial Officer; and Gary Guerrieri, our Chief Credit Officer. Gary will discuss asset quality and then Vince will review the financials.
Today, I will touch on our 2017 financial highlights, review last year's accomplishment and wrap up with the discussion about our strategic objectives for 2018 and beyond. We’ll then open the call up for questions.
As you know 2017 was a transformational year for FNB, as we successfully completed the largest acquisition in our history and may progress toward our long-term performance targets. We delivered operating EPS of $0.93, driven by total average loan growth of 37% and total average deposit growth of 33%, resulting in a year-end loan to deposit ratio at 93.7%.
Non-interest income increased more than 25% from 2016, as we continue to expand our fee based businesses, specifically capital markets, mortgage banking, wealth management and insurance across our footprint. Those businesses combined grew over 16% year-over-year, and of course we continue to demonstrate our ability to diligently manage expenses as the full year efficiency ratio improved 111 basis points to 54.3%.
Moving forward FNB is well positioned to build on the success we've had in serving our four constituencies. Customers, communities, employees and our shareholders will all benefit as we successfully execute our plans.
During the year we made great strides towards improving the customer experience, actively engaging with our communities and investing in our employees. Ongoing success and serving these constituencies positions us well to deliver solid earnings growth and increased value for our shareholders.
For our customers, FNB is focused on bringing the universally consistent, exceptional customer experience across banking in the branches, online or mobile channels and through the delivery of value added products that help customers achieve their goals.
Over the past few years, we've committed significant resources to become more of a technology driven company. One example of this philosophy is our clicks-to-bricks consumer banking strategy through the deployment of solution centers and iPads for account opening across our branches to help customers learn and select the best products for their needs.
Another example is our online banking platform, where we've upgraded our capabilities so our customers can begin applications online and schedule in person consultations in the branch. Additionally, we extended the number of hours so customers can conduct transactions by introducing smart ATMs and intelligent teller machines across the footprint.
In the commercial space, we've introduced more sophisticated products and value added services like swaps, foreign exchange, syndications and small business solutions with plans to offer more of our commercial clients, which I'll touch on later.
Turning to our community commitment, FNB has always had a strong partnership with the communities we serve. Deploying capital to both businesses and individuals, including support for programs designed for financially vulnerable communities. During the year F.N.B. support consisted of millions of dollars of contributions towards initiatives designed to stimulate growth in employment, provide affordable housing options and champion overall social and economic development.
A few of our programs include the low income housing tax credit program, the SBA preferred lender program and the family home ownership and improvement programs to low and moderate income households. Most critical to FNB’s ability to positively impact and connect with its community are our engaged dedicated employees, employees at all level of the company are already actively involved in their communities, serving on a wide range of boards, performing thousands of hours of volunteer service, and in 2017 contributing hundreds of thousands dollars of their own money for natural disaster recovery efforts.
In addition to serving our communities, our employees have done a tremendous job maintaining excellent in service and support to our customers. FNB has undergone rapid expansion and transformational growth throughout the entire organization. And specifically I'm very proud of the successful integration of our Carolina operations.
With tax reform and the expected incremental earnings that will be generated, we are making it a priority to continue to invest in our employees by accelerating our existing plans to increase wages for our hourly employees. Last week we announced an investment in our workforce, by raising the minimum hourly wage for FNB employees to $15 per hour, by the end of 2019. Paying competitive wages will continue to be a focus for attracting and retaining the highest caliber employees to serve our customers.
We are continuing to take a thoughtful approach to this process, but based on current plans, we are targeting this investment to increase 2018 expenses by $6 million to $8 million. Thus investing a small portion of our forecasted tax benefit into our employee base.
By partnering with our communities, investing in our employees, growing new customer relationships and deepening existing ones with a broad set of value-added products and services, we believe FNB is well-positioned to serve our shareholders, by delivering sustained earnings growth and increased value. Our strategic objectives are designed to do just that, and I'll discuss those later in the call.
But before I do, I'd like to turn the call over to Gary, for comments about asset quality for the quarter, Gary?
Thank you, Vince and good morning everyone. The fourth quarter of 2017 ended on a positive note, with stable credit quality results, as we enter 2018, and our loan portfolio favorably positioned.
In the quarter, we saw improvement in a number of our key credit metrics. On a GAAP basis, total delinquency improved 4 basis points over the third quarter to end December at 1.44%, while NPLs and OREO trended down similarly to 66 basis points. Net charge-offs were 22 basis points annualized for both the fourth quarter and full year period, with a quarterly provision at $16.7 million, remaining consistent with the two prior quarters.
Let’s now review our highlights for the originated and acquired portfolios, after which I will touch on some of our 2017 full year performance and team accomplishments. As it relates to the originated portfolio, delinquency improved to a very solid 88 basis points, a 3 basis point reduction from the prior quarter and 16 basis points on a year-over-year basis. We also saw a reduction in our NPLs and OREO, ending December at 81 basis points, reflecting a 10 basis point improvement on a linked quarter and year-over-year basis.
Originated net charge-offs for the fourth quarter totaled $13.1 million or 35 basis points annualized, remaining consistent and in line with historical levels. In total, we ended 2017 at 33 basis points for the full year. The originated provision at $18.5 million covered net charge-offs and organic loan growth in the quarter, with an ending originated reserve position at 1.10%.
Looking next at the acquired portfolio, we ended the quarter at $5.7 billion. Credit quality results were very stable in the quarter, marked by improvements in the level of rated credits, as well as lower past due levels as we continue to de-risk the balance sheet. Contractual delinquency declined by $7 million in the fourth quarter ending December at $168 million.
The ending reserve position for the acquired book remained nearly flat compared to each of the prior two quarters. Inclusive of the credit mark, our loan portfolio in total remains adequately covered with an ending reserve at 1.75%.
As we look back at 2017, the year was a successful one and reflects significant accomplishments. Most notably, we ended the year on a positive note with our loan portfolio favorably positioned with stable credit metrics that have shown some improvement over the last year. Additionally, we closed our largest acquisition to-date and integrated a fully staffed team of banking professionals into our underwriting and approval processes. We are very pleased with the transition and a general performance of the Yadkin book, which continues to remain in line with our expectations.
As we move ahead into 2018, we are presented with many opportunities that come with being a larger more fully integrated organization. These opportunities will continue to be met with our same tried and true approaches to delivering credit and managing risk, which balances prudent and consistent underwriting, a robust risk management framework and a diverse loan portfolio across our geographic footprint. This approach has positioned us well as we look forward to the year ahead.
I will now turn the call over to Vincent Calabrese, our Chief Financial Officer for his remarks.
Thanks, Gary and good morning, everyone. Today I will discuss our financial results provide high level guidance for 2018 and briefly touch on our long-term targets.
As you can see on slide four, our fourth quarter results included a $54 million reduction in the valuation of deferred tax assets recorded in our income tax line in response to tax reform and a small amount of merger related costs. Excluding those items, our operating earnings for the quarter were $0.24 per share. Our TCE ratio decreased 13 basis points from 687 to 674, reflecting an estimated 19 basis point impact from the DTA revaluation.
I should note that we expect to recoup the day one negative earnings impact over the next four to five quarters with the benefit of the lower corporate tax rate as well as growing pre-tax earnings by executing our strategies. For the full year of 2017, excluding the impact of merger related items and the DTA revaluation, our operating earnings were $0.93 per share versus $0.90 per share for the full year of 2016.
Now let's look at the balance sheet for the quarter starting on slide six. Average loan growth was $157 million or 3% annualized. Including annualized commercial loan growth of 1.3% and annualized consumer loan growth of 5.9%. The consumer growth in the quarter was concentrated in residential mortgage, up 18% annualized and indirect auto, up 10% annualized.
Overall on a spot basis, we saw strong growth in the total originated portfolio of about $700 million during the quarter. I'll note that spot originated loan growth in the quarter was partially offset by decreases in acquired loan balances, through a combination of normal amortization, pay-downs, payoffs and the exit of criticized and classified credits. Bringing the acquired portfolio down by $500 million to $5.7 billion at year-end, as we continue to capitalize on opportunities to de-risk the balance sheet.
Average total deposits increased $1 billion or 19% annualized during the quarter. We experienced growth in multiple categories, including 8% annualized growth in non-interest bearing deposits, and 5% annualized growth in interest bearing transaction deposits, as well as a $748 million increase in average time deposits, as we executed our strategy to attract new households and lock in funding in a rising rate environment.
Turning to the income statement, net interest income grew 2.1% or $4.8 million, reflecting the quarter’s growth in earning assets and higher purchase accounting accretion leading to a 5 basis points increase in the reported margin. Excluding the impact of purchase accounting the net interest margin for the quarter was stable at 3.34%, the same as last quarter as shown on slide seven. For the year total purchase accounting accretion was $21.5 million, with $10.4 million from incremental purchase accounting accretion and $11.1 million from cash recoveries.
Let’s look now at net interest income and expense on slides eight and nine. The decrease in reported net interest income reflects $2.8 million of securities gains last quarter. Excluding securities gains non-interest income increased 2.7% for the quarter.
Capital markets revenue rebounded to nearly $5 million and trust services posted a 2.8% quarterly increase. While insurance and securities commissions declined after seasonally higher third quarters. Mortgage banking reported another strong quarter with non-interest revenue up 2.6% due to growth across the footprint with 80% of originations being purchase money mortgages.
As Vince mentioned earlier full year 2017 total non-interest income increased 25% relative to 2016. While we made progress in many of our fee based businesses we faced headwinds in certain businesses that affected our ability to achieve our targeted revenue goals for the full year. As we have discussed in the recent months losing the mortgage team in the Carolinas and retooling the SBA business clearly affected our 2017 results.
Looking forward to this year we expect more meaningful contributions from all our fee based businesses. Vince is going to touch on some of the 2018 initiatives designed to do just that in a minute.
Turning to slide nine, operating expenses increased $3.1 million compared to the third quarter. The biggest driver of this increase was a 4.4% increase in personnel expense related primarily to seasonally higher variable compensation. Outside of that expenses reflected some pluses and minuses with the overall efficiency ratio unchanged from the prior quarter at a very good level of 53.1%.
Next I will discuss our expectations for 2018 shown on slide 10. Spot loans are expected to increase in the high single-digits from year-end. Spot deposits are expected to increase in the mid to high single-digits from year-end. Net interest income is expected to grow in the mid-single-digits compared to the annualized fourth quarter number. This includes full year purchase accounting in the $25 million to $35 million range for 2018.
Non-interest income is expected to grow in the mid to high single-digits from the fourth quarter annualized number. Non-interest expense is expected to grow in the mid-single digits from the fourth quarter annualized operating number. This includes the additional expense for the investments in our employees Vince mentioned earlier, as well as a roughly equivalent amount related to salary related taxes given the larger employee base and the timing of those taxes on our expenses as we reset at the beginning of the year.
In total these two items are expected to account for $16 million to $18 million of additional expenses in 2018. Provision expense is expected to be $70 million to $80 million with originated net charge-offs in the range of 2017 levels. Finally our effective tax rate is expected to be around 20%.
Turing to slide 11, we’ve again laid out our targets, as we look out over the next two to three years. The key elements of our business model are shown on the slide and as you will see we’re performing well on some and have set goals on others we’re working towards. Our 2017 results are shown for each metric. As you can see our net charge-offs for 2017 are well within the 25 to 50 basis points range shown on the slide.
As Gary mentioned earlier, we are comfortable with our asset quality and the overall risk profile of the balance sheet. Our organic loan and deposit growth rates for 2017 came in slightly below our targets as we managed against the headwinds discussed earlier and experienced normal year one acquired loan portfolio activity.
In 2018 we expect lending activity to pick up through a combination of increased demand and entering the second year in the Carolinas, which we believe will lead to achieving our total loan growth targets.
On the deposit side, we have made solid progress with our deposit gathering strategies that we’ve talked about already. So I am also optimistic we can reach our targets there. On the non-interest income side, we believe with the people, products, and processes we now have, and plan to build on, we can achieve our 10% annual growth rate over the next few years, we also recognize that fee-based businesses take time to mature.
We have updated our efficiency ratio target to be less than 50%, over the next two to three years. Granted our net interest income should see the benefit from additional rate hikes, but we intend to get there also by achieving our organic loan and deposit growth objectives. Additionally, we are very focused on growing our non-interest income and diligently managing our expense base to generate positive operating leverage, something we have demonstrated as a core strength.
As Vincent mentioned, we continue to seek ways to optimize our retail bank, and have improved our deposits per branch to $54 million from $50 million at the end of 2016. We look to continue to improve that number over time. Finally, we have set a two to three year ROA target at 1.25%, as we execute on the strategies designed to leverage what we have built at FNB.
Next, Vince will talk about some of those strategies. Vince?
Thanks, Vince. In mid-2017, we laid out our three year strategic plan, for FNB's Board of Directors. I want to touch on some of the major themes of that plan, as we look at 2018 and beyond. We have also included a slide in our presentation.
In the consumer bank, we improved our management of data, which should accelerate the evolution of our internal marketing capabilities, as we seek to deepen relationships with tailored value-added products and services. Initially we use data analytics to improve customer acquisition. The next phase towards using technology and becoming a data driven organization is improving customer retention and capturing a larger share of wallet by addressing client needs.
This includes the plan to develop a platform, which will provide a complete view of each of our customers. Our data strategy will allow our bankers and product specialists to collaborate more easily, and improve our level customer service. And ultimately drive us towards our long-term balance sheet and revenue growth objectives.
We’re also making great strides in our clicks-to-bricks strategy, that I mentioned earlier in the call. And as a proof point to our progress, our investment in our mobile platform was recognized in a study published by S&P global market intelligence, which concluded that the features of FNB's current mobile app are more robust than those currently offered by most national and regional competitors.
In addition FNB offers most of the top features users prefer, including the ability to turn a debit card on and off or report it lost, utilize fingerprint or facial recognition, view balances without logging in, and utilize travel notifications.
As a matter of fact, clicks-to-bricks was mentioned specifically in the study as a differentiator, demonstrating how FNB successfully brings digital technology into the branch experience. Speaking of branches, we continue to rationalize our branch network, as deposits per branch increased to $54 million at the end of December. Through our ongoing optimization program, we will be consolidating more branches over the next year, as well as evaluating attractive de novo location. During 2018, we will keep you updated on our progress.
Touching on a couple of consumer oriented businesses, we are looking to enhance private banking in order to provide a more complete solution to high net worth clients. This would include offering a robust rewards credit card product, building out our practice verticals to help professionals grow their businesses, educating clients about our financial planning tools that include wealth management and insurance products and offering additional mortgage options tailored for their needs.
In general, we are encouraged with the results across the mortgage business, as average residential mortgage loans are up nearly $250 million since March of last year and mortgage fee income has increased more than 50% compared to 2016. We are optimistic that we can further this growth by leveraging our new attractive markets.
In commercial banking, we look to further expand our equipment financing, as our leasing group is starting to gain traction, with more than a 30% increase in their portfolio during 2017. We're also looking to expand via LPOs and establish through adjacent markets, where we can take advantage of market dislocation or attractive demographics. This requires a minimal investment and provides us with a disciplined approach to add new potential relationships, as well as leverage product specialist, we already have across the footprint.
The commercial bank will continue to build out new specialty verticals in areas such as government contractor lending and healthcare finance. Here again, we believe disciplined approaches to these plans will help deliver on our long-term balance sheet growth objectives.
We also believe there is meaningful upside in several of our newer fee base businesses. Notably capital market and SBA, we've had increasing 7% compared to 2016. With more contributions expected in 2018 from the Carolinas.
To build on the existing foundation of these businesses, we've hired an Executive Vice President of Capital Markets and Specialty Finance to lead a commercially focused fee based product group which will include SBA and equipment finance. Our strategy is to align our product specialists across the entire company and unify these businesses into a singular holistic vision that should drive additional growth.
Looking at other fee-based businesses, wealth management and insurance performed well in 2017 with these business units up nearly 10% compared to 2016 on a combined basis. We've rolled out product specialists across all FNB market and will look to these units to help us achieve our double-digit long-term growth objective for total non-interest income.
These are just a few of the major initiatives we've laid out as part of our long-term strategic plan, designed to fully leverage what we've built at FNB to meet our growth objectives and maintain our risk profile.
The revenue and expenses associated with our strategic objectives are either embedded in our historical performance or included in our 2018 guidance. As I mentioned in my earlier comment, FNB has never been position better to serve our constituencies by providing a more consultative experience to our customers, actively engaging with communities, investing in our dedicated employees and ultimately delivering greater shareholder value through a sustained earnings growth trajectory.
With that, I'll turn the call over to the operator for questions. Thank you.
We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Jared Shaw with Wells Fargo. Please go ahead.
Hi, good morning.
Good morning, Jared.
Hey, Jared.
Actually if I can just start maybe on the expenses, when you are looking at the growth for 2018, so we should -- is about 662 a good base that’s annualizing with the core fourth quarter numbers of the base we should be looking at growing from?
Yes.
And then what I guess is the primary source -- I hear you say the $16 million to $18 million from the FICA [ph] expenses, where else are you seeing that growth is it primarily in adding new personal or systems or what’s sort of the breakdown on where we're seeing that growth come from?
Sure, I can comment on that. The 662 is the correct number to use and as we mentioned we are forecasting a mid-single digit increase. There is a few big drivers to that, the $6 million to $8 million that Vince mentioned earlier where we're investing a portion of the tax reform is part of that that’s baked into the guidance. We normalized the fourth quarter I should say because the noise from Yadkin to try to use full year to full year is just too confusing.
So we used the fourth quarter expense number any adds that were made during the year as of September 30th are in that number, so it was kind of cleaner. So it gives us a clear number to extrapolate off of so like payroll taxes for instances are always lower to lowest in the fourth quarter because people pass the caps.
So there is $6 million to $8 million from the investments that Vince mentioned, there is $8 million for just kind of normalization of payroll taxes. When you go from fourth to first quarter that usually increases at least a half penny more than three quarters of a penny. So there is $8 million or so for normalization of payroll taxes. Normal merit increases that come in April 1, 2% to 2.5% it's kind of like all of our peers is what's kind of baked into that.
And then we had shares tax rate went up in Pennsylvania from where it was. It was 89 last year went up to 95 that's $5 million $6 million of additional expense from the shares tax. Those components Jared explain over 80% of the year-over-year delta and the other pieces are smaller pieces. But that's -- those are really the main drivers to that. To add just to that, I should comment to are very limited, if it's on one page and most of them are income producing folks probably about half and half.
Okay, thanks. And then can you give a little update on what you're seeing out of the newer markets down in the Yadkin area? If you expect to see additional sort of call it accelerated paydown in that portfolio? And I guess how the pipeline looks and what you're seeing in terms of growth opportunity down there?
Yeah. I can comment on that. This is Vince Delie. Let's start with personnel because people will ask the question. I think I've listen to other calls. In the commercial bank, we run about a 5% vacancy pretty much consistently across the company. Since the acquisition, we've been at about 5% vacancy, which equates to between 5 and 10 FTEs in the commercial bank in that area North and South Carolina.
As you look at deposits, and I'm going to cover everything comprehensively. On the deposit side we've had very little attrition that's continued to the first eight months of the year. It remains strong with just single-digit attrition in those portfolios in North and South Carolina. So that's held pretty solidly. Personnel within those groups has also been consistent with other vacancy rates across the company in the retail bank.
On the loan side, in North Carolina in particular we're right at our planned levels. When we model these acquisitions, there is a lot of churn in the portfolio. So we don't model extensive growth in the first year. We're eight months into this, and we're right at our planned levels for 2018 actually exceeding the launch points that we set. We have a very strong pipeline in that market that has grown in the weeks following year-end. At the end of the year it was about $135 million, so pretty solid.
And I guess taking a step back if you look at the loan growth overall across the entire company. If we segment it out C&I and leasing growth, it was exceptional in the quarter. I mean we were up 4.18% in C&I lending across the company and 11.7% in leasing across the company. And I'll tell you the North Carolina market was a huge contributor despite all the noise in the portfolio in both of those categories.
If we move on to SBA, the SBA Group was acquired through the Yadkin acquisition. The fee income contribution in 2017 was disappointing to say the least, part of it was planned, part of it was a function of how we account for the pipeline coming over with the delay we missed an opportunity to book $4 million in gains or more from a GAAP perspective and ended up accreting to capital, but impacted our earnings run rate. We feel that that's behind us. The SBA has been reconfigured. The majority of the sales people are in their seats, the pipeline for the first quarter is pretty solid and should enable us to achieve our planned objectives in the SBA segment.
In mortgage, we lost a number of mortgage banking professionals, because of a lift out prior to the conversion in March of last year. Again very disappointing results in North and South Carolina. We've done a stellar job of hiring people in those markets. We've hired 16 people in the mortgage space so we've nearly filled out the majority of those seats. We are also planning on hiring opportunistically across those markets. And we have a fairly good line on some high performers in both North and South Carolina.
So we're very optimistic that that unit will contribute as well in '18. So that's kind of an overall summary of North Carolina for the benefit of everybody. So thanks for the question. Sorry for the long answer.
Yes the only thing I would add to that is just if you look at the acquired portfolio I mentioned in my remarks originated growth of $700 million and the acquired loan portfolio coming down by $500 million, I think it’s important to remember that there’s always a significant level of activity in the first year of an acquisition. And given the shared size of Yadkin it translates into more evident impact on the total company.
But we had a pretty small what we call exit portfolio $110 million or so of loans that we specifically targeted to exit. But then you also have the other activity we have loans that come up for renewal, some of them were more aggressive on than others that we want to retain, others we’re okay with some of those maybe criticized loans kind of moving on. So those credits coming up for renewal for the first time that you have another touch point there.
The renewals we do retain that move over into originated loans so that contributes to some of the originated growth. So it’s a lot of normal movement in year one. If we did the math kind of from day one that translates into about a four year average life at day one for the overall Yadkin portfolio just looking at kind of what the decrease have been quarter-by-quarter. But as we look into ‘18 we definitely expect that $500 million number to moderate so that the gross originations that you see will show up more and that’s baked into our guidance, but just to give people a little kind of context to that number on the acquired side.
Great, thank you.
Our next question is from Michael Young with SunTrust. Please go ahead.
Hey, good morning.
Good morning.
Vince I wanted to dig a little deeper into the net-interest income guidance and just make sure I understand all the moving pieces. First wanted to make sure I understood the interest rate hike assumptions that are embedded in that and then also does that include the adjustment to FTE net interest margin and is that all included in that number?
Yes, I mean we have what’s in our guidance is basically three moves, December, March and September. I know the Fed is at 3 for this I guess we’ll see what happens there, but we have 3 baked into our guidance. It does reflect the FTE adjustment given the new tax rates, so that’s also baked into the guidance. And our FTE adjustment isn’t that large, $4 million, $4.5 million a quarter or so and you just apply the lower tax rate to 21 instead of the 35 that so but that is baked into the guidance too.
Okay, perfect. And if I can switch gears a little bit just back to the expense side, understand all the areas that are causing some normal inflation in expenses. But what are sort of the opportunity set to also prune expenses as we move forward whether it be from the branch network that’s now more up and running with the digital investment or in other places within the franchise?
Yes, I would just say that as a company we always focus on and we are again for ‘18 are generating positive operating leverage. So the guidance that we have there including the investments that we’re making in our employees still generates positive operating leverage and that’s a key focus for us. And it happens on both sides.
I mean this quarter while expenses were up a little bit our efficiency ratio was 53.1 so it’s unchanged. So the expense increase was offset by revenue increase for the quarter. So as we think about 2018 we’re diligently managing expenses as we always do. The programs that we’ve talked about in the past that are ongoing as we have a program for rationalizing the branches that we’ve been doing for many years. We typically would take 6 to 12 branches and consolidate and something we’ve done every year and we’ll be evaluating that as part of our ‘18 plan.
The vendor management program continues. We got a few $3 million to $5 million worth of savings realized already and then we have some significant contracts that are up for renewal this year that we’re continuing to work on, getting at better pricing for those on a go-forward basis. And there’s some level of that baked into the expenses. So it’s kind of blocking and tackling that we’ve done to be able to generate positive operating leverage and continue to improve on efficiency ratio.
And as I commented in our long-term -- our two to three year targets now we’ve changed our 53% target to get to be below 50 over that two to three year horizon. So that obviously happens with positive operating leverage.
Our next question comes from Casey Haire with Jeffries. Please go ahead.
Thanks, good morning guys. Just to circle back a little bit on loan growth just so I'm clear it sounds like the exit portfolio today is $110 million and then what’s been sort of the acquired run-off since Yadkin has been about $500 million. Is that accurate, and what is sort of the expectation in 2018?
Casey that $110 million was the original identified exit portfolio, we are basically through that at this point. During Q4 we were able to remove about $60 million of desired exits and for the most part we are basically through that portfolio at this point.
Okay, alright. And then just on the expense side again, if I am hearing you correctly Vince, it sounds like 80% of the expense guide is kind of hard dollar. And so that that would mean, if the top-line disappoints, the only thing that's flexible is about 20% of the expense guide, is that accurate?
Well we always have that the plans we have, the initiatives that are in place, we always kind of monitor, how are you tracking and make the call every day as to whether you continue to go forward with initiatives are not. So, the expenses that are tied, there is some staff adds that would be tied to some of the revenue creation and if that doesn't happen then you don't add those positions. So, I mean, it's something we would manage very closely.
So you can’t just take up a 20% on because some of the normal expenses you just have to kind of evaluate and decide where to go from there. So I think that the $6 million to $8 million that’s in there that I mentioned for the employee investments, obviously that's -- the pieces that I mentioned are going to have them. So…
Yes, we have a fairly large expense base to take action on. So we don't just sit here passively managing month-by-month increases in expenses, I think if anything we’ve proven that we've been able to manage our expense base over time. I think given that the acquisitions behind us there is enough time to establish the core run rate for our expenses. We’ll keep expenses in line. If we disappoint on the top-line, we will take the appropriate action. We have always done that.
So I wouldn’t look at it as just the 80% of the amount that Vince is trying to reconcile, he is just trying to give you a reconciliation some frame of reference on an annualized fourth quarter and then try to bridge you to the build.
Okay, understood. And just last one for me, on slide 11, the other long-term growth strategy, it looks like, I mean, so the fees at 10% a year that seems, if I am looking across that page that is probably the most aggressive, is that the big gainer to getting to that sub-50% efficiency ratio?
Well it’s definitely a big driver to it, because to take the whole base non-interest income including deposit service charges they don’t grow at those same clips is includes a lot of upside for that the newer businesses that we are in and particularly in the Carolinas continuing to grow the capital markets, the wealth business down in there, insurance. So there's upside there in those businesses that obviously you need to grow faster than 10% a year to offset the slower growth in the deposit side.
So, that’s definitely a big driver, the SBA getting to levels that kind of they used to run at over this two to three year horizon is a key contributor to that. And the capital markets is still very new for the Carolinas and on the swap side they started to do some as we went through the year in ‘17 and there's significant upside still to come there. So that is a big driver.
And then the loan growth, getting loan growth in deposits in the mid to high single-digits obviously generates strong interest income too. But the fee income is clearly a big driver.
Got it, thank you.
Thank you.
Our next question is from Russell Gunther with D.A. Davidson. Please go ahead.
Good morning, guys.
Good morning, Russell.
Just a quick follow-up on, on sort of the fee income conversation; one, could you just start perhaps quantify what the contribution was out of the Yadkin franchise within those kind of three key verticals of mortgage, SBA and capital markets. And then as a follow on to that, what your expectations are for those verticals throughout 2018 and in terms of ramping up. I mean, are we stepping into 1Q at full strength or is that going to slowly build over the year?
Yes, I think, we are not going to get into details of breaking out those individual components, but I will tell you that the contribution from those areas as I said was disappointing. It minimally contributed to 2017. So I think execution of our plans in those markets should drive accretion all by themselves. So I don't know how to say it, but I think as we look at it all of those fee based businesses are seasonal, some of them are lumpy, the capital markets area for example.
So I would look for a build overtime that maybe some lumpiness as well, and kind of look back over the full year to measure it. Because it's difficult to go quarter-to-quarter especially when you have big moving parts in capital markets and gauge your success. You kind of have to look over the full year period. But I would expect it to build overtime, and get us to where we need to be within the guidance that was established.
Sure, understood.
Yes, I would say the capital markets side Russell, we have the people in the seats right now and they're working with the team particularly the Carolinas. And I think that will pay off. We saw that the swap activity build from kind of zero and it's built to a few swaps as you go through. Each quarter was a little bit more. I think what's we have the people we need and I think it's just seem that activity start to build. The mortgage side, we're still have seats to fill there. So I think that's still we're not a full ramp up or launch point from a people side there in the Carolina.
So there is still some folks and the timing of the year people are going to wait so they get their bonuses and then where quite a few prospects we have more than enough to fill the seats that we need to on the MOO side, but that's still something we need to fill out.
Got it, okay. And what are the deltas to get -- the guide's for mid-to-high single-digit growth. So what needs to happen for you to hit the high end of that?
The question you were asking, relative to up and down the guidance?
On the fee income side right. I think it's mid-to-high single-digit growth there. I appreciate the color on those verticals. But just kind of curious in your mind, what needs to happen from an execution perspective to get you to the high end of that guidance?
I think it's the items we just talked about are key part of that.
It's really having the people in the seats more than product development or any other areas. So I think it's a function of having stabilization in the markets, having some stability within the customer base and then driving that fee income growth across your customer base with the people that you have. We have the product specialists in place, we have the bankers in the seats. The portfolio has stabilized and is poised to grow. So we should see that continue to improve overtime.
Plus the metro markets are still relatively new. It hasn't been part of us for all that along.
Got it, okay. And then just -- thank you guys, just a follow-up see if I heard you correctly. So with regard to NII outlook, that’s three rate hikes for ‘18 that's March, September and December all of 2018, is that correct?
No, it's actually was December of '17 and March and September of '18. And I should clarify something that just to make sure everybody is clear, the net interest income guide that we gave does not include the FTE adjustment. I was commenting on what the impact is to the FTE adjustment, but the guide is just kind of the GAAP net interest income. Just to make sure everybody has that straight.
Appreciate that. And then just the last follow-up, what the backdrop is or what are you assuming in terms of deposit betas for ‘18?
We're still using the same conservative numbers we've been using. So kind of the 50 and 80. I would tell you we've looked at the impact so far in '17. And we pass through about 22% of the Fed move starting with the December '16 during the year. So we're still I would say we're still conservative in the betas. Our goal obviously is to manage more profitably from that standpoint, but that's the way we model it. And we've done some sensitivity analysis where do we kind of manage it too, how much can you lag. So there is -- from an interest rate risk perspective it's conservative. The guidance we have is baked on how we manage the company. So I think that's an important thing.
It's built into the NIM.
It's built into the guidance, right.
Okay, very good. Thank you guys. That's all I had.
Our next question comes from Austin Nicholas with Stephens. Please go ahead.
Hey guys. I think most of my questions have been answered. But maybe just digging into that net interest income guidance a little bit as it pertains to the NIM. I know you gave some good color on the purchase accounting accretion assumptions, but maybe just as we walk through 2018 could you give some -- I guess give some guidance on the core margin and what assumptions are going into that in order to get to that the net interest income guidance?
Well if you kind of back into it if you use -- we gave you the $25 million to $35 million, which granted is a broad range, but the accretion is lumpy from quarter-to-quarter. So that’s baked into there the net interest income growing into the mid-single digits guidance gives you a lot the loans to deposit number gives you a lot. We’re not giving specific NIM guidance, but what I would say as we continue to be asset sensitive.
So if you look at our interest rate risk portfolio so for plus 100 ramp where it goes up 0.8%, for a plus 200 it goes up 1.4%. So directionally and it gives you just some numbers there as far as what the impact is of rates moving up from here. And then on a short basis it’s 1.3% for a 100 and 2.3% for plus 200.
So we’re still asset sensitive and we still benefit from rates moving up. We’re just not giving specific NIM guidance because I think with all the pieces we’re giving you here you can kind of can do the math.
Understood, yes agreed. Okay, great. And then I guess broader picture looking at I guess capital is it safe to assume that the payout ratio continues to kind of drift down call it to the 40% or maybe even a little below that as we look out over the next couple of years? And then maybe with that what is the outlook for M&A with Yadkin mostly fully integrated here?
So I’ll comment on capital and then turn it to Vince for the M&A commentary. As we’ve discussed in recent months, I mean, our targeted TC ratio historically we’ve talked about -- I shouldn’t say historically last couple years 6.5 to 7 and in the last few months we talking about moving that number up north of 7. And that when you look at our three year strategic planning cycle, we reach to mid-7s by 2020.
The tax reform obviously helps us get there earlier than previously projected. But we would still track to kind of a 2020 achievement to get to that that kind of mid-7 level. We’re very comfortable with all of our capital ratios the day one impact as I mentioned recoup that in four to five quarters. We’re fine where we are with the DTA hit and then the quick recoupment obviously helps. And then consistent with our philosophy we’ve always had, I mean, we continue to evaluate our dividend every quarter.
We reinvest in the business to support the expected loan growth especially as we enter the second quarter with the team in place in the Carolinas and expecting that loan growth to increase versus ‘17.
And then when you look at the benefit of tax reform from a kind of a payout ratio standpoint obviously we get to a more normalized payout ratio quicker. When you look about two to three year horizon and as you do that you get down into the mid-30s that obviously provides more flexibility for dividend actions in the future. I mean, our current yield of 34 [ph] still very attractive and at that time as we do every quarter we evaluate our opportunities to deploy the capital in the business or at least when you get down to more normalized payout you have more flexibility and more levers.
And then on the M&A front as I’ve said before we are squarely focused on delivering the EPS accretion that we have modeled and more. So we are focused on growing earnings the Yadkin, the two acquisitions we did added 33% to our asset basis, fairly sizeable over the last 18 months.
We’re starting to feel really good about being one company and driving our strategy, which we don’t spend a lot of time talking about, but we’ve made considerable investments in technology that are also embedded in our historical run rate. So we’re going to leverage that, leverage the investment in the new markets, leverage the investment in technology and focus squarely as a management team on driving EPS growth. That’s our objective.
Great, thanks for the color guys.
Thank you.
Our next question is from Frank Schiraldi with Sandler O’Neil & Partners. Please go ahead.
Good morning, guys. Just a couple of questions on guidance, it seems like obviously you points to two to three year efficiency ratio under 50%, is that start ramping -- I mean obviously it’s already ramped down, I mean, you’ve had positive operating leverage this year clearly. But as far as 2018, I guess does the operating leverage take a little bit of a pause as you invest -- some of the investments you've talked about making back into the employee base, in the franchise and then really start to ramp down in 2019 or no?
I would say that the positive operating leverage in 2018 is there, and that’s what we’re going to manage to. I would say that the investments that Vince mentioned, the kind of $6 million to $8 million, that affects your efficiency ratio, the tax reform affects the bottom-line. So, again we are investing a small portion of the tax benefits in that, and we think that's a smart thing to do.
So, from a net income standpoint obviously you’re going to get the lift there. Our positive operating leverage will be a little less than it would have been otherwise of course, because you are adding $6 million to $8 million worth of expense, but it’s still positive and that's our mantra that’s -- the board holds to that, we hold ourselves to that is that we have to generate positive operating leverage.
And as Vince said earlier, if things change on the revenue side then we take action. So, it’s part of how we run the company. So is it a little bit less with the $6 million to $8 million, yes it is of course. But it’s still positive and kind of improve that number from there and if you get from a 53% to getting down below 50% in three years, I mean, I think the 53$ is really good, I think that's a good accomplishment and a good goal for us to strive for.
And I think you should clarify I don’t know if this is a question or not for anybody, but the $6 million to $8 million is included in the expense guide, just so everybody understand.
Right, yes, that’s fully in there.
Right, okay. And then just one additional follow-up on the NII guidance, I might have just missed it. But, in terms of the operating number the annualized operating 4Q number you're using, is that just the 2.30 or do you pull out the incremental purchase accounting. And then use that number mid-single digits off of that and then add back in your purchase accounting estimate for the year?
It’s up to all in, right.
Yes, so it’s off the all-in number, Frank, so it’s $920 million is the number, the base number.
Starting point. Okay, alright, great. Thank you.
Thank you Frank.
Our next question is from Collyn Gilbert with KBW. Please go ahead.
Thanks, good morning guys. Vince I just want to follow-up Delie on your just the comment you just made, that you guys are squarely focused on EPS growth, now you kind of streamlined the organization and your full momentum and a great position relative to certainly where you’ve been in the past, the strongest position. Can you just sort of quantifying maybe how you think that could translate into what level of EPS growth and a lot of moving parts in ‘18 obviously you get the benefit from the tax bill. But then in ‘19, I mean, do you see yourselves migrating to a 7% to 9% EPS grow or you still think you're kind of hover in that low single-digit range?
Yes I think, I have to bring you back to the guidance, I don’t think I can go out that far without my General Counsel shooting me. But I think that obviously if you look at what's been done, Collyn, there is a very solid base in place. And what others outside of the company fail to see is that there were significant investments in technology made that impacted run rate earnings in the past, there were regulatory issues rising over $10 billion it was only 2013 when we exceeded $10 billion.
So we've had headwinds, I think at this stage in the game, we have a fairly significant tailwind, both with the economic recovery and tax reform. So I am very, very optimistic about our ability to drive earnings growth and EPS expansion, as we move forward. And I also feel that the investments that we have made historically vis-à-vis, the acquisitions have really provided a lot of cover for many of those expense items and unplanned regulatory events or governmental driven revenue detractions that have occurred over time.
So I think that, it will all play out as we move forward and I think it’s a good time for us to take a step back, start to manage the businesses that we have and focus on driving growth. That's where I am.
Okay, okay that’s helpful. Everything else I had, had been already answered. Thanks, guys.
Thank you, Collyn.
Thanks, Collyn.
Our next question is from Brian Martin with FIG partners. Please go ahead.
Hey, guys.
Hi, Brian.
Hey, Brian.
Vince Delie, this is maybe for you just because it seems like we've beat a dead horse, but this NII just so unclear on that you just talked about the 930 all an annualizing, that 930 includes the purchase accounting from fourth quarter. So I guess if we're adding it in should it not be the 220 that was out there, that was ex to purchase accounting annualized based on the fact that you've guidance for the purchase accounting for ‘18, or am I missing that?
The number I mentioned was 920 Brian, so that's the annualized…
Okay. I got you.
Basically just serves as a reference point for you to apply the guidance too right because we couldn't produce ‘17 full year because we don't have the Yadkin in there for the full year. So…
Okay, got you. So the 220 annualized and then add in the additional accretion that you've guided to?
Well the attrition is -- yes, 920 include the accretion and the guidance includes the accretion also. So that's not additive to the guidance. The $25 million to $35 million is baked into the mid-single digit.
Okay.
So all in it’s in both Brian, I guess is the right way to say it.
Okay. I think I got you. All right. And then just on the -- Vince talked about the just the fee income and as far as kind of where your outlook is that it was disappointing in ‘17, but more optimistic in ‘18. But can you just talk about fourth quarter relative, I mean, I understand earlier in the year when some things were going on it was, I mean, how do you feel about the fourth quarter as you kind of seem like you upped the staff, I mean, would you rate that a little bit different and disappointing earlier in the year?
Yes, I think we started to see recoveries in the fourth quarter, obviously as we built out the team. The mortgage business we got some contribution, but we've already miss the seasonal peak. So, the impact too was pretty significant throughout that cycle. So that really didn't help.
On the SBA side, yes, we've started to see a pickup in activity we were able to fill, we moved from a national strategy to more regionalized, or to cover our 6 to 8 footprint. We've been able to hire the people that we need to generate opportunities within our footprint and with our commercial bankers as a product specialist. So we're starting to see that benefit is there.
So there -- I would say that we're not where we need to be, we have some momentum heading into the first quarter and that feels pretty good from a fee income prospective. I would also tell you that our ability to achieve our double-digit growth in fee income also is heavily dependent on our ability to gain commercial clients. A lot of the fee income is driven off of C&I clients prospects that are converted to clients where we able to cross sell products and services. And given the numbers that I excited, I feel pretty good about moving into the first quarter as well.
So, I think we've got a good base going into the first quarter and we need to execute on that base.
Fair enough. Okay, that's helpful. And just the part about the originations versus the payoffs, can you just talk a little bit more about that it sounds like I mean maybe just give us an idea of, have the originations been pretty consistent the last two quarters. And then when you look at payoffs going forward, I understand the part about the acquired portfolio, but is there -- just as far as other payoffs in the portfolio from a commercial real estate standpoint kind of what we are seeing with some other banks, is that respect payoffs there to be pretty consistent higher or lower?
We've seen first of all the production level, and it's hard to equate production to balance sheet impact because you've got a lot of moving parts and for us production is we give credit for it funding up overtime. So the timing of that impact of the production could be carried out over a longer period of time, not just in one contained quarter. So when we talk about $700 million in production versus $500 million in payoffs and exits. I mean, that's not a 100% apples-to-apples but it gives you an indication.
I think the production levels for us from a origination standpoint have been very good. So I would say that our people have been doing what they need to do to bring customers. The runoff, first of all big chunk of the portfolio that we acquired both with Metro and Yadkin we had planned on exiting and we announced that, And our ability or Gary’s team’s ability to exit those criticized and classified assets is a very positive thing.
And given that the economy is so robust and the competition is so intense, it gives us an opportunity to exit other undesirable of credits that maybe marginal from a credit risk rating perspective. But is an industry or is a type of asset that we don't view as favorably. And I'll let Gary talk about it. But I think if you examine the amount of payoffs that we've had, a portion of it is related to good performing real estate loans.
Where we've had construction loans that have funded up and they were planned to be taken out that's part of it. Part of it is exits that Gary mentioned, you sold a portfolio, you exited $150 million. And over the course of the year or nine months of criticized and classified assets. And then you have a whole pool of assets that I would throw into a kind of a watch status that we're not necessarily thrilled with. That we may choose to exit.
Given all of that that typically happens over a nine months period, six to nine month period post-acquisition, there is a lot of churn. I think the positive is that’s happened and I'll let Gary speak to future payoffs or how he feels about the portfolio overall. But I think we've essentially taken the risk off of the table so to speak in a large portion of our portfolio. And it’s now starting to build.
Vince has covered pretty well there. Some of the other items that you have here Brian is primarily related to the CRE focus of the Yadkin Institution. And they had a heavier CRE book. A lot of that small CRE, some of it not strategic from our perspective, and on the weaker side of the acceptable range. So quite a bit of the early churn is allowing some of that to move off the balance sheet.
Those assets are not classified as exits, but as we get through that portfolio and we continue to analyze the risk with them, they're not strategic assets for us and we're going to put our focus elsewhere. So we roll through those over the course of that timeframe.
And I would say overall, when you speak to the bankers in the field, we've not lost customers that we wanted to lose. In fact, we've recently won several large opportunities from CCAR banks in North Carolina where we've been able to one was $25 million exposure to a middle market company is a very strong credit and we were able to cross sell five or six different fee based products to that customer. That's an example what we want. What we don't want are where we're running our balance sheet to finance a piece of real estate for a C&I company. And we don't have the operating credit, that's some of what Gary is speaking about. But I think that we're in a very good place today.
If I can just clarify one thing too, the $700 million is the net originated growth during the quarter as oppose to production, but to make people understand that.
Yes. Okay. I think that's it from me. Just I guess maybe the other thing I was going to ask you about just the loan growth Vince. If you talk about the just the pipeline and where it is today. I think you mentioned it, I didn't hear it. But the where it stands relative to last quarter. Has it -- is it up?
At the end of the year it finished down a couple of hundred million dollars because we did process a lot of activity as I mentioned. Particularly in North Carolina and North Carolina moved from about $1 billion to somewhere above $800 million, but it's back up again. And that's pretty normal too. So you see it cycle through.
So I would say as we sit today, our pipelines are above where they were at the end of the third quarter. At the end of December once stuff flows through they came down a couple of hundred million dollars, but today it's actually higher. And some of the fundings, Vince mentioned net change in balance versus my production comment. What I was trying to say is in certain circumstances we will close a loan and it won't fund until the first quarter. So you see some of that coming through with the elevated incentive compensation. So we had a good end to the fourth quarter.
And being above launch points is obviously a positive.
Yes, okay. Perfect, that's it from me guys. Thanks so much.
Thanks, Brian.
This concludes our question-and-answer-session. I would like to turn the conference back over to Vince Delie for any closing remarks.
Yes, so I'd like to thank everybody for participating in our call. I think we had some great questions. We're looking forward to delivering the EPS growth that we spoke about on the call. I know that our people are really charged up to get out there and prove that we can do it. I have all the confidence in the world in our employee base I think we’ve got tremendous people and that’s what matters the most, tremendous market and tremendous people. So we’ve got what we need to get the job done.
I’d also like to point out that in the first time in our history, if you look at the full year results FNB exceeded $1 billion in revenue that gives us significant scale and the ability to take appropriate actions to ensure that we achieve the results that we expect. So with that I would like to thank everybody for participating and thank you for your continued interest in FNB. Have a great day.
The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.