KeyCorp
NYSE:KEY
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KeyCorp
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Good morning and welcome to KeyCorp’s Second Quarter 2018 Earnings Conference Call. As a reminder, this conference is being recorded.
I would now like to turn the conference over to the Chairman and CEO, Beth Mooney. Please go ahead.
Thank you, operator. Good morning and welcome to KeyCorp’s Second Quarter 2018 Earnings Conference Call. In the room with me are Don Kimble, our Chief Financial Officer; Mark Midkiff, our Chief Risk Officer and Chris Gorman, President of Banking.
Slide 2 is our statement on forward-looking disclosure and non-GAAP financial measures. It covers our presentation materials and comments, as well as the question-and-answer segment of our call.
I’m now turning to Slide 3. KEY reported strong results for the second quarter, with earnings per common share of $0.44, up 22% from the year-ago period and 16% from the first quarter. Our cash efficiency ratio was 58.8%, and our return on average tangible common equity was 16.7%. Results this quarter included a number of notable items, including a gain from the sale of our insurance business and some offsetting items that were unique to this quarter.
Don will walk through the line item detail in his comments. We continue to generate positive operating leverage from both the prior year and prior quarter. With our results driven by continued revenue growth as well as strong expense discipline.
Net interest income benefited from a four basis point improvement in our net interest margin and growth in average earning assets. Average loans grew 2% from the prior year and prior quarter, driven by double-digit growth in commercial and industrial loans as we continue to grow the number of relationships and do more with our existing clients.
With a solid economic backdrop and positive client sentiment, we continue to see good business flows and activity. We are taking share and our pipelines remain strong. Our fee-based businesses, once again, reflected our ability to offer a full range of solutions to our clients. Investment banking and debt placement fees reached a new record level for the second quarter, driven by strong advisory fees.
Cards and payments were up 15% from the prior quarter, reflecting the investments we have made in the business and our success across our franchise. Expenses this quarter included some notable items related to efficiency initiatives as well as cost incurred from the sale of our insurance business. Excluding these items, expenses were down $40 million or 4% from last quarter, reflecting both seasonal trends and cost savings. This included realizing the remaining First Niagara cost savings, bringing our total annual savings to $450 million or approximately 46% of the acquired expense base.
As we discussed in our first quarter call, we also implemented a number of expense initiatives that benefited both the current quarter as well as future period. These initiatives included branch consolidations, savings from third-party vendor contracts and adjusting staffing models and business realignment. These actions are part of the path and plan to approach the high end of our long-term cash efficiency ratio target of 54% to 56% by year-end and we remain committed to achieving our expense outlook for the year.
The final two sections on this slide highlight our strong position in terms of both risk management and capital. Credit quality remains a strength, with net charge-offs to loans of 27 basis points. And our approach to capital has remained consistent and focused on maintaining a strong capital position, while returning a large portion of our earnings to our shareholders through dividends and share repurchases.
KEY’s Common Equity Tier 1 ratio ended the quarter at 10.1%, consistent with our 2018 Capital Plan, our Board of Directors recently approved a 42% increase in our common stock dividend payable in the third quarter, which was our third increase over the past year and will reflect a 3.4% dividend yield for our shareholders.
Our Capital Plan also included a share repurchase authorization of $1.2 billion. These actions are consistent with our stated capital priorities, which we believe will continue to drive long-term shareholder value.
I will conclude my remarks by restating that it was a strong quarter with broad-based growth across our franchise in both our commercial and consumer businesses. We grew loans including 5% linked quarter growth in C&I. We grew fees with record quarters for investment banking and debt placement fees as well as cards and payments. We managed our expenses, which excluding notable items were down $40 million from the prior quarter and we maintained our credit quality with the net charge-off ratio of 27 basis points.
And finally, we were disciplined with our capital, including a 42% increase in the common share dividend bringing us closer to our targeted payout range of 40% to 50% overtime. Our results this quarter represent a step change in our performance with meaningful improvement in productivity, efficiency and returns and with a definitive move toward our long-term performance targets. We remain committed to achieving our guidance for the year and continuing to deliver value for our shareholders.
With that, I will close and turn the call over to Don. Don?
Thanks and I’m on Slide 5. As Beth said, we reported second quarter net income from continuing operations of $0.44 per common share. Our results compared to $0.36 per share in the year-ago period and $0.38 in the first quarter. There were a number of notable items during the quarter, which in total, resulted in a $2 million after-tax impact. In the year-ago period, we had notable items with a $27 million after-tax benefit. Notable items are listed on the bottom of this slide and additional detail can be found in the appendix of our presentation materials. I’ll cover many of the remaining items on this slide in the rest of my presentation.
So, I’m now turning to Slide 6. Total of average loans of $89 billion were up $1.7 billion unannualized from the first quarter. Second quarter growth was driven by strong commercial industrial loans, which were up $2.3 billion or 5% linked quarter unannualized. We saw a growth across commercial client segments in both our Community Bank and Corporate Bank.
We continue to see good growth from new business activity, which was partially offset by elevated paydowns and lower line utilization, which impacted our period-end balance. We entered the second half of the year with strong pipelines and continued to expect loan balances to be within our targeted range of $88.5 billion to $89.5 billion for the full year.
Continuing on to Slide 7. Average deposits totaled $104 billion for the second quarter of 2018, up $1.4 billion or 1% unannualized compared to the first quarter. The cost of our total deposits was up 7 basis points from the first quarter, reflecting recent rate increases as well as the continued migration of our portfolio into higher-yielding products. Our deposit beta for the current quarter was 41%, resulting in a cumulative beta of 25%, which we expect to migrate higher overtime.
Our outlook assumes our betas will be ramping up to more historic levels in the mid-50% range during the second half of this year. On a linked quarter basis, deposit growth was primarily driven by higher, NOW and money market balances, as we benefit from strong retail deposit growth, commercial relationships and a continued shift into higher-yielding deposit products. We continued to have a strong, stable core deposit base with consumer deposits accounting for over 60% of our total deposit mix.
Turning to Slide 8. Taxable equivalent net interest income was $987 million for the second quarter of 2018 and the net interest margin was 3.19%. These results compared to a taxable equivalent net interest income of $987 million and a net interest margin of 3.3% in the second quarter of 2017, and $952 million and 3.15% in the first quarter. Purchase accounting accretion contributed $28 million or 9 basis points to our second quarter results. This compares with $33 million or 11 basis points in the first quarter and $100 million or 33 basis points in the second quarter of 2017.
Excluding purchase accounting accretion, net interest income was up $72 million or 8% from the second quarter of 2017. The increase was largely driven by higher interest rates and earning asset growth. Net interest income increased $40 million or 4% from the prior quarter excluding purchase accounting accretion benefiting from higher interest rates, strong commercial loan growth, asset sensitivity and one additional day in the quarter.
As noted earlier, our deposit betas increased faster than originally expected. As a result, we have included in our outlook a deposit beta ramping up to the mid-50% range during the second half of this year. With this, we expect our core net interest margin, excluding purchase accounting accretion to move modestly higher in the remainder of this year, which assumes continued growth in our balance sheet and one more rate increase toward the end of the year.
Moving on to Slide 9. KEY’s non-interest income was $660 million for the second quarter of 2018, compared to $653 million for the year-ago quarter, with both periods including a number of notable items. In the current quarter, this included a $42 million lease residuals, which impacted our operating lease income. The loss was from a leveraged lease on a coal power plant that was originated over 20 years ago. It is unique and singular in terms of the nature of the asset, site and structure, and we have not originated a leverage lease in over a decade.
We also recognize the $78 million gains in the sale of our insurance business, which impacted other income. In the year-ago period, the $61 million of notable items included a gain from the merchant services acquisition and a purchase accounting finalization. Excluding all notable items, non-interest income was up $32 million or 5% from the year-ago period. Not included within the notable items, but also impacting the second quarter results was a $9 million charge related to the Visa’s litigation escrow account funding.
Growth from the prior year was largely driven by continued momentum in our fee-based businesses, including a record second quarter from investment banking and debt placement fees, which were up $20 million from the year-ago period as we benefited from the acquisition of Cain Brothers and stronger advisory fees.
We also saw growth in mortgage servicing and corporate services. Compared to the first quarter of 2018, non-interest income increased by $23 million excluding notable items. Investment banking and debt placement fees as well as cards and payments related revenues, each grew as we benefitted from ongoing momentum across the franchise.
Turning to the Slide 10. KEY’s non-interest expense was $993 million for the second quarter of 2018. Again, there were a number of notable items that impacted our results, including expenses related to our efficiency improvement efforts and cost related to the sale of our insurance business. These items totaled $27 million for the current quarter, which we would not expect to continue in the back half of this year.
As we discussed on our first quarter conference call in April, we implemented plan this quarter reduced cut cost including plans for branch consolidation, savings in third-party vendor contracts, middle and back office efficiencies, business unit realignment and staffing model adjustments.
These plans represent initiatives that were kicked-off last year coming out of our First Niagara integration, which keep us on a path to approaching the high-end of our efficiency ratio target by the end of this year. These costs are clearly outsized compared to our normal continuous improvement efforts, which will continue into next year. Compared to the first quarter, excluding notable items, expenses of $966 million were down to $40 million or 4%.
This decline reflects expected seasonal trends in the realization of cost savings. One of the largest drivers was employee benefit expense, which was down $23 million on a linked quarter basis. Excluding notable items which totaled $60 million in the year-ago period, non-interest expense grew $31 million from the prior year as a result of the acquisitions and investments we’ve made across the organization.
This includes Cain Brothers, HelloWallet, the addition of client facing roles and investments in our mortgage – residential mortgage business. Costs associated with these investments offset and benefit from the merger-related cost savings. We continue to expect to be within our full-year guidance range with non-interest expense of $3.85 billion to $3.95 billion and again, approaching the high-end of our long-term efficiency ratio target of 54% to 56% by the end of this year.
Moving to Slide 11. Our credit quality remains strong. Net charge-offs were $60 million or 27 basis points of average total loans in the second quarter, which continues to be below our targeted range. The provision for credit losses was $54 million for the quarter. Non-performing loans were relatively stable with the prior quarter and represented about 62 basis points of period end loans. At June 30, 2018, our loan loss reserve – our total reserve for loan losses represented 1.01% of total period end loans and 163% coverage of our non-performing loans.
Turning to Slide 12. Capital also remains the strength of our company with a common equity Tier 1 ratio at the end of the second quarter of 10.1%. As Beth mentioned earlier, we increased our common share dividend by 14% during the quarter and we continue to repurchase common shares, which totaled to $126 million. Our 2018 capital plan included last week’s announcement of a 42% increase in dividend, positions us for a meaningful increase in shareholder payout and progress as we move toward our long-term targeted levels of capital and common dividend payouts.
Slide 13 is our outlook for 2018, which remains the same as what we shared with you in April. We continue to expect average loan balances to increase to the $88.5 billion to $89.5 billion range with deposits growing less than loans. Net interest income is expected to be in the range of $3.95 billion to $4.05 billion. This assumes one additional rate increase in November and in our Appendix, we have updated the interest rate sensitivity slide, which provides different rates and balance sheet assumptions.
We anticipate the non-interest income will be in the range of $2.5 billion to $2.6 billion as we continue to drive growth from our core businesses and deliver First Niagara revenue synergies. And we continue to expect non-interest expense to be in the range of $3.85 billion to $3.95 billion. Net charge-offs are expected to remain below our targeted range of 40 basis points to 60 basis points, and our loan loss provision should slightly exceed the level of net charge-offs to provide for loan growth.
As we continue to expect our GAAP tax rate to be in the range of 17% to 18%. Beth said, this was a strong quarter, with continued growth across our franchise. We are benefiting from the results of our efforts to improve efficiency and returns and look forward to continuing to deliver on the commitments we have made.
I’ll now turn the call back over to the operator for instructions in the Q&A portion of our call. Operator?
[Operator Instructions]. Our first question today comes from the line of Matt O’Connor with Deutsche Bank. Please go ahead.
Good morning.
Good morning.
Good morning.
I was just wondering if you could talk about the competitive landscape a bit. We’re seeing some kind of the bigger banks talk about expanding into some of your markets. Actually, one of your regional competitors have talked about increasing your marketing spend in a big way going forward. So, I’m just wondering it’s always been very competitive environment, I think, for the banks overall and maybe in the Midwest in particular, but I just wondering if you could talk about the start?
Yes, Matt. This is Beth. I’ll start and then look to Chris to see if he has any additional color or commentary. But I would tell you that it is always a competitive landscape, but as you can see in our performance, we continue to grow loan, we continue to grow deposits with particular success in our commercial franchise. Post First Niagara, we too have increased our marketing spend and believe our business model is well positioned with our relationship strategy, our targeted value propositions in our consumer to our commercial businesses.
So as we look, I don’t see any particular shift in the landscape that would suggest that this is outsized competitive intensity and our franchise also, we enhanced it with the First Niagara acquisition and the northeast in particular. The strength and the growth we have in our western markets. So again, we feel like we have a balanced franchise, a competitive value proposition I have seen, strong results and momentum across our businesses.
Matt, it’s Chris. The only thing I would add to that, you asked specifically about the Midwest. As we look at what’s going on in the Midwest, we’re probably having the strongest year in the Midwest that we’ve had in the last three years. So, we feel like we have good momentum, since you asked about the Midwest. Other areas where we have a lot of momentum are in Metro New York, Colorado, Salt Lake City and Portland, and our Community Bank. And I think we benefit there from pretty robust economies and a lot of in migration.
As we think about our Corporate Bank, where we have a lot of momentum there is really an M&A, which is taking shares specifically around the healthcare area. And as we think about our other businesses, we’ve got a lot of momentum and technology as well. So I think it’s a step back, yes. It’s a competitive landscape. Yes, the level of competition is stiff. But I think all the investments we’ve made over the last five years in bankers and other investments are really paying off.
That’s helpful color. If I could just ask a separate, related – unrelated question on asset quality. I mean overall, quite strong, if you look at the early-stage delinquencies, they bounced up and I realized it’s off of really low levels last quarter and also low levels a year ago. But they did jump up a bit there. I was wondering, if there’s any color on that you could provide?
Yeah. Hi, Matt. This is Don. As far as the early-stage delinquencies, those are really influenced by some loan renewals that didn’t get completed by the end of that 30-day window. And so we don’t see that as a trend as far as overall credit quality. And so we think that the things are progressing as expected with normal seasonality.
Just on the delay of the renewals, is that I guess what would be driving that?
Just getting the paperwork signed, and that’s really the only thing that drives that. And unfortunately, does create some bumps every now and then in that 30-day delinquency bucket.
Okay. All right. That’s really helpful. Thank you.
And we do have a question from the line of Ken Zerbe with Morgan Stanley. Please go ahead.
Great, thanks. I guess one of your regional competitors this morning, got a little more negative, it seemed on their deposit pricing in terms of higher deposit beta, even so far is taking down their NIM guidance just a little bit despite moving up rate hikes. I was hoping – given you have a very similar overlapping footprint, I was hoping you could actually talk about what you’re seeing in the markets from a deposit pricing standpoint. And certainly, also your expectations about for deposit betas or deposit costs over the course of the rest of this year? Thanks.
Right. And we did see the deposit betas pop up this quarter. And as we said, our deposit beta was 41%, and our cumulative deposit beta is 25%. So we did see a change. What we have seen change in, really, is more on the commercial side and a continued migration of some of the consumers into a more higher-yielding offerings, whether it’s time deposits or higher-yield money-market type of product. We’re especially seeing that in the wealth area of our bank, our private banking type of customers that are accessing that. But we have adjusted our guidance a little bit by saying that we expect to see the betas continuing to ramp up to close to or into that mid-50 range throughout the rest of this year. So, it is more competitive from that perspective, but we still feel very comfortable with our outlook as far as net interest income and overall margin. And so it’s something we’ll continue to watch. But we feel we’re in good shape there.
Got it, okay. And then just separately, in terms of your tax rate, I saw the guidance. I think it was unchanged. But it seemed that this quarter may have been a little light. You’ve been backing out sort of the tax impact of the one-time items. Does – are you implying potentially that the second half tax rate could be just incrementally higher to stay within your range? Or is there any reason to think second half tax would change?
Not seeing a significant change for the second half tax rate. I would say that second quarter did have some credits as well. But I think that the range is still appropriate, which implies maybe a slight tick-up in the overall tax rate.
Got it. Thank you.
And we do have a question from the line of Scott Siefers with Sandler O’Neill. Please go ahead.
Hey, good morning, guys. This is actually Brendan from Scott’s team. So, as I look at guidance for both season expenses for the second half of the year, it seems like it implies a pretty good ramp in fee income from the first half while expenses are going to be relatively flat compared to the first half, if not down a little bit, just to get to the midpoint. I’m just curious, one, what are the specific drivers of the in-fee income that can deliver that growth in the back half of the year. And then two, what are the levers on the expense side that allow you to ramp up fee income while holding expenses relatively flat?
Great. As far as fee income that – we tend to see, especially the fourth quarter, be a peak quarter for us in several categories, including investment banking, debt placement fees and some of the other activity-based accounts, including cards and payments-related revenues. And so we would expect to see some seasonal growth from those categories, and that’s why we’ve continued to maintain our outlook for fee income.
On the expense side, what you’re looking at there is a guidance range. It would be using our second quarter baseline of the $966 million in expenses, and assuming that we can continue to remain that rate – maintain that in the same general level and have that relatively stable. We think we can achieve that by continuing to benefit from the remaining portion of the cost savings for some of the charges we just took and some of the efforts we announced earlier in the quarter. And also, our outlook does continue to assume that the additional assessment from the FDIC premium does go away in the fourth quarter, and that’s about a $12 million benefit for us. And so that’s all predicated on that adjustment coming through, and it’s consistent with our outlook that we’ve had throughout the year.
And then FDIC $12 million benefit, is that per quarter or for the entire back half of the year?
That’s in the fourth quarter only. So that is per quarter.
All right, great. All right. Thanks for taking my question.
Thank you.
And we do have a question from the line of Ken Usdin with Jefferies. Please go ahead.
Thanks a lot. Hey Don, just – first, I just wanted to double confirm. The full year guides for – and – for fees and for expenses, are those all just GAAP basis inclusive of the items this quarter?
That is true that we’re showing reported results. And so it does include those actual numbers. And I would say that we would still be within the guidance range even if you went on adjusted for notable items, but it does include reported results.
Okay, got it. And then as you look forward, you reiterated your view that you expect to get towards the high end of the 54% cash efficiency – 54%, 56% cash efficiency ratio by year-end this year. Any color you can give us on – do you believe you have a chance of getting inside that range for full year of 2019?
We’ll provide 2019 guidance later, but I would say that we’re clearly on our trajectory to continue to show positive operating leverage. And we think that our efficiency ratio will come down, and so we think that we’re on the right path. And we’ll provide more clarity on the 2019 outlook later.
Okay, great. And then just last true up then. On the expense side, are – will you – do you expect to continue to have in the second half of the year some of these efficiency-rated – efficiency-related items as well? Or was that a second quarter cleanup type of thing?
That really, for the most part, was a second-quarter cleanup. We will have some minor type of severance charges later in the year. But if you look at the charge we took in the second quarter, it’s four to five times what we would typically see in any normal quarter for these types of continuous improvement efforts. And it really reflects the accumulation of those plans that we weren’t able to implement last year and are putting into place this year.
Got it. Okay. Thanks, Don.
Thank you.
And we do have a question from the line of Steven Alexopoulos with JPMorgan. Please go ahead.
Hey good morning, everybody.
Good morning.
Good morning.
You guys had really solid commercial loan growth in the quarter. I’m curious, what impact – the tariffs always talk of a trade war. What impact is that having on confidence levels of your commercial customers? And is it impacting loan pipelines at all yet?
Steve, it’s Chris. We’re out talking to our clients all the time. Clearly, it’s a topic of discussion, but it hasn’t manifested itself really in any change of plans that we’re seeing. Also, keep in mind that the tariffs that have been imposed and those that are being discussed do have different impacts for different clients. But short answer to your question is we are not seeing the impacts yet.
I think, Chris, could you give a little color, which industry verticals are driving such strong loan growth here?
Well, it was really across the board. I mean, let me start with our Community Bank. We really had just very strong loan growth across ours geographies. And as I mentioned a little earlier, the particular highlights were places like Metro New York and some of the places in the west. We’re also really pleased with the traction that we had in the Midwest. And so those are kind of from the geography perspective, Steve, where we’re getting a lot of growth. As it relates to our Corporate Bank that it would be where you would expect to see debt growth, and that would be in places like industrial, some portions of real estate, some portions of energy.
Great. And maybe just to shift directions for a second. We’re seeing regulatory relief now being provided to banks below $100 billion in assets. And given that you guys are at the lower end of that $100 billion to $250 billion range, I’m curious, have conversations with banks your size started yet regarding potentially getting regulatory relief.
Obviously, there is a window in which the regulators get to assess the potential timing and magnitude of how they will implement the regulatory relief. And clearly, we, in the industry, have a point of view and are in – always in discussion with our regulators. But it is early days since the passage of the Senate bill, and there is nothing further that I would comment on it at this point.
Okay. And Don, can you remind us what level of CET1, do you think you need if you are out of CCAR at some point.
We’ve talked about as having a CET1 of 9% to 9.5%. And we believe that is an appropriate capital range for us, and it also allows us to maintain a strength in our capital. So, we don’t have to issue capital in the downturn and continue to maintain our debt ratings that we have as well that we like being A-rated bank, and that’s helpful to reinforce that.
Perfect. Thanks for taking my questions.
Thank you.
Thanks, Steve.
And we do have a question from the line of Gerard Cassidy with RBC. Please go ahead.
Good morning, Beth. Good morning, Don.
Good morning.
Good morning.
Don, can you share with us – there’s been a number of discussion points from all the banks this quarter on the betas going higher, just like you guys discussed. And you pointed out that you’re still expecting to see margin expansion going forward, and hopefully, higher net interest income. Can you share with us, what can you do? Because I think people are getting quite alarmed that the betas are going to be negative, rising betas. What can you do to offset that to drive that margin higher or net interest revenue growth higher?
We’ve got a couple of levers that others might not have available to them. One is that we’ve got about $1.2 billion in cash flow right now off our investment portfolio. And the yield of the cash flows coming out of 2.15%, and we’re getting about 125 basis points to 130 basis points additional yield on that rollover. And so that’s helpful for us, and we’re seeing benefit there. We also have, as we’ve talked before, about $18 billion worth of received fixed swaps that we use for our asset liability management. We’ve got about $6 billion of those that mature over the next year, and the received tax rate on those $6 billion is 1.1%. And so if we were to replace those today, we’d have about 170 basis point pickup in the yield. And even if we didn’t replace that, we’d still have a 90 basis point benefit, because right now, we’re paying 2% and receiving 1.1%. And so both of those will be additive.
And I’d say lastly, we’re seeing our loan yield for new originations being in line with what is the average yield for our portfolio today. And so we’re not seeing the pressure there as much as what we would have seen historically. And so each one of those, I think, are helpful to help offset some of the impact from the higher betas going forward.
And speaking of the betas, Don, has regulation – the repeated regulation queue, I think it was finalized in 2011. Has that impacted the betas yet in your guidance business?
I think it just shows a little bit more flexibility for some of our commercial customers. And what I think you’re seeing for the industry right now is that many of those commercial customers are going past their earnings credit rate they have on the deposits, and so they’re starting to move some of those excess funds into either interest-bearing deposits are taking them off balance sheet. And thank goodness for us, what we’re seeing is our non-interest-bearing deposits are relatively stable over the last several quarters. and so we’re able to retain those commercial customers and also maintain strength in that commercial loan servicing business, which help support those balances also.
And then just a final quick follow-up. On the capital return, obviously, you guys got a strong number. In terms of the buyback, is it equally weighted in terms if you take the total amount and divide that by four for each quarter? Or is it front-end loaded? How do you guys get approval – how did you get the approval?
Well, I would say that it’s biased to being a little front-end loaded, and I’ll leave it at that.
Okay, that’s fair. Thanks. Appreciate it.
Thank you.
And we do have a question from the line of Peter Winter with Wedbush Securities. Please go ahead.
Good morning.
Good morning.
The C&I loan growth has been really much stronger than peers for the past two quarters, which is kind of a change from the past. And I’m just wondering, are you guys doing something different than you had in the past that’s driving this growth?
Peter, it’s Chris. No, our strategy is unchanged. In fact, as we think about it, we – our credit box is unchanged, our strategy is unchanged. We’ve always been very targeted, and we’re out there growing new customers in the areas that we’re good at, and C&I is one of those. We also, of course, have a business model where, from time to time, there’s a lot of velocity of our balance sheet. So you get certain ebbs and flows. But as we – our leading indicators are, we look at how many new clients we bring on, and we look at how many enhanced relationships. And the progress has been pretty steady.
Peter, this is Don. I just had a couple of other snippets there as well. In the second half of last year, we were really burdened by some fairly large increases in the paydowns. And I’d say, in the first half of this year, while they’re still elevated compared to historic levels, they’re much lower than what we would’ve seen in the second half. And the second piece I would add to that too is that you also have to remember that many of our former First Niagara markets were working through their conversions and customer assimilation. And we start to really see that origination volumes pick up here late last year and early part of this year. And one of the markets we did see some success this – early this year was in Philadelphia. And so we’re seeing some growth there that wouldn’t have been present in the 2017 results.
Okay. That’s helpful. And then just the reserve-to-loan ratio down to about 1%. And I realize it’s formula-driven, but just given the strong loan growth, would you expect to add reserves more aggressively? Is there a certain level you wouldn’t want to see that reserve-to-loan ratio fall below?
Even though you’re right that we’re at a 1.01% allowance of total loans, if you would back out the impact of purchase accounting and just book the reserve as they would be done on a normal basis, our reserves would be 1.16%. So, that’s more in line with peers. And I thought you might be going at it from a different angle. But we’re actually adding to our reserves, whereas many of our peers are showing provision below our charge-offs. And so we will continue to maintain the appropriate reserves and believe that we are with the credit quality, and it continues to remain in a very good position. And so we think that the reserves are appropriate at this point.
Okay, great. Thank you.
[Operator Instructions]. Our next question comes from the line of John Pancari with Evercore. Please go ahead.
Good morning.
Good morning.
Good morning.
I just want to go back to the loan growth question from the other side of the demand. My NIM – I believe you indicated line utilization is of a little bit. Just want to see where are you seeing any weaker demand. And also, where are the areas that you’re still maybe more cautious on or de-emphasizing?
John, a couple of things. First of all, if you think about commercial real estate, that would be an area that we’re accommodating our clients in that we’ve raised 19% more capital this year than last year. But in terms of what we’re putting on our balance sheet, we’re being extremely careful there. So in one of Don’s slides, I think, it shows that our construction piece is about 11%. So if you look at real estate, for example, we’re below the market. We’re actually shrinking by 1.2%, the market is growing by 1.1%, but that is really by strategy. And so that would be an area that I would point out to you where we’re kind of an outlier.
Okay. All right. And then separately, on the core margin, I know you implied that it’ll be moving modestly higher through the year. Can you just give us a little bit more color on how that progression could look like? How should we think about the pace of that improvement? And then separately, do you still see three basis points to four basis points of margin upside for each 25 basis point hike? Or is that changing?
Well, in the appendix, we have some updated information as far as the interest rate sensitivity. We do show there for a 25 basis point increase, it’s a $4 million to $8 million kind of benefit on each quarter for that rate increase versus with a lower beta, it would’ve been a $12 million. And so that three basis points to four basis points is probably in the two basis points to three basis points range for each rate increase. And so we will continue to benefit from that. But also keep in mind what will continue to help support our margin is the rollover in that investment portfolio on the swap book, and each one of those should be additive as far as the overall margin impact.
Okay. And the progression of the NIM through the year?
Well, what we’ve said basically is there’s one rate increase for June that’s not reflected in the second quarter results. And the next rate increase is not until November, and so we’ll have very little impact there. And so I would say, margin for the third quarter should step up a little bit, but in the fourth quarter probably relatively stable.
Got it. All right. Thanks.
And we do have a question from the line of Saul Martinez with UBS. Please go ahead.
Hi. Good morning everybody. Just following up on the deposit beta discussion, the 41% going to mid-50s. I assume your guidance is implying a mid-50% deposit beta both for the June and the November hike. Is that right?
It’s say that we’re ramping up through the we’ll see some of that drift into the fourth quarter. So I don’t know if it’s going to be all there in the June rate hike in the third quarter, but our expectation would be at that level later in the year.
Got it. So, it’s drifting up from the 41%, but it gets to a run rate with likely the November hike, if that comes to fruition, I guess.
Right.
Okay. And then on, I guess related question on NIM. You had a very nice uptick in commercial loan yields, I think it was 19 bps. Commercial mortgages was up, I think, 15, 16 bps. Is that – should we think of that as being a result of the LIBOR fed fund spread. And if we do see that coming in, what does it mean? How do we think about C&I yields, CRE yields in – with each incremental hike?
You’re right. The second quarter, we saw average one month LIBOR up 32 basis points. So that was a little stronger than fed funds. And offsetting that, as far as the commercial loan yields, is a good portion of that $18 billion in received fixed swaps are pecked against that C&I loan yield. And so that minimizes the growth in margin from that perspective. And so third quarter will probably move more in line with what we see for the average one month LIBOR as opposed to fed funds, and you’ll see that trend to continue.
Got it. Thanks a lot.
And we do have a question from the line of Erika Najarian with Bank of America. Please go ahead.
Hi, good morning.
Hey, Erika.
Hey, good morning.
Just wanted to clarify, Don, your response to Saul’s question. As I think about Slide 18 and – reflecting a deposit pricing beta that ramps up to 55%, does that compare to the 41% deposit beta you mentioned? Or is that compared to the cumulative 25% that you mentioned earlier?
Compared to the 41%. Thank you for clarifying.
Got it. Okay. And the second question is, as we listened to Chris and all your other peers, it seems like the outlook for activity levels, especially for M&A, is quite strong in the second half of the year. As we think about potential upside surprises to investment banking and debt placement fees, what should we think about in terms of the incremental efficiency ratio for every dollar of revenue that we assume comes in through that line? Or am I thinking about it the wrong way and you’ve already sort of accrued for some of the comp in the first half of the year?
I would say, one, our outlook does assume the normal seasonal trends and some of the market indications as far as what we would expect from the second half of the year for revenues. And two, what we said as far as the expense correlation that – it is highly incentive-based. And so we said that for each incremental dollar in investment banking debt basement fees, there tends to be about a 30% increase in the corresponding incentive line item. And so you would typically see, for us, fourth quarter incentives as one of the higher levels, because we’re also seeing investment banking debt placement fees at the higher level at that point of time in the year as well.
Got it. Thank you.
And we do have the question from the line of Kevin Reevey with D.A. Davidson. Please go ahead.
Good morning.
Good morning.
Good morning.
So, it looks like you had very strong growth in your average CD balances of $100,000 and greater. Was that driven more by customers just seeking higher yields or was it that you have any rate specials during the quarter which drove that growth?
Yeah. That CD category really is the first area of that of our retail customers are accessing to get the benefit from higher rates. And as far as the CD specials, we really don’t broadcast or advertise. We really look at the relationship level as far as how we price the products. And so we do have attractive rate offers for those customers that are seeking that to get a little bit better yield. But I don’t think that we’re out in the market actively campaigning with teaser rates or overstated rates on the time deposit category.
And then your pipeline, can you give us some color on your pipeline for the third quarter for investment banking and debt placement fees? It looks like your second quarter was exceptionally strong. And I know you mentioned that the fourth quarter is usually the strongest of the four quarters. How should we think about the third quarter?
Yeah. We always think about this business really on a trailing 12 basis. But having said that, since you asked about the third quarter, the discussions and activities we’re having with our clients and our prospect are strong. I would characterize our third quarter investment banking and debt placement fee pipeline as being strong.
And then lastly, with First Niagara behind you, have you – what’s your appetite as far as acquisitions of depository institutions?
Yes, Kevin. This is Beth. And as we have looked at our capital priorities, we’ve been very clear that while we believe First Niagara was a good use of our capital and has been additive to our franchise, we are focused on our organic growth strategies and preserving capital for that purpose and making sure that we support return of capital to our shareholders. We’ve talked about targeting a dividend payout of some 40% to 50% and made a meaningful move with this year’s CCAR submission as well as continuing to repurchase our shares, which we believe creates good value for our shareholders. And then to the extent we have other nonorganic uses we call the people, product and capabilities, and over the last year, I think you can see examples of where we feel, for example, a year ago, acquiring HelloWallet, bringing on Cain Brothers on to our platform in the fourth quarter, reacquiring and relaunching our merchant servicing businesses. Those are examples of how we see augmenting our franchise is appropriate uses of capital in lieu of not interest or prioritizing bank acquisitions.
Thank you. Congrats on a great quarter.
Thank you.
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