Synovus Financial Corp
NYSE:SNV
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Synovus Financial Corp
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Good morning. And welcome to the Synovus Second Quarter 2023 Earnings 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 will now turn the call over to Cal Evans, Head of Investor Relations. Please go ahead.
Thank you and good morning. During today’s call, we will reference the slides and press release that are available within the Investor Relations section of our website synovus.com. Chairman, CEO and President, Kevin Blair will begin the call. He will be followed by Jamie Gregory, Chief Financial Officer and they will be available to answer your questions at the end of the call.
Our comments include forward-looking statements. These statements are subject to risks and uncertainties and the actual results could vary materially. We list these factors that might cause results to differ materially in our press release and in our SEC filings, which are available on our website. We do not assume any obligation to update any forward-looking statements because of new information, early developments or otherwise, except as may be required by law.
During the call, we will reference non-GAAP financial measures related to the company’s performance. You may see the reconciliation of these measures in the appendix to our presentation.
And now, Kevin Blair, will provide an overview of the quarter.
Thank you, Cal. Good morning, everyone. And thank you for joining us for our second quarter 2023 earnings call. Before we get into our results, I’d like to sincerely thank Cal for his tremendous contributions over the last two years serving in his Investor Relations role.
Cal has been instrumental as we have all navigated through the economic highs and lows with his strong background in market analytics and credit. He’s guided us well, worked hard to strengthen relationships and build even greater trust with all of you cover us and the investors you stand for.
We are thrilled to welcome Jennifer Demba to the team, bringing her vast industry knowledge and sell-side perspective into our strategy setting and shareholder activities. Her extensive financial services background will be incredibly valuable as we move through the current cycle, as well as execute on our strategic plan. So, thank you, Cal, and officially welcome, Jennifer. We couldn’t be in better hands with the two of you in your new roles for our company.
What you will see today is financial performance that remains quite strong with PPNR up 8% year-over-year and an adjusted return on tangible common equity of 18%, despite a slowing economic environment and tighter liquidity market, which led to another quarter of contraction in our net interest margin.
We continue to see evidence that our relationship-based model serves as a strong platform to attract and retain talent, as well as clients. Our team member turnover is the lowest it’s been in many years, engagement levels are high and we continue to add talent in key revenue producing in corporate services areas.
From a client perspective, deposit production remained strong with second quarter levels over 130% higher compared to the same period last year. While loan production remains muted versus last year, commitment levels increased 4% versus last quarter and second quarter adjusted fee income is up 10% versus the previous year.
And while you will see shifts in some of our expectations for the year to adjust to the trends we are seeing internally and externally, we also still strongly believe our success to-date, as well as our path-forward is the result of our intentional approach to expand our business, diversify our client base and gain share of wallet. All while increasing our investments in innovative solutions to further enhance the client experience and sources of revenue.
We have also quickly responded to the changing economic environment and the recent industry headwinds to better manage the emerging risk. Over the course of the year, we have increased our CET1 ratio by approximately 20 basis points, reduced the percentage of deposits that are uninsured, increased contingent funding sources to $26 billion and reduce the midpoint of our expense guidance for the year by 3 percentage points, excluding the impact of the Qualpay transaction.
Our bank has made significant strides in recent years, paving a path-forward towards achieving our long-term financial goals. While pursuing growth opportunities and maximizing profitability in this environment, we remain committed to optimizing our overall risk profile.
By implementing robust risk management practices, closely monitoring market trends and adapting to regulatory changes, we aim to ensure the stability and resilience of our operations. Our dedicated teams strive to strike a balance between growth and risk management, fostering a culture of prudence and innovation that sets us on a trajectory of sustainable success.
Now let’s move to slide three for the quarterly financial highlights. When looking at the same period in the previous year, revenue and PPNR grew at high single-digit rates supported by strong operating metrics, which linked-quarter saw revenue and PPNR headwinds as a result of increased deposit cost and NIB remixing leading to margin contraction.
Loans increased $309 million or 1% quarter-over-quarter. As we saw in the first quarter, this growth rate declined from prior year levels as we continue to experience lower loan production due to client demand and our increased emphasis on returns and relationship-based lending.
After seasonal tax-related outflows in April, core deposits increased modestly and ended the quarter roughly flat with the first quarter. Much like the rest of the industry, we continue to see pressures from non-interest-bearing deposit remixing as clients have increased their use of their operating funds, thereby further reducing average balance per account.
Our underlying credit performance remains solid and although our credit metrics are experiencing some expected increases as a result of the current environment, overall credit trends are healthy and we have not seen meaningful change in the underlying performance of our borrowing base or stress focused in any particular industry or asset class.
Lastly, as I have stated previously, we continue to focus on maintaining a strong capital position as we navigate through the uncertain environment and with the CET1 position ending the quarter at 9.85%, we are well on side of achieving our objective of exceeding 10% CET1 by the end of the year.
Now I will turn it over to Jamie to cover the second quarter results in greater detail. Jamie?
Thank you, Kevin. I might begin with loan growth as seen on slide four. Total loan balances ended the second quarter at $44 billion, reflecting growth of $309 million. As Kevin mentioned, new production and overall growth have slowed as new fundings are focused on customers with more broad-based relationships. Similar to previous quarters, CRE growth was a function of draws related to existing multifamily commitments and a low level of payoffs.
On the C&I side, the slight decline in balances was driven by lower utilization an exit of certain syndicated loan-only relationships. Lower C&I utilization is a positive credit signal, reflective of the health of our overall borrowing base.
In the current environment, we are rationalizing growth in areas that have a lower return profile or don’t meet our strategic relationship objectives. On that note, in July, we signed an agreement to sell a $1.3 billion medical office CRE portfolio. This transaction is expected to result in a onetime negative net income impact of approximately $25 million in the third quarter and reflects the exit of a business that maintained pristine credit quality, despite not meeting our long-term strategic criteria.
Turning to slide five. Deposit balances remained relatively flat for the quarter. Core deposits saw a modest increase after April seasonal declines, and despite a more tempered outlook, we continue to expect deposit growth through the remainder of the year. Supporting this growth are seasonal tailwinds along with targeted deposit efforts, including deposit, specialist hires and focused industry vertical initiatives.
Looking at the composition of the quarterly change in balances. Non-interest-bearing deposits were down $1 billion quarter-over-quarter, a byproduct of the aforementioned seasonality from tax payments, cash deployment of excess funds and continued pressures from the higher rate environment.
As in the first quarter, the decline in MMA was largely impacted by a shift to other products, in particular to CDs within our consumer customer base. As we look at deposit rates, our average cost of deposits increased 51 basis points in the second quarter to 1.95%, which equates to a cycle to-date total deposit beta of 37% through Q2.
Our deposit cost and betas were impacted by the anticipated pricing lags on core interest-bearing deposits, as well as the decline in non-interest-bearing deposits. We expect those same dynamics to play out in Q3, with deposit pricing lags continuing, albeit at a slower pace given the FOMC’s slower pace of tightening and with some further decline in non-interest-bearing deposits as a percent of total deposits. The result is further pressure on our expectations for through-the-cycle total deposit betas, which we now approximate will end the year in the context of 46% to 48%.
Last quarter, we included statistics on our liquidity position that detailed our level of insured deposits and contingent liquidity sources. These figures have been updated and are available in the appendix to this presentation.
Now to slide six. Net interest income was $456 million in the second quarter, an increase of 7% versus the like quarter one year ago and a decline of 5% from the first quarter, in line with our previously disclosed expectations.
The asset side of our balance sheet continued to benefit from both higher balances and rates. Though as in the first quarter, higher deposit pricing and remixing within our NIB deposit portfolio offset those gains resulting in overall NIM compression.
As we look forward, we expect Q3 NIM to continue to contract at a pace similar to that in Q2, followed by some relative stabilization thereafter as deposit pricing lags and NIB remixing slow. Against those diminishing headwinds would be the gradual benefit, which accrues to the margin from fixed rate repricing, which has a compounding effect and should support the margin through time, assuming this higher rate environment remains.
Slide seven shows total adjusted non-interest revenue of $111 million, down $7 million from the previous quarter and up $10 million year-over-year. The primary variance in quarter-on-quarter fee income was due to the extremely strong first quarter for Capital Markets, which normalized as expected.
That said, despite lower overall industry-wide transaction volume, the current level of capital markets income reflects the benefit of strategic investments in our CIB and middle market banking platforms.
As we step back and look at the overall levels of durable core client fee income, excluding mortgage, the investments across our franchise and products and services continue to bear fruit. Over the last four years, we have compounded core client fee income at nearly a double-digit pace as we continue to invest in valuable revenue streams such as treasury and payment solutions, capital markets and wealth management.
Also of note in the second quarter is the closing of our Qualpay investment, which we announced last year. The go-forward impact is expected to have an immaterial impact to consolidated net income and is reflected in our guidance for the full year.
Moving to expenses, slide eight highlights total adjusted non-interest expense of $301 million, down $4 million from the prior quarter and up $17 million year-over-year, representing a 6% increase.
We are very proud of the team for our prudent expense management in a challenging operating environment. Where production volumes have declined, we have implemented headcount reduction strategies and discretionary spend has been reduced across the organization.
In addition, as we have said before, our incentive plan alignment allows for expense flexibility in times when revenues are under pressure. We will continue to operate with heightened expense discipline in the near-term and adapt our expense base to maintain a competitive overall efficiency ratio.
Moving to slide nine on credit quality. Overall, credit performance continues to perform in line with expectations, as evidenced by the relatively stable life-of-loan loss expectations in the allowance calculation.
As we saw last quarter, the 2 basis points increase in the allowance was a result of modest deterioration in the forecasted economic outlook. The quality of our originations remains strong and the impact of a few credit downgrades were offset by improvements in the performance of the aggregate loan portfolio.
As we look to the second half of 2023, we expect credit costs to remain manageable, with expected full year charge-offs of 25 basis points to 30 basis points, reflecting a second half charge-off range of 30 basis points to 40 basis points.
We continue to have confidence in the strength and quality of our portfolio. We do not see any specific industry or sector stress within our loan book and we will continue to apply our conservative underwriting practices and advanced market analytics to both new loan originations and portfolio monitoring and management.
As seen on slide 10, our capital position continued to grow in the second quarter, with the common equity Tier 1 ratio reaching 9.85% and with total risk based capital now at 12.79%. Our organic earnings profile supported capital accretion in Q2, which along with a somewhat slower pace of loan growth, was more than sufficient to offset marginal headwinds in the consolidation of our Qualpay investment.
As we look ahead, we remain focused on eclipsing the 10% CET1 threshold. At which time we intend to reassess the broader macroeconomic environment and consider what actions, if any, may be prudent as we diligently manage our capital position to the interest of all stakeholders.
I will now turn it back to Kevin to discuss our guidance.
Thank you, Jamie. Now I will continue with our updated guidance for the quarter. Before we review the details, it’s worth noting that outside of loan growth, the ranges provided do not reflect the impact of the impending FDIC special assessment nor the impact of the medical office CRE sale as the transaction is yet to be settled.
As you can see on slide 11, the changes in the operating environment that have impacted the industry over the last 90 days are reflected in our revised guidance. Loan growth is now expected to be 0% to 2% for the year. This reduced guidance is due to lower anticipated production volume, as well as the impact of the expected medical office CRE sale.
Despite lower demand and a higher hurdle rate for new business, we continue to have growth oriented lines of business such as middle market and CIB, which we expect to produce strong second half growth. We expect core deposit growth to increase 1% to 4% driven by the previously mentioned seasonal tailwinds and new growth initiatives.
The adjusted revenue growth outlook of 0% to 3% aligns with an FOMC that reaches a target rate of 5.5% and holds through the end of the year. Changes to the revenue guidance are the result of lower loan growth expectations and overall deposit betas, which are now expected to reach 46% to 48% by year end.
We expect 4% to 6% expense growth in 2023, while the environment has resulted in some strategic shifts and priorities, we remain confident in our growth strategies, including Maast and CIB, but have applied additional discipline across the entire expense base to better manage levels of growth.
Over the course of the year, we have significantly reduced our guidance range and when adjusting for new growth initiatives, as well as uncontrollable environmental costs such as FDIC and healthcare, our core expense base is expected to be flat to up 1% year-over-year.
Moving to capital, as we previously communicated, we are targeting a CET1 ratio above 10%. At this time, we continue to believe it is prudent to build a larger capital buffer and we intend to continue to build capital levels through year end through the retention of organic capital generation and slowing balance sheet growth.
Lastly, we expect our full year tax rate to be near the midpoint of our previous guidance range of 21% to 23%, supported by new federal tax investments, which will go into effect in the second half of the year.
Our commitment to agility and responsiveness will be instrumental in navigating the ever evolving landscape. As we continue to focus on growing tangible book value, we also recognize an opportunity to right-size our balance sheet for sustainable profitable growth.
Our medical office transaction announced this quarter is an example of diligent balance sheet management optimization efforts, where we free up capital and liquidity to pursue higher returning, more expandable relationships.
As we move forward, we remain steadfast in our dedication to managing expenses and leveraging other strategic measures to perform optimally in the current environment. By staying adaptable and resilient, we are confident in our ability to achieve sustainable growth and to deliver value to our shareholders, customers and communities alike.
And now, Operator, let’s open up the call for Q&A.
Thank you. [Operator Instructions] The first question is from the line of Steven Alexopoulos with J.P. Morgan. Please go ahead. Your line is open.
Hey. Good morning, everybody.
Good morning.
Good morning, Steve.
Start on the updated revenue guide -- hi. So the environment is tough. I don’t know if it’s that much tougher than we thought it was a quarter ago. What’s really changed to drive the revenue outlook moving down to the 0% to 3% range?
Yeah. Steven, this is Jamie. Thanks for the question. As we look at the revenue outlook for 2023 compared to what we said in April. It’s really two different components. On the asset side, you have a couple composites.
We expect spread revenue to remain high and that going on spreads to remain at these elevated levels. But we do have the impact of lower loan growth and some of that is environmental due to the economy and part of it is due to the sale of that medical office CRE portfolio.
On the liability side of the balance sheet, you have the impact of further deposit mix headwinds and that’s really due to the decline in non-interest-bearing deposits that’s above prior expectations.
Got it. Okay. And then, Jamie, to follow-up on that. So basically indicating NIM down about the same amount of the third quarter but then leveling out. So should we think about this really the NIM should bottom in the third quarter then maybe be flat to up past that and what are you assuming for non-interest-bearing, is that mix shift basically done once we get past the third quarter also? Thanks.
We do expect, as you said, the margin to decline in the third quarter a little less than what we saw here in the second quarter and that does include continued remixing of the deposit base with further declines in NIB to total deposits.
We have tried to look at it in multiple ways. It’s a hard thing to model given everything that’s going on that’s kind of outside of our control. You think about the exogenous factors of the Fed balance sheet and rate tightening and trillions of dollars in stimulus in a GDP growth environment, and so we try to look at history and determine where it’s going to go.
Unfortunately, the prior tightening cycles don’t give us a lot of insight. The mid-2000s is probably best, but it still wouldn’t imply declines like what we are seeing right now. I think a lot of that has to do with diminishment.
When we look at the cash flows of our clients and using the same analysis that we have spoken about in the past about credit, we see that our client spend is the growth and it is declining, and we think that our clients are being managing their cash flows and so we do expect to see some of that diminishment slow as we go through this year.
But we do expect to see declines, heading into year-end, we expect about another 3% decline in NIB to total deposits, and perhaps, if rates stay high, a little more decline, maybe another percent in 2024.
But that’s how we are thinking about that mix, but it’s probably one of the more uncertain pieces of the model as we look forward. But we are just trying to be conservative in how we look at it, make sure that the guide we gave is pretty clear in that regard.
Got it. So even with a sustained remixing, there’s not a benefit coming from the fixed assets pricing that NIM should be relatively stable in 4Q is what you are saying right?
Yeah. That’s right.
Okay.
That’s right. And so let me talk about that for a second, as we look at the margin, you will see the decline in the third quarter, and then you are right, we do expect relative stability. But the benefit of fixed rate asset or exposure repricing will come through, and here in 2023, it will likely be offset by the kind of tail end of this deposit cost increase and then you start to get the benefit in 2024.
But just to put numbers on that, in any given month, we expect approximately $250 million of fixed rate loans to paid off or paydown. And when you look at the impact of that as you go forward, looking forward about a year, there’s about an 11-basis-point impact to the margin a year from now, just due to the fixed rate loans repricing and that’s mortgages plus commercial loans.
So we have that tailwind and that’s excluding the benefit of securities, which have a little bit slower paydown and hedges and we have another $1 billion of hedges that mature in the first quarter as well. So, you are right to point out that, that is a tailwind and that’s what we will start to see in 2024 and we believe that, that’s going to be the platform for growth as we look at revenue going forward.
Got it. Thanks for all the color.
Yeah.
Our next question comes from the line of Brady Gailey with KBW. Brady, please go ahead. Your line is now open.
Thank you. Good morning, guys.
Good morning, Brady.
So maybe just a little more color on why you guys are exiting the medical office space and I heard the comments on the call about how it’s a low return business. Maybe just a little more color on what made that a low return business for you all and a little more color on why you made that move?
Yeah. Brady, thanks for the question. First, we are extremely pleased with this transaction and the performance of the team that built this business. The pristine nature of the credit in this portfolio, the medical office CRE portfolio was evident really throughout the diligence process and it led to the strong pricing that we have on this portfolio.
But to your point, this portfolio performed exactly as designed and it was a great asset for the bank and a zero interest rate environment where a high single-digit ROE was accretive. But in this environment with much higher interest rates our return requirements are a lot higher.
And as a part of all of our more broad balance sheet optimization efforts, we determined that this portfolio was one that was not as core of a fit, given that it has very low relationship value, even though it’s pristine credit but a high single-digit ROE.
And so it helped us achieve a few of our key strategic objectives. First, it accelerates the timing to our capital objectives that we believe position us really well for growth going forward. Second, it improves our liquidity profile and it helps increase our core deposit funding percentages. Third, these capital and liquidity benefits will really give us the platform for growth going forward and it also reduces our CRE office exposure.
The cost of this, I mentioned high single-digit ROE, it’s really about a 2% spread is the way to think about it and that will be a headwind to us in the near-term. But longer term, we are convicted that we can go and build and grow core clients, deep relationships that offset and exceed the lost NII from this portfolio.
Okay. And then the $25 million burden, if you look at that on a pre-tax point of view, I think, it’s only like 2.5% of the loans being sold. So that’s a pretty minimal loss there. But I was wondering, what was the reserve on that portfolio, that reserve probably gets wiped out. I am just wondering what the overall loss was on selling those loans?
Yeah. Brady, that will -- we will put all that out there at closing. But you are right to think that that’s a net number and so we do feel good about it is a little less than the 2.5% you mentioned, but it’s a net number and we will put out all the details of the economics at closing.
Okay. And then just finally, it’s great to see Qualpay close. I know that is beneficial to Maast. Can you just remind us the benefit that, that has on Maast and with that business now closed, as your outlook for Maast change at all?
Brady, Qualpay is the front-end for our payment facilitation platform so that we can process payments through the Maast platform. And so we have been very clear that having a majority ownership interest in Qualpay allows us to ensure that the capital that’s provided to our platform is their number one priority. So it is great to have it closed.
It has a minimal impact to our P&L, but it’s a big impact as we continue to expand the capabilities and functionalities of Maast. When we started this program a little over a year ago, what we said is we would get into 2023 and we would start to pilot with a couple of software vendors.
Well, we are up to three partners that are on board today and we also have five others that have signed on. So we will have a total of eight that will be on the platform, with five additional software vendors in the contract phase today. So that could take us to as many as 13 software vendors that are signing on to the platform.
So I think we have confirmed our initial hypothesis that Maast would be a product that is highly desirable by the software vendors, just based on the interest and the individuals that have signed up to this point.
But I think it’s premature to talk about what the revenue is going to be from those software vendors, because we are still finalizing the NVP product and that will be rolled out more broad-based at the end of this quarter to all of those eight software vendors that have signed up.
And then the final stage, which will determine how fast the revenue grows will be the end user adoption. So those clients that are using the software, will they leave deposits on the platform, will they sign up for the money movement capabilities and eventually the lending capabilities.
But having Qualpay finalized ensures that a big component of the capabilities within the platform, we have control over not only what’s there today, but the ultimate advancement and development on that platform.
Okay. Got it. Thanks for the color.
Thanks, Brady.
Our next question comes from the line of Stephen Scouten with Piper Sandler. Stephen, please go ahead. Your line is now open.
Thanks guys. Good morning. I just wanted to follow-up on the earlier conversation about kind of balance sheet trends around the non-interest bearing. I know that’s really hard to predict in this environment, but you did note that average balances have declined a little bit. I am curious if you have some more detail around that, what those average balances look like now maybe to pre-COVID and kind of how we can think about the room for potential normalization there?
Stephen, it’s a great point to Jamie’s point, there’s so many variables that go into determining what the terminal level is going to be with non-interest-bearing. If you look at our consumer operating accounts, the average balance declined about 9% quarter-on-quarter and that puts it back at about 10% higher than where it was prior to COVID.
And if you think about those balances on an inflation adjusted basis, it would lead you to believe that we are largely back to where we were pre-COVID. On the commercial side, we saw about a 7% decline quarter-on-quarter in average balance, but they are still about 30% higher than they were pre-COVID.
So you can look at that in two different ways. Number one, I do believe that we have been increasing the average size of our deposits in commercial just based on our middle market and CIB strategy. So the production that we have had since COVID has brought on larger deposits. So I would expect that the average deposit to increase.
Two, I think, our clients are carrying extra cash, especially as we enter uncertainty in this economic environment, so some of that will stick.
But three, it would lead you to believe there’s probably still a little excess cash that’s seen on our commercial operating account balances and you could continue to see some diminishment there. And that’s why, I think, Jamie, when he went through our analysis for the rest of the year, we would expect there to be a little more decline in the percentage of total deposits in NIB.
Got it. That’s really good color, Kevin. Appreciate that. And then, I guess, maybe just a high level question for you guys, as you think about your business, how have things changed maybe at a high level, if there’s one or two things you could highlight since February? I mean, obviously, we know there’s tons of funding pressure in sustaining your clients is different, but we get all these questions about regional banks won’t be able to make any money. The whole business model is dead. Can you kind of give us some color on why that’s not true and kind of what has changed or what hasn’t?
Well, look, I will tell you what hasn’t changed is our value proposition to our clients, and Stephen, when you go back to last quarter when we talk about being recognized by J.D. Power as being the number one bank in the Southeast for client service and trust. I think it gets back to the heart of why clients choose banks and the primacy that we bring to the table. They want folks that provide great service, and they want advice and we are going to continue to provide that.
I think what gets lost in all of this is what’s happening today is just a contraction in margin, and unfortunately, in our business, we are not like manufacturing. When we get an increased cost for our cost of goods, we can’t just pass that on to the clients, a lot of our loans are already on the balance sheet.
So having a little bit of margin contraction is not something that’s new to this industry. It’s been happening over the last really 20 years. And so I don’t think there’s anything out of the ordinary, I don’t think regional banks are experiencing any greater margin contraction, obviously, the big banks have a little bit of an advantage as it relates to scale and funding.
But I think when we get through this next quarter, as Jamie just talked about and margins stabilize, we are right back to where we started, which is who’s going to win market share, who’s going to grow, it’s those banks that are providing the best level service, they are providing the client experience and are winning market share. I think we were doing that before. I think we will do it again on the other side and the contraction story will be one that’s kind of one of history.
The other question mark, that I think is out there is credit. So when we get to the other side of whatever this cycle is and we prove out the credit cycle, and I have said from day one that I feel like there are going to be winners and losers in this environment based on where your portfolio sets, what geography and what asset classes you are in, and so when we get through that side, you hear a lot of the rhetoric that regional banks are carrying a lot of the CRE and a lot of negativity there.
So between margin contraction and the credit story, I think, that just has to play out, and it feels like it is playing out and we get to the other side, it will be back to one of growth story and client primacy.
That’s great. Great answer, Kevin. They will lay that out for CNBC later today, too, we will all appreciate it. Thanks for the time.
I will do that.
Our next question comes from the line of Kevin Fitzsimmons with D.A. Davidson. Kevin, please go ahead. Your line is open.
Hey. Good morning, everyone.
Good morning, Kevin.
I was just hoping one thing I noticed was in your prior guidance slide you addressed PPNR growth and you don’t have that in this slide. Is that simply because it’s sort of implied that, that’s going down with the revenue guidance or did you want to address that?
That’s right. That’s right. I mean we -- by giving the expense guide, the revenue guide, it’s implied and also it’s just, there are so many different iterations of what can happen between those two line items that we didn’t think it was as useful as it was last quarter.
But I do want to -- while we are talking about PPNR, I want to speak for a second about expenses, because our expense guide is important to us. And when you look at kind of how we progress through this year on expenses, we started the year with a guide that was a lot higher than where we are right now, is 5% to 9% and as we think about the growth there, in the very beginning of the year, we started to read the tea leaves, look forward and see that the environment was deteriorating.
And so we started cutting back on our initiatives, cutting back on our spend and that led to the reduction in the guide last quarter and then you see the reduction in the guide this quarter. And when I say reduction, it looks like it’s the same, but we are also including the approximate $10 million impact of Qualpay to the expense line this quarter that was not in the guide last quarter.
So, we feel good about that component of our guide, especially when you take into account that about 5% of expense growth comes from growth initiatives and then other environmental costs like the FDIC increase this year and healthcare costs. And so that’s something that we spend a lot of time on working on our expense base be inefficient and I think that’s an important part of the story when you think about PPNR year-over-year.
So, Jamie, when you are -- so you are saying that 4% to 6%, it’s staying the same, but this bullet point over -- this assumption over to the right of the new initiatives, FDIC and healthcare costs, and these other core operating expenses were not necessarily in the prior guide, but you finding ways to offset it, is that…
No. No. No. I am saying that what was not in the prior guide is the 1% impact of Qualpay. The other growth initiatives were in the guidance in January, as well as the guide in April. But what I would say on the growth initiatives is those initiatives have been trim down a little bit individually and in various ways as we progress through this environment. And so the spend on both Maast and CIB is a little bit less than what we guided to in January, but the only change in those spends from April was really just the Qualpay addition.
Understood. Okay. And one quick follow-on, I think, it -- some banks are talking about or that they are evaluating potential bond transactions where you would take some kind of upfront loss, but then we would be able to put those proceeds to work at higher rates and/or paydown debt. I would suspect that, with your goal of getting to the 10% CET1, maybe that’s not something that’s near-term so you get to that point, but is that something you guys are evaluating and over what timeframe? Thanks.
It’s a great question. As we look at our bond portfolio, first off, in aggregate, the duration and the payback is too long to consider transaction like that. And you are right and you can see this through our MOB transaction.
It’s our intent to accrete capital at the moment. We remain really excited about with the opportunity that’s in front of us in the Southeast to drive client growth and that’s our highest and best use of capital and so we are not that interested in realizing a loss in the securities portfolio to mark the yield to market at the moment.
Okay. Thanks very much.
Our next question comes from the line of Jared Shaw with Wells Fargo. Jared, please go ahead. Your line is now open.
Hey. Good morning. Thanks.
Hi, Jared.
Just following up on the loan sales that the participations in the medical office. Is that the end of loan sales at this point and what are the uses of from the proceeds there? Should we just assume that the that wholesale FHLB has paid down or what’s the use of fund there?
We are not anticipating further loan sales. Truthfully, that’s not something that we would anticipate in normal course of business outside of the third-party portfolio. Typically, in -- especially in an environment like this, the best course of action for a business that may have a lower return than what you are targeting would be just to let it a trite and that would be a normal course of business is let the loans pay off at par and move on and pre-up the balance sheet that way and that’s the traditional way to exit a high performing business like the medical office. That was just a unique one that the credit quality was so pristine that we were able to get what we believe was a very fair price for that portfolio. And with regards to the use of funds, you are right, it will go to paydown just more expensive funding, whether that’s FHLB or broker deposits, it will likely be one of those two.
And that $25 million that you called out, that’s net of the paydowns or that’s just the $25 million hit from losing the loans and then we can see an offset on the fund there?
Mark.
That’s the mark. That’s the price mark effectively on the loan sale.
Got it. Got it. Okay. And then on credit, as we look at the trends with the expectation for higher net charge-offs going into the end of the year, what’s driving that higher levels of expected loss and as we sort of flip the calendar into 2024. Is that a trend, do you expect that trend to increase and continue going into next year?
Yeah. Hey, Jared. This is Bob. Just as Jamie mentioned, I mean, you are going to see a slight drift up in charge-offs and in credit metrics in general, within, and again, we would expect that. The drivers are not anything systemic. It’s just the pressure that our clients continue to feel and some of them with more leverage are certainly feeling it more than others.
But that will push charge-offs and non-accrual slightly up. We certainly increased this quarter. That was just a couple of credits that happened to fall in the same quarter. We don’t see it coming from any specific industry or any specific asset class, but we do see just general credit pressure.
I don’t like the term normalization, but certainly in the environment we are in, we should expect credit to kind of ease up as it relates to the credit cost in total and that’s what we saw and that’s what we expect to see in the third quarter and fourth quarter.
We have done a lot of deep dives into these portfolios and really feel good about our guide of sort of 30% to 40% in the back half of the year, coming off a very low -- pretty low base in the first half, still lands us in that sort of high 20s basis points, 30 basis points or so for the year.
As far as 2024 is concerned, we will get more specific on that in January as we talk about our guidance. But I mean, the general feel is, overall, is kind of more of the same at least in the near-term.
Okay. All right. Thanks. And when you look at that allowance ratio tied in, going up a couple of basis points this quarter. Still -- is that still sort of margin higher or given the expectation -- the broader economic expectations today that that’s maybe a stable level?
Yeah. We -- as we look forward, clearly, we think we are adequately reserved today. We feel good about the allowance. I would point out that embedded in the allowance this quarter, we do have a 20% weighting to that stagflation scenario, which is pretty onerous.
We don’t show 2025 economic data for that forecast, but unemployment rate starts to approach 9% at the end of that forecast, which is pretty high number and so that’s embedded in our allowance this quarter.
As we look forward, could we see it continue to increase slightly? I think that, that’s fair. But it could also remain at current levels and it will just be dependent on the economic outlook and the portfolio performance.
Great. Thank you.
Our next question comes from Manan Gosalia with Morgan Stanley. Please go ahead, Manan. Your line is now open.
Hi. Good morning. I had more of a bigger picture question on credit just based on your conversations with clients. What impact has -- have 5 percentage points and more of high rates had on middle market and small business balance sheets and what do you think their appetite is to absorb these interest costs if rates stay higher for longer through 2024?
Yeah. Thanks for the question, Manan. This is, Bob, again. Overall, we do commercial client survey and I will point to that first. And we have been doing that for several quarters now and that survey gives us a lot of good data points.
And what it’s generally telling us is that our clients are starting to feel marginally worse about the future expectations of their business but not materially. So it’s in keeping with this inflation rate being higher and keeping with their cost and input costs being higher longer and some potential pressure on the revenue line. But so we certainly are tracking that. That matches up with what Cal and his team are doing with our cash inflows and outflow analysis and that algorithm.
So we have got a lot of data points, generally speaking. We think there is some pressure, particularly on smaller businesses as they just don’t have the access to capital that a larger credit would. As it relates to middle market, I mean, certainly, it depends certainly on the industry and the effects of COVID or the longer term effects of what COVID may have on those industries.
But, overall, it’s just general margin pressure that we continue to see in a slightly worsening environment, that we expect to kind of continue as long as we stay at these levels. That’s what our surveys are telling us, that’s what our analytics are telling us, and anecdotally, that’s what our discussions with our clients are telling us.
And Bob just to add to that, when you talk with clients, I mean, it obviously had an impact on pipelines going into this year were down. But we have seen a stabilization of pipeline, so it feels like the reduction in demand that we saw in the fourth -- first quarter has stabilized.
And you think about some of our clients who have been able to pass on that higher cost on to their clients and that’s what we have seen through much of the cycle. The challenge that comes to Bob’s point is when you have increased input costs and you no longer can pass that price increase on to your clients and given where inflation has been and given the consumer and the health of the consumer, I think, we are getting to a point where it becomes harder and harder to pass it on.
And so I think that leads to lower demand, but ultimately, it leads as Bob said, the lower margins. But in general, if you look at it kind of through the cycle, many of these small businesses and commercial clients still look very healthy as it relates to their historical returns.
Got it. And then separately, I know you don’t fall in the category of banks that regulators are most focused on for new regulation. But I am assuming that the supervision process will get guided for of all asset sizes. So I noted your loan sale this quarter and your comments that you want to keep accreting capital at least for the near-term. But, in terms of the overall balance sheet and capital and liquidity, are you doing anything else to prepare for the tighter regulatory environment?
There’s nothing else that we are working on right now from a capital and liquidity. I mean I think when you look at our strategic plan, what you will see is, we will be building capital and improving our liquidity positioning.
Now we feel very comfortable with our liquidity where it is right now. You see $26 billion of contingent liquidity. But we also believe that we can improve the positioning and reduce the overall cost of our funding as well and that’s something you will see over the next couple of years, and so that’s just going to be part of our strategy, part of our strategic plan.
If you look at the leadership team that Kevin has built here, it’s their -- the leadership team, especially in the corporate services, there’s a lot of large bank history and you think about what’s coming down the pipeline to $100 billion and higher banks, most people here have lived that, breathed it and we know what it takes.
And so it’s already part of our nature. It’s part of how we manage the bank when we look at scenario analysis. We look at risk management. It’s how we manage our day-to-day. So for us, that’s not -- regardless of the change officially is not a big change in how we operate day-to-day.
The only thing that I would say that is a debate for us and it doesn’t impact us is the potential impact of AOCI on capital for the banks over $100 billion. It will be interesting to see how that plays out.
But if indeed, how the maturity is excluded from that, then that’s something that we will have to consider is, how do we leverage the held to maturity designation, because it’s not something that we use today.
Great. Thank you.
Our next question comes from Brandon King with Truist Securities. Brandon, please go ahead. Your line is open.
Hi, there. Good morning.
Good morning, Brandon.
So I want to I wanted to talk about the core deposit guide and just wanted to get your expectations as far as what kind of percentage contribution you expect from seasonal benefits versus the new deposit initiatives?
Well, look, it’s true, Brandon, that when you look at the fourth quarter specifically, there’s usually seasonal inflows, both on the public funds side, as well as generally the commercial side. So I think it’s 50-50. What we said to this point is that, we have been focusing on new deposit production, our production on a year-to-date basis is up 183% over where it was in 2022. We believe that will continue, and yes, some of that has come in our CD promotions and alike, but it’s really up across all of our lines of business.
Number two, we continue to focus on the blocking and tackling, which just means that we are using analytics and what [ph] equity to reach out to existing relationships to ensure that we have a full share of wallet.
We talked earlier this year about changing incentive plans to align the bank’s interest with our relationship managers and we think that also pays dividends and will continue into the third quarter and fourth quarter.
We have on-boarded a new liquidity product specialist who will focus in kind of the large corporate, middle market space and bringing in larger deposit opportunities and we will continue with some of our promotions that we have out there today.
So seasonality is something that we are counting on, but it’s not the only reason that we are growing. We think that the other half of the story is really around the production that will continue into the second half of the year.
Got it. Got it. And with the new deposit initiatives, just could you give us kind of a big picture view strategically of how you think that will play into particularly next year as far as maybe able to drive deposit growth, maybe higher than what it’s been historically?
Look, it will definitely be higher than it was this last year. I can tell you that. Because with all the diminishment that we have had that Jamie talked about earlier. Our story is not one of production, it’s been a story of diminishment and with all these excess balances sitting on the balance sheet, it’s hard to overcome the reduction in the average balances.
And I think as we have talked about that abating the production will obviously be much more impactful in terms of growing deposits. And so, what we would love to be able to see coming out of the other side of the diminishment story is a production level that closely mirrors that of loan production.
So to Jamie’s point, we believe that we can reduce our wholesale funding in the coming quarters and we feel very good about our loan-to-deposit ratio today, which is 190%. And going forward, if we match our deposit growth with our loan growth, we feel very good about not only the margin impact of that, but ultimately, our ability to continue to fund our growth story as we look into 2024 and 2025.
Got it. That’s all I had. Thanks for taking my questions.
Thank you.
Our next question comes from the line of Brody Preston with UBS. Brody, please go ahead. Your line is now open.
Hey. Good morning, everyone.
Good morning.
I wanted just to ask on the -- Jamie, could you help me just on the derivative hedge portfolio. The 1.82% rate that’s been pretty consistent for the last several quarters. Is that a net rate? I guess, is that net of the what you are paying on the floating and receiving on the fixed or just -- can you help me better understand the moving parts there?
That is the received fixed rate versus -- so we will be receiving fixed at 1.82% and then we pay on the index on the other side. So, historically, that…
Got it.
…more on the floating rate LIBOR on those.
Got it. Okay. So that’s probably SOFR, I guess, at this point. Okay. Cool. And then just on -- I appreciated the slide, I think, it was slide six or so. I think you had tucked in the repricing dynamics on the fixed rate portfolio. I just wanted to focus in on the non-mortgage portion. That 2.3-year duration, is that -- is that like -- is that a good cadence to use in terms of even repricing from the fixed rate loan perspective or is there any kind of chunky periods of fixed rate loan repricing within there?
There’s no real fix -- there is no real chunky portions of that. It’s actually fairly steady.
Okay. Okay. So that should just be consistent repricing going forward. All right. Cool. And then I just wanted to sneak in one last one, just on the deposit outlook. I think on one of the slides, you said that you expected, I think, it was 46% to 48% total deposit beta range through December 2023? So that kind of calls for a bit of a step-up in the back half. I was just wondering how competition is evolving in the Southeast markets, especially now that FHN is back fully competing for deposits with everyone?
So, Brody, let me take the competition, I will let Jamie talk about the betas. So it was interesting when we go back and look at our competitive data in the second quarter, what we saw was for the first time that we have been tracking this, that we had multiple banks that had CD promotions that were higher than the brokered rates and I won’t mention the names, you know who they are. o that did drive up the cost of promotional CD production.
Number two, when you look at the change in the standard rates for just money market, both on the consumer and on the commercial side, we saw on average about a 90-basis-point to 95-basis-point increase in standard rates in the second quarter. If you compare that to the first quarter, where we actually saw more rate hikes, it was only up about 45 basis points.
So what we saw in the competitive landscape was a 2x movement on standard rates in the second quarter and I think that’s what’s driving a lot of the deposit beta discussion, but I will let Jamie talk about our forecast, a big piece of that is the NIB remix.
That’s right. That’s right. I mean as we think about deposit cost movements from the month of June that you see in our presentation to the end of the year, we do expect to see a fairly steady just monthly step down in the rate of increase of total deposit costs. And so that’s how we think it will play out and you will just see that steadily decline start to approach zero at the end of the year.
And Brody, to your prior question, I will point back to an answer I gave earlier about the -- on the fixed rate loans. That’s the $250 million that we have each month that is maturing or paying down this repricing.
Got it. Thank you very much, guys. I really appreciate it.
Yeah.
This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Kevin Blair for any closing remarks.
Thank you. As we close today’s call, let me thank everyone for their attendance, and obviously, your interest in our company. I am pleased with our bank’s performance and it remains very strong despite the challenges posed by the slowing economic environment, higher cost of funding and the tighter liquidity market. I think we have demonstrated resilience and adaptability in the face of these headwinds and we are proactively adjusting and fine-tuning our activities to navigate the evolving landscape.
To ensure we have sustained growth, we have undertaken some short-term balance sheet optimization measures, reduced our expenses and grown our capital levels, all of which will enable us to return to our strong growth story over the long run.
We also continue to show the health and strength of our borrower base as our credit performance to-date and our view into the future reinforces my belief that our diversification, our prudent underwriting and our strong footprint will differentiate us in the cycle.
While we acknowledge the current marketing conditions and the subsequent contraction in our margin, we want to emphasize that the underlying growth story of our bank has not changed. We firmly believe in the long-term potential and value that this institution offers not only to our customers, but also to our clients and our shareholders.
We understand that our team members are driving force behind our success and their dedication and enthusiasm are crucial to delivering our exceptional service to our clients. As such, I was extremely proud of the results of our Voice of the Team Member survey that we received just this week, which revealed a team member engagement and favorability that ranks us in the top 5% of the industry.
That statistic reaffirms our commitment to fostering a workplace that attracts and retains top talent. And as I shared last quarter, our client service levels remain best-in-class with services like J.D. Power and Greenwich affirming as much with their recent awards.
The client experiences and the resulted trusting relationships that are created translate into sources of growth as we deepen the wallet share of our existing clients and it serves as a referral source to attract new ones.
As we navigate through the current environment, we remain focused on taking actions that will mitigate the pressures on returns, while maintaining our commitment to our customers, our shareholders and our employees. We will continue to prioritize prudent risk management, operational excellence and strategic investments to drive future growth.
I am confident in our ability to continue to differentiate ourselves in the competitive landscape, but also in the long-term growth potential of the bank and remain committed to delivering value to all of our stakeholders. Thank you again for your continued support and we look forward to the future with confidence.
And with that, Operator, we will close today’s call.
Thank you. This now concludes the Synovus second quarter 2023 earnings call. You may now disconnect.