Truist Financial Corp
NYSE:TFC
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Truist Financial Corp
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Greetings, ladies and gentlemen, and welcome to the BB&T Corporation Earnings Conference Call. Currently, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this event is being recorded.
It is now my pleasure to introduce your host, Alan Greer of Investor Relations from BB&T Corporation.
Thank you, Gail, and good morning, everyone. Thanks to all of our listeners for joining us today. On today’s call, we have Kelly King, our Chairman and Chief Executive Officer; and Daryl Bible, our Chief Financial Officer, who will review the results for the second quarter and provide some thoughts for the third quarter and the remainder of this year. We also have Chris Henson, our President and Chief Operating Officer; and Clarke Starnes, our Chief Risk Officer, to participate in the Q&A session.
We will reference a slide presentation during our call today. A copy of the presentation as well as our earnings release and supplemental financial information are available on the BB&T website. Let me remind you that BB&T does not provide public earnings predictions or forecasts. However, there may be statements made during the course of this call that express management’s intentions, beliefs or expectations. BB&T’s actual results may differ materially from those contemplated by these forward-looking statements.
Please refer to the cautionary statements regarding forward-looking information in our presentation and our SEC filings. Please also note that the presentation contains certain non-GAAP disclosures. Please refer to Page 2 and the appendix of our presentation for the appropriate reconciliations to GAAP.
And now, I’ll turn it over to Kelly.
Thank you, Alan. Good morning, everybody. Thanks for joining our call. We always appreciate your time and attention. So I’d say the second quarter was overall very strong, particularly when you look through all the parts. We had record earnings, record returns, strong revenue, very good expense control, great asset quality and improved loan growth.
Net income was record $775 million or up 22% versus second 2017. Excluding mergers, it was the record $792 million. Diluted EPS was $0.99, up 28%. Adjusted diluted EPS was a record $1.01, which was up 29% versus the second quarter.
I would point out that if you look at the pre-tax ex-merger earnings, and they are up 6% versus second quarter 2017, which is simply showing that independent of the tax reductions, our business is meaningfully improving.
ROA, RO Common Equity and Return on Tangible were 1.49%, 11.74% and 19.78% respectively. And I think importantly, if you look at adjusted ROA, ROCE and ROTCE, it was 1.52%, 12.01%, and a very strong 20.2% on Return on Tangible.
Importantly, we did achieve positive operating leverage in the second. And also quarterly revenue totaled $2.9 billion, which was up 9.2% annualized compared to the first, that was insurance seasonality, but it’s still a very strong revenue quarter.
Loans held for investment did perform very, very well, up 3.5%. So we’re seeing the turn that we have been expecting over the last two, three quarters. Net interest margin increased 1 basis point to 3.45%. And our core was up 2 basis points to 3.34%, and a strong fee income ratio of 42.5%, which was up from 41.9% in the first quarter.
Adjusted efficiency ratio was 57.4% versus 57.3%, so about flat. Adjusted noninterest expenses totaled $1.6 billion, which was a decrease of 2.1% versus 2017. I’m very pleased with our expense discipline. I would say to you that our flat guidance for the year, remember, includes Regions, so it is net down, which is I think very good, when you hear in a minute and I’ll talk about a lot of different things we are doing.
Credit quality was just great. NPA ratio was 0.28%, decrease of 2 basis points. Charge-offs were 30 basis points versus 41 basis points in the first, and 37 basis points in second last year. So great credit quality.
If you’re following along, I’m on Page 3. In terms of strategic highlights, I would point out, we did close the Regions Insurance deal, which is a really attractive deal we closed out on July 2, great addition from both a cultural and market perspective. Strengthened our presence in many Southeastern markets, and importantly, expanded into new markets in Texas, Arkansas, Louisiana and Indiana.
In our capital plan, we did not have a fed objection. We have an 8% increase in quarterly dividend planned on top of the 13.6% increase that we did in the first quarter. And up to $1.7 billion in share repurchases. Some of that we used in the Regions acquisition.
But if you look at the combination of the first and the projected third quarterly dividend increase, it’s up 22.7% from the fourth quarter 2017. We’re maintaining a strong and growing dividend, for our shareholders this is very important and we are executing on that.
On Page 4, we just had fairly straightforward selected items, mostly related to real estate losses, and closing branches, and back-room facilities. That was about $0.02 a share.
On Page 5, I’ll talk a little bit about loan growth. We’re very pleased that we’re seeing the turn that we’ve been expecting. So we had 3.5% growth in loans, that are very strong in C&I which was up 6.3%. Strong performance in a number of areas, corporate banking, mortgage warehouse lending. Sheffield was up 32% annualized, and that’s seasonal, but still strong. Commercial Equipment Capital was up 16% annualized; Dealer floor plan and the Premium Finance. I’d point out Community Bank was up 3.5%. That’s a big deal, because if you recall over the last several quarters, I’ve been talking to you about how for the last number of years Main Street has been kind of dead in the water and we’ve been expecting it to recover. Well, it is recovering. Optimism is strong. Equipment purchases, other types of acquisitions and purchase are happening. So we’re really pleased to see Community Bank. That’s an engine for our company.
CRE is up 2.8% annualized. And that’s very, very strong. I would also point out that our end-of-period loans are up $3 billion, greater than end-of-period loans for the first quarter, which is 9% annualized. Our auto portfolio made the turn in the quarter as we expected. Our mortgage loans grew on average as we expected. So really both the optimizing portfolios have now turned and that will be a positive push in terms of total loan growth as we go forward.
So when we think about loan growth, I’ll get Daryl talk about the guidance in a little bit. But I personally think that loan growth should be in plus or minus 4% as we go into the third, barring any major changes in the economy.
If you look at Page 6, in terms of deposits, it was a healthy quarter for us. I’m very pleased that our noninterest-bearing deposits or DDA growth we were at 4.3%. That’s very strong compared to the industry and reflects a lot of our [inner growth] [ph] strategies that are really paying dividends now. Our noninterest-bearing deposits grew very strongly, increased $567 million. Percentage of noninterest-bearing deposits increased to 34.2%.
I do want to make a comment about betas, So cost of interest-bearing deposits was 0.57%, up 11 basis points or a 41% implied beta. I would just comment to you that that was a beta outside maybe what you expected, but we have frankly a few markets that we were getting some outsized competition, and we made a conscious decision to react in those markets. That’s not a kind of normalized beta increase that was more of marketing strategic change. So I would expect that betas to lower from that level, Daryl will give you a commentary on that, but I would expect to see that lower. So I know that looked a little outside to you, but that’s why that is.
I want to make just a comment for turn out to Daryl in terms of the economy, in general, what we are seeing out there, it’s really very positive and very strong. I’ve just completed 23 of our 24 regional visits. As you know I go out and spend a whole day in the region, I did two of them last week. When I talk to business CEOs, they are very optimistic, they are spending and planning the spend on CapEx, interestingly competitions hitting up, beta is facing intense wage pressure and difficulty in finding the people that they need. One construction CEO told me that in certain cases, he was having to raise prices 25% to get the kind of people that he made it.
So not take away from there from an economic perspective is we can expect higher inflation and higher rates. There is no incongruent information out there, contrary to that. So I think that’s most likely as we look forward, which is good news for the economy and good news for banks.
I am going to comment a little bit later on some of our key strategies, that I think very important in your view of how it’s going to be for BB&T. But for right now, let me let Daryl give you more color in terms of more of the numbers.
Thank you, Kelly, and good morning, everyone. Today, I am excited to talk about our excellent credit quality, improving margins and loan growth, strong expense control, and our guidance for third quarter and full year 2018.
Turning to Slide 7, credit quality remains very strong, net charge-offs totaled $109 million, down 11 basis points. We had improvement across most loan categories, but indirect loan charge-offs drove most of the decline. Loans 90 days or more past due and still accruing as a percent of loans and leases decreased 4 basis points from both link and like quarters. Loans 30 to 89 days past due increased 5 basis points due to seasonality and 1 basis point from a year ago. The NPA ratio was 28 basis points and matched the lowest level since 2006. We saw declines in nonperforming assets in most categories.
Continuing on Slide 8, our allowance coverage ratios remained strong at 3.49 times for net charge-offs and 2.74 times for NPLs. The allowance to loans ratio was 1.05% flat from last quarter. We recorded a provision of $135 million compared to net charge-offs of $109 million. The provision was $26 million higher. The net charge-offs contributing to a flat allowance to loans ratio with period ended loans up more than $3 billion from March 31.
Turning to Slide 9. The reported net interest margin was 3.45%, up 1 basis point. Core margin was 3.34%, up 2 basis points. Both increases reflect asset-sensitivity and higher short-term rates. The deposit beta for this quarter was 41% slightly less than our modeled about 50% beta. In addition to the index accounts repricing this quarter, deposit costs were impacted by many rate specials and many of our markets, we expect this to abate in the next quarter. Since 2015, our cumulative deposit beta has been 24%. Asset-sensitivity decreased due to changes in our loan mix and deposit mix offset by the decline in the investment portfolio.
Continuing on Slide 10, our fee income ratio was 42.5%, up slightly mostly due to seasonality. Noninterest income totaled $1.2 million, insurance income was up $45 million, mostly due to the seasonal increase in P&C commissions. We don’t expect prior year storms and other events to significantly impact profit based commissions for the rest of this year.
On July 2, Insurance Group acquisition will benefit insurance income starting the third quarter. Keep in mind that insurance income is seasonally lower in the third quarter. Service charges on deposits return to normal levels following last quarter’s system outage. Mortgage banking income declined $5 million primarily due to gain-on-sale margins declined 30 basis points mostly due to retail originations. Investment banking and brokerage income declined $4 million mostly due to deal timing.
Turning to Slide 11. The adjusted expense came in just under $1.7 billion or up $38 million. Personnel cost increased $35 million due to annual merit increases and the increase in performance-based incentives. FTEs declined 126.
The initiative to reduce the amount of space continues to have a positive impact on occupancy and equipment expense down $7 million. About 740,000 square feet of BB&T occupied space has been vacated since January. Other expenses were up $12 million mostly due to the increase in the Visa indemnification reserve, which was not expected.
Merger-related and restructuring charges were down $4 million, nearly all these costs were related to real estate losses due to our branch closing strategy. Expenses were include the impacted Regions Insurance acquisition starting in the third quarter. Well-controlled expenses contributed positive operating leverage versus second quarter of 2017.
Continuing to Slide 12. Our capital, liquidity and payout ratios remain strong. The approved capital plan includes a dividend increase and share repurchases. Our $2.9 billion capital plan is similar to what we did last year, we did more heavily towards dividend payout. The 7.5% dividend increase represents a cumulative 22.7% increase since the fourth quarter 2017. The Regions Insurance acquisition will impact third quarter share buyback.
Now let’s look at our segment results beginning on Slide 13. Community Banking Retail and Consumer Finance net income was $377 million. The $53 million improvement was driven by balance sheet growth, improving deposit spreads, seasonal increase in card-based fees and deposit service income offsetting the negative impact from the February system outage.
Residential mortgage originations were up 17%. The production-based mix was 77% purchase and 23% refi and the gain-on-sale margin was 1.40% versus 1.72% last quarter. We closed 80 branches and plan to close about 85 more later this year. This strategy continues to help us controlled expenses and provide more funds to invest in our businesses.
Continuing on Slide 14. Average loans increased $721 million driven by residential mortgage and the seasonal pickup in the mortgage warehouse funding. As expected the auto portfolio stabilized and we expected to grow going forward. Deposit balances increased $983 million when growth in both DDA and CDs. The deposit beta was 19%.
Turning to Slide 15. Community Banking commercial net income was $277 million, a $7 million increase was mainly due to improving deposit spreads. The commercial pipeline was up compared to both link and like quarter. Continuing on Slide 16, average loan balances were up $268 million, growth in C&I construction loans were partially offset by the decline in income producing property loans. End of period loans grew 4.4% annualized. Competitive pressures on loan repricing remain as we saw a decline in loan spreads. Deposits were down $203 million due to decline in public fund deposits, which was partially offset by increases in commercial deposits. The deposit beta was about 67%.
Turning to Slide 17. Financial Services and Commercial Finance net income was $145 million, driven by loan growth and improving deposit spreads. This was offset by slower fee income due to the timing of investment banking deals and an increase in an incentive-based compensation. Continuing on Slide 18. Average loans were up $292 million and deposits were flat. Corporate Banking, Wealth and Grandbridge all showed good loan growth. Interest-bearing deposits were up 20 basis points and a beta of 74%.
Turning to Slide 19. Insurance Holdings and Premium Finance net income totaled $73 million. The $11 million improvement was driven by seasonality in P&C commissions, partially offset by the related increase in incentive-based compensation. Like quarter organic growth was up 5.2% mostly due to a 15% increase in new business.
Our Regions Insurance acquisition will add about $70 million in revenue for the second half of this year. And the EBITDA margin for the second half of 2018 will be about 20%. Turning to Slide 20, you will see our outlook.
For the second quarter, we met all of our guidance except for noninterest income, which we talked about publically last quarter. This is mostly due to mortgage. Investment banking was also a little soft this quarter, due to the timing of some of the deals closing.
Looking to the third quarter, we expect loans to be up 2% to 4%, annualized link. Our guidance has improved in light of the quarter’s performance and strong momentum, such that the high-end of the range plus or minus 4% looks promising. Net charge-offs to be in a range of 35 to 45 basis points, the loan-loss provision to match net charge-off plus loan growth.
The build this quarter is the result of strong end-of-period loan growth, which positions us well for future quarters. The GAAP and core margin to be up slightly, fee income to be up 3% to 5% versus like-quarter. Seeing deals close already in investment banking this quarter, gives us more confidence that we’ll be at the higher end of this range.
Expenses to be up 1% to 3% versus like-quarter and an effective tax rate of about 20%. For the full year 2018, we expect loans to grow in the 1% to 3% range, taxable-equivalent revenues are expected to be up 1% to 3%. The decline from previous annual guidance reflect slower mortgage banking income growth.
Expenses are expected to be flat. This is a bit higher due to the FDI surcharge, which was added back into the fourth quarter and an effective tax rate for the year of 20% to 21%. We continue to feel confident that revenue growth along with flat noninterest expenses will result in positive operating leverage for the full year 2018.
In summary, we had quarterly earnings, positive operating leverage, very strong credit quality and excellent expense control. Now, let me turn it back over to Kelly for additional comments.
Thanks, Al. So, as you just heard, Daryl summarized very well the overall integrated very positive results for the quarter. But I’m going to talk to you a minute or two about what’s really important. I mean, focusing on what’s going on every quarter and the detail of quarter is interesting. So much more importantly, it’s key is what do we do and as we look forward for the future of this company for our shareholders and our other constituencies.
So we are working very, very hard on what I’ve been calling for several quarters our Disrupt-or-Die strategy. You can see that in a graph on Page 21. We laid it out in terms of disrupt or die to simply to get our own people’s attention, because the world is really changing. It’s changing really, really fast. It’s going to continue to change at a more rapid pace.
I think AI, machine learning, digital, all of the various comos [ph] we all know about are real. And so, we are very, very seriously focusing on the front-room and the back-room of our businesses, focusing on reconceptualization and figuring out how to operate our businesses more efficiently and more effectively.
For example, right now and this has been in place for a number of weeks. We’ve already got major projects going on in terms of reconceptualizing operations in our whole IT area, think Agile and DevOps and all of the things that go to that. Our insurance business is going through a top to bottom reconceptualization process, incorporating the Regions Insurance acquisition. And we expect substantial improvement in our insurance business as a result of that.
We have major projects going on in reconceptualizing our Commercial and Retail banking and the Community Bank. Just to give you a couple of anecdotes, so for example, we have a project going on right now that will reduce the turnaround time in making a small business loan from 28 days to 3 days. That’s really, really important stuff in terms of making it more convenient and easy for our clients, in terms of our branches, auto loan business. By the end of this year, we will have our loan approval time down from 1.5 days to 4 minutes. This is big stuff. This will change the business.
As Daryl pointed out, we’ll be closing like 160 branches this year to be able to reinvest in other aspects of our branch system and other aspects of the bank. In our commercial area, we are working on a project that will evaluate and improve performance from end to end, that’s from the beginning of the request, all the way through the final booking of the loan.
We’re considering and are very likely soon going to start a major project on general expenses including things like layers of management – you can see we’re looking top to bottom every aspect of the company, because we simply have to reinvest in the future of the business. That you know, it’s basically an online banking business that we and everybody else has, we have to protect that, but at the same time we have to streamline it and harvest expenses out of that old bank and reinvest it into new bank.
And it needs to be focused primarily on client interaction and relationship management. So what are we doing? We are developing right now an entirely new ATM strategy. We have an substantially improved retail product line, for example, we just introduced last couple of weeks five new credit cards, feedback from the field is fantastic. We are encouraging and really kind of pushing our market leaders, our branch managers to be out making calls in the market three times per day, which is a dramatic improvement.
We have in the retail and the commercial side a new program we called Financial Insights. This is a big deal. So historically, we and other banks have gone out called on clients to ask about the loans and deposits from fee income, we don’t do that anymore. We go out and talked our clients about their dreams, their goals, their hopes in life. What are their financial plans? And we particularly focus on talking to them about their leadership, because we believe everything starts and stops around leadership, and so if we can help our clients and prospects improve their leadership, we know they will do better that’s a good thing, and then in return we will do better.
We focus on helping them grow their business. Inherently we get more loan deposits and fee income. We have a number of things on the marketing support side that are really big deal. We have a new program called Voice of the Client. Historically, we were basically only be able to give our people in the branches and other parts of the bank feedback about once a year. This Voice of the Client is essentially a real time feedback.
So if a brand – a person comes out of a branch in Dallas, Texas today within a day or so [delayed you] [ph] sometimes the same day that banker and their bankers’ supervisor and all the way up to me, we know exactly whether it was good or bad, our interaction. If it was good, we pat them on the back, if it’s bad we coach them in terms of how to improve.
We set up a new program called Cloud First solutions, when we are looking diligently continuously on how we can improved our business to make it easier, simpler, faster and more secure for our clients. This year-to-date, backroom has uncovered 32 clients. And hence, we just instituted a couple of months ago a virtual banking center. So that when our clients are less likely to come in at the branch, we will be much more active in terms of touching them on a regular basis in the manner they want to be touched from a digital perspective. We’re enhancing our marketing and digital sales, frankly, we are getting fantastic four to five then one paybacks on the investment in those areas, and we are very excited about it.
In the Retail Community Bank, we have an agile revenue team that meets once a month, actually, it’s multiple teams. Their challenge is to continuously look for ways to improve what we do, product lineup, the way we deliver any aspect of the business and give it into effect really fast, kind of an agile or kind of approach that’s very, very exciting.
And we back all of that up by a much more enhanced focus on client insights and analytics. So the concept is to disrupt the old bank, cut cost, reallocate and await and re-conceptualize the business and it’s working very, very well. Keep in mind that we are investing a substantial portion of those cost reductions, back into the new way. But at the same time, we are holding expenses flat for 2018 and expect to in 2019, that’s a pretty big deal. And that’s what we need to do. So our people working really, really hard to work on all that.
But most importantly beyond all that, I will just remind you BB&T will be a little different than some companies. We are intensely focused on why we are here. We believe that when we focus on the fundamental purpose for our organization, we are more effective and more success.
Now we make loans, we get deposits and we get fees and all that, but that’s not why we are here. We are here to make the world a better place to live, we are with very serious about that, and that’s why we focus on things like Financial Insights. When we made the world a better place to live by making loans and deposits, et cetera, of course our bank has grown, our shareholder does well.
When you get up in the morning and you’re focusing on other people, other companies and doing most best for them, good things in life happen. You get up in the morning, you’re focusing on yourself, how many loans you can make and deposits you will get, and how much – what’s your personal raise is going to be, what’s your personal bonus is going to be, life doesn’t work out so well.
So we are making sure that our culture is consistent across our organization that everybody in our company has to be on the same page in terms of where we are. But that’s a big deal. We can talk to you more about that when we have our Investment Day. So I just wanted to mention to you, if you look at the Page 22, on our deck, we are having our Investor Day on November 13 and 14 in Greensboro. We’re having it on our new BB&T Leadership Institute. We’re very excited about it. It’s almost $40 million new project, is to sit back and [a nice time for wood setting, balcony quils] [ph]. It has 48 attached rooms.
I’ve been to a lot of these leadership programs in different places around the country. This is the best in class. So I’m excited about showing it to you. I hope you will come on the evening of the 13th. We will have a special presentation and show you around the institute. I think you’d be really impressed with it.
I will mention that we do have 48 rooms attached to the institute. So the first 48 investors that sign up, you will get to stay in these brand new really nice rooms there at the institute. Of course, there is a nearby really nice hotel for the rest.
So we’re looking forward to seeing you in Greensboro on November 13 and spending the next day with you. So with that I will turn it back to Alan and we’ll go to questions.
Okay. Thank you, Kelly. Gail, at this time if you will come back on the line and explain how our listeners can participate in the Q&A session.
Certainly, sir. [Operator Instructions] Our first question is coming from John Pancari from Evercore. Please go ahead. Your line is open.
Good morning.
Good morning.
Good morning.
I want to just ask on the expense side. I know you just indicated that you do expect expenses for the year to be flat. I believe that you had indicated previously flat to down modestly and for the year. Did anything change, is impacting that outlook? And if so, can you give some more color on it? Thanks.
Yeah, John. This is Daryl. I said in my beginning remarks that we used to have in the fourth the FDIC surcharge coming out. We put that back in. When you look at the diff, the diff numbers from the last two quarters are flat basically. So while there is still a chance it may come out in the fourth quarter, we weren’t sure about that. So we wanted to be conservative to make sure that we were given proper guidance.
So if it does come out in the fourth quarter that would be an upside for us.
But, John, keep in mind, that that is flat including Regions. And so, our core expenses are still down, including the FDIC [indiscernible].
Okay. All right, I got it. And then, for the loan growth, I know you are – you just indicated, Kelly, that you feel better that it could reach 4% plus or minus. What is that timeframe for when you think you can get to that level? Is that more of a longer-term thing? And I believe previously you had indicated maybe a longer-term range of 4% to 6%, so I just want to get your thoughts.
Yeah, so a plus or minus 4%, John, is for the third. I know we technically showed in our deck 3% to 4%. But I’m just saying based on what I’m see, and as I said, I’ve been to 23 regions, I’ve been to two regions last week. And based on everything I see and talked to our people, I think we got a very good chance. I can’t guarantee it, of course. I think we got a very good chance that it’d be into plus or minus 4% for the third. And then the guidance we’ve given before still stands as we go well beyond that.
John, the specific categories for the next quarter, we’re seeing – besides C&I and mortgage, which really helped us this quarter, we’re seeing really good traction in our indirect businesses. in auto and Sheffield, and also credit card. So, all those should get us to that level.
Okay. Got it, got it. And then one last thing if I could, on the insurance side, your insurance revenue was flat year-over-year. We had looked for a few percent growth. Can you give us a little bit of more color on the – what’s impacting that?
Yeah, sure, John. Keep in mind, a year ago, we had $12 million in performance based commissions that we did not receive because of the storms in the fall. So if you exclude that, really we were up 5.2% core organic growth in the quarter, and so far 4.2% year to date. And we’re seeing actually acceleration in our new business production. First quarter was 11.8%, we were up 15% in the second quarter. I haven’t seen those kind of numbers really in years. So the economic expansion is really helping drive that.
And pricing is up in 2%, 2.5%. We see that sort of stabilizing as opposed to sort of down to like it was in the year 2017. So I’d just leave you with that. As a result, we’ve been kind of guiding up 2.5% to 3% in organic growth. And really for the year 2018, what we’re really seeing is up now about, we think we’re going to be up in the 3.5% to 4%. So we’re kind of moving it up 1% if you would.
Got it. All right, thank you.
Our next question is coming from Jennifer Demba from SunTrust. Please go ahead.
Thank you. Good morning.
Good morning.
I have two questions. First, Kelly, could you just talk about your capacity and interest for bank M&A now? And secondly, that the slide – the Disrupt-or-Die slide on number 21, very helpful – which strategies on that slide do you think present the most opportunity for BBT over the next couple of years?
Yeah, so on the M&A front keep in mind that we’ve been in this pause in terms of M&A. I haven’t officially lifted that pause. But I will be candid with you. I think we’re basically ready to get back in M&A, in terms of our internal capacities. We took this pause, because we needed to make sure we got all these major projects worked and that they are all in really good shape.
We’re still in the process of working through the final step with regard to the consent order. You saw we have been released from the consent order with the FDIC in the state. We’re not yet been released with regard to the fed. And we’re working with them on that. I expect that to be released in the not too distant future, but I can’t control that. And so, but I remind you, in any event, at some point that will be released. And there is some possibility in fourth release we can still do M&A. So, I mean, I’m not overly worried about that.
The bigger issue is the availability of mergers and the economics. I will tell you that there is a meaningful increase in activity in really just the last couple of months, so we’ve been approached by a number of institutions in the last 60 days that would like to consider a partnership with us. And we’re very humbled by that. We very much appreciate that.
And of course, we will look at them. But it’s all about economics. And I’ve said repeatedly that the economics of M&A has changed, because when we talk about this change in terms of digital banking and the change in demand for convenience from our clients, that’s real stuff.
And so, we’re seeing declines in the 5%-plus range in terms of branches of the bank. Banks are seeing the same thing. And so, when you particularly price an out-of-market deal, unlike in the past where you would forecast an increasing cash flow and discounted [ag you got with the price] [ph], now you’re forecasting a declining cash flow and [discounting of ag] [ph]. And then the market is really not yet quite caught up with that. They’ll figure it out, but they haven’t quite figured it out yet. So I think odds of us doing out-of-market deals are pretty slim. I think odds of us being on the in-market deals are pretty good.
But I know every time I say that, sometimes people say they want to go sell our stock. I’ll tell you, that’s not a smart move, because if we do deals, it will be good for our shareholders. We’re just not going to do stupid deals. We’re not going to do deals that has long-term dilutive economics that makes no sense to our shareholders. So we’re going to look at deals and we’ll do them if it makes economic sense. When we do a deal, you’ll be happy we did the deal.
With regard to the Disrupt-or-Die, I appreciate your question on that. I think that’s the most important thing, because that sets up all of the investments and sets up improved EPS and improved stock price as we do M&A. So it all innovates [ph] together. I would say the most immediate substantial impact is the reconceptualizations in the Community Bank.
It’s a – that our guys David Weaver and Brant Standridge are doing substantial changes in terms of the cost structure and reallocation of resources, and the penetration of the market. It’s the big deal. I’d say they follow closely by our IT, reconceptualization which is a complete change top to bottom in terms of how we do that.
And then, I’d say followed closely by insurance. And so – and then a number of all those, but that’s kind of the top three I would say, but all of it together is what’s allowing us to how flat expenses and making these major investments into future of the bank that’s – I can’t overemphasize how important that is for investors are look at banks. Banks that are out, they’re just cutting expenses, and where they’re nearly are not investing for the future may not have a very bright future. And so we’ve been have a very bright future and we think doing what we’re doing is appropriate. So thanks for the question and that’s when we see it.
Thank you.
Our next question is coming from Betsy Graseck from Morgan Stanley. Please go ahead. Your line is open.
Hi, good morning.
Good morning, Betsy.
Hey, so a couple of follow-ups. One on the reinvesting in the business, very passionate presentation you gave on Page 21, Kelly. The question I have is, have you look out over time and we’re talking two to three, four years, do you think that this has an impact on the expense ratio of the organization or does everything that you’re doing keep pace with the expense ratio to that?
Betsy, we’re in a new world. And it’s hard to – of those who have been around long time, we can think, we just maybe more clearly about historically [indiscernible] what the fact are. When you’re in a whole new world, and you’re trying to develop new understandings of various costs or makes it little harder. So given that, I think we will be able to make the kinds of re-conceptualizations, investing the business and still see a slowdown with pressure on our efficiency ratio.
Now insurance businesses are going to be fast and that pushing of the pricing. You know how that works. But when you put all of that together are still see in the short run my target is 55. And I think longer term as revenue kicks up, you can even push a little lower than that. But other next few years, I would be thinking in terms of doing all we doing and still seeing positive operating leverage and downward pressure on the efficiency ratio.
Got it. [Technical Difficulty]
Betsy, I am sorry, we can’t hear your last question.
We can’t hear you, Betsy.
Betsy, we can’t hear you maybe if you can dial back. We’ll let somebody else and we’ll let you come right back in behind them if you can dial back in.
[Operator Instructions] We have now a question coming from Ken Usdin from Jefferies. Please go ahead.
Hi, this is Amanda Larsen on for Ken.
Hey, Amanda.
How are you doing?
Good.
Can you talk about the balance sheet and liquidity in management strategy here given the expectations that loans will continue to grow. What’s your outlook for deposit growth in mix and what betas are you assuming over the next few quarters?
Yeah, Amanda, so we are starting to get traction on our loan growth, you saw that this quarter and we’re guiding to have stronger loan growth next quarter and hopefully continuing on from there. So we want to have both oars in the water, so we will and as we start to see deposits also start to grow. I think, we’re still fortunate that our DDA is growing. That is growing not as fast as it was, but it’s still positive. But we are getting growth in our checking as well as MMDA products. In last couple of quarters, we’ve got growth in CDs, we will toggle our deposit growth to match our loan growth the best that we can.
As far as deposit betas go, we did see a big spike up in our deposit beta from last quarter from 24 to 41. If you work out it, we had increases both in REIT, consumer, commercial and the wealth in large corporate. Our guess is that, that will moderate this next quarter. We believe that, it will go probably from the low-40s, back into the 30s, as we continue to have more traction and growth in deposits. We’re pretty much, what we see in the pipeline right now, feel that we’re going to have a good deposit growth quarter this next quarter with the size that we see now and that should match really well with the loan growth.
But we will continue to monitor that, but I think next quarter or two basis, I think, deposit pressures will abate a little bit.
Okay, great. And then, can you talk about your expectation for purchase accounting accretion in now 2H, and your expectations for the extend of decline in 2019, and how that interplays into your NIM expectations for both 2H and 2019? Thank you.
Yeah, so purchase accounting probably by the end of 2019, you probably won’t even be asking the question where as it continues to follow. Right now, the difference between reported margin and core margins of 11 basis points. We see that contracting probably by the end of 2019 going down to maybe only 4, 5 basis points difference. I think, each quarter that goes by, it’s 1 or 2 basis points GAAP change between the two of them. So it is coming in over that time period, over the next four to six quarters. Did that help?
Absolutely. Thank you.
Our next question is coming from John McDonald from Bernstein. Please go ahead. Your line is open.
Hey, guys. Good morning. Daryl, I wanted to ask on the fee revenue looks like the guidance came down a bit, look like it was 2 to 4 previously 1 to 3 for the year. Is that more of a year-to-date performance or do you expect lower growth in the second half maybe you can talk about the drivers there on the fee revenue side?
Since half the year is in there, it’s really driven by what we’ve seen in mortgage to date, and quite honestly what mortgage volumes are very strong, spreads continue to be very tight. As Chris mentioned, insurance rebounding, so we should have some nice growth, organic growth on that insurance side to help offset part of that. And then the investment banking, what we believe that is timing, this past quarter we missed our forecast our investment banking, but with the deals that we’ve seen close already this quarter. We feel very confident, investment banking and brokerage have a strong second half of the year.
So I think we’re going to have with investment banking, service charges and insurance, a decent and relative strong fee income for the second half of 2018 just with mortgage be a little bit softer.
So the timing aside, just to the extent of full year is a little lighter than you might have not coming, and it’s really mortgage as a driver there for the full year?
Yeah, we went through these cycles many times, when refi volume goes down, there is less volume and people just bid up very competitively, very lower pricing and you see that dramatically in the retail businesses, our strategy just down a lot and I think you’re seeing that across the whole industry. But we are positioned very well, our purchase activity is strong, our producers, originators out there are gaining share. So I think, we are equal to regaining share in the marketplace, it’s just the spreads are tighter.
Okay. And then, I’ll follow-up on expenses, you mentioned the FDIC charges, the driver of the change in expense guidance for the full year, if you’re assuming the FDIC surcharge remains. How much is that – can you just remind us how much that FDIC charges and then how you’re feeling about the ability to generate positive operating leverage on the second half of the year and for 2018?
So the surcharge was worth $21 million a quarter. I would say, if you look at linked quarter between second and third that’s a tough comp for us just because we have seasonality and some of the fee businesses, insurance and Regions coming in. From the Regions Insurance, we will not get any synergies really in that business until we get through the system conversions. System conversion is scheduled for November of this year. After that, Chris can comment on, but we think margins will go from about 20% up to about 30% over the next year through 2019. So we take margins will rise there.
So I would say linked quarter, third quarter challenging in a good run, it’s going to be cause to go either way, but for the half a year, fourth quarter definitely year-over-year for very good that should also have operating leverage there. So I think, we really have a lot of good momentum going on. I basically see revenue growing 2% to 3% and expenses being in flat. That’s kind of the story that we have right now.
Okay.
Absorbing the expense base of Regions.
Got you. Got you. One last thing, guys, when we look at the CECL coming on what’s kind of progress you guys having with the preparations for CECL?
So if you work at it, there was a good white paper they came out this past week by the bank policy institute. They did a research white paper, and we’ve been talking about CECL now for a couple of years. And it really confirm what we’ve been saying is that, it’s very pro-cyclical, and it’s a major threat to the economic stability and our financial crisis.
Greg Bair [ph], their CEO testified in Congress this past week on that. But if you really look at what would came out of the study, which is amazing is that CECL expect that you have perfect knowledge of what’s going to happen, if you look that the economic forecast in 2007, nobody was foreseeing a big recession coming. So if you model in what expectations were, they did this in those white paper and actually doubled the contraction of the recession, if you had CECL in place back 11 and 12 years ago. So I think that’s a huge risk to the country to the economy that people really need to think about it.
When you look at CECL, while the economics of lending hasn’t changed accounting has departed from economics. When you frontload all your expenses that impacts earnings and capital. Since we are in the industry where capital is part of an accounting number and it’s part of how we managed the company, you have to pay attention for the accounting piece.
So I would say, one foot in economics, one foot in accounting. And the regulators and hopefully FASB will make some modifications before they put a lot of risk into the economy. It’s not good for the term assets, but you see in the consumer portfolios, it’s not good for our portfolios that have higher risk and subprime. So there are lot of negatives out there.
Ironically, the way CECL is actually set up, we’re actually seeing less reserves on the commercial side, because you’re actually reserving to the maturity and not really to the expected life of the assets. So the whole economics of the CECL versus accounting has been totally disconnected.
Got it. Thanks, guys.
Yeah.
Your next question is coming from Gerard Cassidy from RBC. Please go ahead.
Good morning, Kelly, Good morning, Daryl.
Good morning.
Hey, Daryl. How are you doing?
Good. Kelly, I took with some interest your comments about visiting your different regions of the franchise and talking to your customers particularly the one you highlighted, the construction owner and what they have to do for raising prices. And you’ve been passing on your thoughts about maybe interest rates will go higher than what we are currently forecast by the Fed. So my question is when you guys underwrite your very little rate loans what kind of interest rate assumptions are – interest rate increases assumptions are using in that underwriting? And second, will you change them or will there go up even higher if you start to see higher inflation?
Gerard, this is Clarke. That’s a great question. I think that’s – we think is something differentiates our approach to CRE lending from others for many years. We don’t underwrite specifically on current cap rates, we always look at stress exit underwriting. So we always look at, at least couple of hundred basis points over the current accrual rate with the floor and our floors been in roughly the 6.5 range, but because of the issue you and Kelly just raised, we’re evaluating whether that for needs to go up or not, so we always try to get ahead and make sure we stress these projects or the potential rate shocks and don’t fool ourselves about how we size the loan. But we certainly see less of that focus by others in the markets, which creates a lot – we believe oversized new credits in many cases.
Does that make it harder for you guys to compete then, because you’re doing it more conservatively than some of your peers?
Absolutely in certain aspects, for example, I will tell you right now is very difficult to compete on a fully stabilized IPP project for what I just said, they tend to have very high sizing based upon trended rents and extrapolation of expenses and low vacancy and so non-recourse. So we’re just not applying there, we think that that’s just too much levered. So we’re doing more C&D, where we have very strong initial equity, guarantees, stress underwriting. So we’re well protected for we believe the risk were taken. So we’re having to pick our positions to play based upon that, but we still think we can compete effectively even that said.
Gerard, as you well know, we run the business from a long-term through the cycle perspective. And when we get into this period of the cycle, we always see it, many competitors scrambling for asset growth, very short-term focused. And they’re willing to price and structure, whatever it takes to get growth. That feels good today. But it got to feel so good when the pricing come. So we run through the cycle, so we’re good on both sides.
So, yeah, it does make it harder for us today. We work hard around it. We don’t give up. But we’re not going to go out there and make loans at the prices some of these people are making and the structures some people are making just to get loan growth. It’s a fool’s game.
And then as a follow-up question, Kelly, going back to Slide 21, I took with interest how you’re going to increase the national lending business. And I recognize that in equipment finance, mortgage and Sheffield, you’re basically already there. But I’m more interested in the corporate and commercial real estate. When you don’t really have national customer base, I know you have some customers but it’s not in your footprint, how do you avoid adverse selection if you’re going at the national level?
Well, you have really good people and you have local knowledge people. So we have a great team headed by Rufus Yates and Cory Boyte. And when we ask them to expand as we have, we give the resources to go into the markets and hire local knowledge people, because we learnt, used it in over the years, somebody can leave one market and send some people on the plane and fly out there to West Coast to make a few loans. It doesn’t work out so well.
So our strategy is to domiciled people in the marketplace that have local knowledge. And so, we’re not at a competitive disadvantage in terms of appropriate knowledge. So we will be able to expand. And it’s really just a matter of resource allocation. And we’re allocating more resources there because our people have performed extremely well.
And, Gerard, this is Chris. I would just add. We have a Grandbridge business, which really is a national business. And it has been for years. And we have people throughout the country today.
And so, it’s really about ruthless working with Grandbridge and sort of duplicate what he did on the corporate side and bringing in bank balance sheet lenders to kind of sit alongside the Grandbridge folks, which are really kind of secondary market kind of lenders. And we think that will work really well, to be able to put more on the balance sheet and to be able to do construction type financing that we might not have done in the past as well.
Great. Thank you. Look forward to seeing you in November.
You bet. See you then.
Thank you, Gerard.
Next question is coming from Mike Mayo from Wells Fargo Securities. Please go ahead.
Hi. Can you hear me?
Yes, yeah, go ahead.
You’re fine.
Okay. Can you elaborate more on your efficiency guidance? I mean, record EPS, lower guidance for efficiency. So it’s little bit of a disconnect. I know you’ve addressed that. But you’re lowering the range from 100 to 400 basis points of positive operating leverage to 100 to 300 basis of positive operating leverage. And I think what you said is the FDIC benefit you pushed out and it’s a little bit of mortgage softness. Maybe there are some investing in there.
That’s still a pretty wide range for just two quarters left. I don’t know if you can be more specific to the 100 to 300 basis points annual positive operating leverage.
And I think the reason for the sensitivity to this is you guys didn’t assure efficiency targets a few years ago. Your efficiency did become the worst it’s been for BB&T in a decade. And, look, it’s still good progress. It’s still good efficiency. But it hasn’t been the best efficiency like it once was. So what’s your commitment to that 55% short-term? I guess, can you define short term? Is that maybe in 2020, could it be next year? What’s your commitment and conviction to improving the efficiency since you’re pulling back a little bit your guidance here.
So, Mike, I’ll give you on the conceptual and Daryl can give some detail. Our commitment and conviction is absolute. But you just need to remember, Mike, what happened to us. During the – frankly, during the ‘90s and the 2000s, we were growing really, really fast through mergers. We kind of had to. And we did that well. But in that period of time, we didn’t invest as much as investors expect. Maybe we should have in the back-room.
So as we headed into the last 10 years, we simply had to substantially ramp up our investment in updating a number of our systems like our – in our new accounting system, our new commercial loan system, our new data center, and a long list of other systems. So we had them accelerated, I’d say three or four year period of substantial ramp-ups. I told our people at that time, I told the market at that time that it would drive our efficiency ratio up. But it would start to subside.
That’s exactly what happened, it popped up. So 59.5% is our goal on an adjusted basis. It’s now down to about 57.3%. And it’s moving on a trajectory as we projected in the 55-ish% kind of range. Obviously, the denominator matters, and we talked about that in the past.
But denominator aside, it’s somewhat neutralized, yeah, I feel good about that, being able to make all the investments we’re making and moving towards that 55-ish% kind of target, because we are really figuring out some unique ways to do our business better. I mean, this isn’t just about trying to work hard or do what you did, just working a little harder. This is about working smarter. And this business today, that’s required. And the good news is there are substantial new tools, think AI, machine learning, robotics, et cetera, that we’ve never had before.
And so, yeah, we’re confident and excited about it.
Okay. So little detail, Mike, you want to focus on the things that we can control. So, on the expense side we’ve been doing a great job this year on controlling expenses. If you look at our FTEs, year-over-year we’re down 1,600 FTEs. And we haven’t missed a beat in how we’re operating our company. As that goes forward, I would expect our FTEs also to continue to be right-sized going into the future.
As Kelly mentioned, in the branches, we’re rationalizing the branch system. We also have a big program within our back-office facilities. We’re just starting some testing and learning in the front-office facility. So when we started this venture, we have about – had about 21 million square feet in the company. Right now, we’re about 18.5 million. And that continue to come down. We’ll probably on the next two to three years, everything else being equal, will be close to 16 million square feet, maybe a little bit better than that.
We’re going to use those costs as Kelly said, redeploy them in robotics and digital, help drive revenue, while continuing to drive costs, all that comes together. So if we can continue to keep cost flat and continue to make investments, we feel that based on the economy, revenue could be 1% or 2% or it could be 3%, 4%, 5%. We will get what we can within our risk appetite, but we will definitely generate positive operating leverage.
And then one follow-up, since mergers have impacted the efficiency and, Kelly, I agree with you. Since Southern National mergers absolutely have propelled outperformance by BB&T. We’re talking several decades. So if you look at your stock price versus peers or the S&P, absolutely. But the deals most recently in Pennsylvania, I’m not so sure they helped. And I think you talked about fishing – I think I was triggered when Daryl said, as oars are in the water, because your fishing analogy, if the fish aren’t biting on one side of the boat, well, maybe you catch the fish on the other side.
So I think in-market deals are better received than out-of-market deals. So what additional confidence can you give us that if BB&T were to pursue acquisition, it’d be more like the 25-year record than say the stock price performance after the Pennsylvania deal?
And also, if you can define – you said a meaningful increase in activity. If you could define activity, it’s not like we’ve actually seen a lot of deals, so what does that mean?
Yeah, so I think I would generally agree, Mike, with your assessment of the last 25 years with one caveat. When you peg it to the Southern National thing, that’s a lofty peg; that was the most effective MOE in the entire country. We were 10, they were 9. We were all over each other. I think we got to call 50%. I mean, it was a sweetheart deal. Comparing that to Pennsylvania is apples and oranges, it might even been apples and turtles. And so, you can’t really make that comparison.
But, yeah, Pennsylvania was not as attractive as Southern National, but it was very attractive. Now, has it gone a little slower than I expected? Yes. But I’ll tell you, Mike, it’s – they have really turned. I mean, I was up there two times last week. In fact, it was really turned. It’s a stable kind of market. Again, it’s not go-go market like Atlanta or Dallas, stable kind of market, particularly where we are, Mercer, and Lancaster, and Allentown, and that area.
So it takes you a little longer. But when you get there, it’s a really good place to be. So – and remember, those were done right at the beginning of the substantial change in terms of economics around digital acceptance.
So as we go forward, the kind of stock price impact, EPS impact, et cetera, that we had historically on deals, I think is what you would expect going forward. And so, you do fish on the side of boat where the fish are. But sometime the fish on the side of boat that are biting aren’t the kind of fish you want.
And so, that’s what I’ve been trying to say about out-of-market. Yeah, there are a lot of fish out there for us on that side of the boat today. Out-of-the-market is just that the price didn’t go to work. But in terms of the activity, we had four pretty attractive candidates approach us in the last 60 days. We haven’t yet gone back down sort of looking yet, because I think we’re a preferred acquirer. So we’re going to have – I’m sorry, go ahead.
Last short follow-up, so what size? Are these tadpoles? Are these sharks? I’m not a big fisherman, but what size deals you guys are looking for here?
Well, they’re couple of – I wouldn’t call them tadpoles, I’d call them little growm [ph]. But they’re a couple of little growm [ph]. But – so we wouldn’t be particularly interested in them. But we – but there are some that are good size catfish. I’m not a fisherman either, Mike. But let me be more specific. I’m thinking kind of our minimum target area is $20 billion and we really kind of like $30 billion more than $20 billion. So the days are the – you know all those deals we used to do, Mike, you remember they were two $500 million. [I’m very familiar in all those days] [ph]. Those days are gone.
So it’s more like $20 billion to $30 billion today up to, say, $50 billion.
All right, thank you.
Yeah.
We will now take a final question from Saul Martinez from UBS. Please go ahead. Your line is open.
Good morning.
Mr. Martinez?
Hello, hello.
Hello.
Hello.
Hello, can you hear me?
Yeah, go ahead.
Yes.
Sorry about that. I didn’t hear that I was called. Hey, I just wanted to come full circle on the discussion on deposit betas and then make sure I understand the logic. So, obviously, you’re expecting it to tick down from the 41% this quarter into the 30%-plus range. Having said that, the cumulative beta has been about 24%. I think you mentioned that you’re modeling about 50%. And frankly, 41% doesn’t seem that high given where we are in the cycle, in the tightening cycle right now.
So how do we think about the progressions, just say, beyond the next couple of quarters? Do we see a bit of a downtick, both as we progress in the interest rate cycle and get closer to whatever the terminal fed fund rate is? Where do you see the incremental deposit beta tracking to and how do we think about sort of the cumulative deposit beta in this cycle?
So I think what we’re trying to convey is that we had a spike up in the second that was part the market itself, but a substantial part of our own strategic decisioning to respond to some market conditions. That part will subside as we head into the third and the fourth. Now, if we continue to see substantial increases in rates, and if corporations continue to use their available cash, which they’re doing today, and there is more demand for lending, lending pace goes up. There will be more demand for – I mean, more demand relative to just flat for funding and that will drop betas.
So my own personal view is it will – for us, it will subside, I mean, in next couple of quarters. And then depending on what happens, the rates will move slowly, more naturally tick up, because you’re right. I mean 41% in and of itself is not inherently bad. It’s just that it popped up real fast and we want to try to explain why it popped up real fast. You would expect it to gotten it out little more over a several quarter kind of period.
Yeah, if you look historically in bad cycles it’s been between 40% and 60% deposit beta. Right now, our cumulative number is 24%. I don’t see it getting over 50% cumulatively. It’s going to be at the low-end of that range. But as Kelly said, once we have abated it in the next quarter or two, it will probably gradually grow up. It will probably stay in the lower end of that range going forward.
Okay. That’s helpful. Got it. And then just a quick follow-up on Regions, have you disclosed or given a sense of what the magnitude is of how much the acquisition could impact your buyback in 3Q?
We have a – best take right now, we’ll probably buy back about $200 million of shares this quarter, and then as depending on the size of the balance sheet. We communicated to the marketplace last quarter that we want our capital ratios to have a CET1 that’s over 10%. The reason we’re doing that is that if we cross over $250 billion over the next couple of years, we have the AOCI risk that goes through our numbers. And right now with higher interest rates. The capital hit with our portfolio and pension that we have out there is about 100 basis points.
So our CET1 would fall when you cross over $250 billion from, call it, 10% to 9% on day-one once you cross over. So that will probably, the long answer to it, we won’t probably spend all the $1.7 billion that we ask for. Some of that was used up with the Regions Insurance acquisition and some of it we won’t be able to spend just because we want to keep it over 10%. But it really depends on how much our balance sheet grows and how fast. We will update every quarter, what we’re looking to buy, repurchase in the earnings call. But right now for this quarter, I’d say about $200 million.
Okay. That’s helpful. Thanks a lot.
Yeah.
That will conclude today’s conference call. I would like now to turn the call back to our host for any additional or closing remarks.
Okay. Thank you, Gail. And thanks to everyone for joining us. I apologize to the questioners in the queue that we didn’t have time to get to. And we will call you later today. Thank you and I hope everyone has a good day.
Ladies and gentlemen, that will conclude today’s conference call. Thank you very much for your participation. You may now disconnect.