Good day, and welcome to the First Horizon National Corp. Third Quarter 2020 Earnings Conference Call. All participants will be in listen only mode. Please note this event is being recorded. I would now like to turn the conference over to Ellen Taylor, Head of Investor Relations.
Please go ahead.
Thanks, Sarah, and good morning, everyone. Thanks so much for joining us today. To kick things off, our CEO, Brian Jordan and CFO, BJ Loesch, will provide an overview of our results, and then we're going to open things up for questions. We're really pleased to have Susan Springfield, our Chief Credit Officer, with us to help with that effort. So our remarks today will reference the earnings presentation, which is available at ir.fhnc.com.
And I should note that we will make forward looking statements that are subject to risks and uncertainties, and you should review the factors in our SEC filings that may cause our results to differ from our expectations. Our statements reflect our views today, and we aren't obligated to update them. We will also address our adjusted results in our remarks, which are non GAAP measures, and you absolutely should review the GAAP information in our supplement and on page 2 of our presentation. And with that, I'm going to hand it over to Brian.
Thank you, Alan. Good morning, everybody. Thank you for joining us this morning. This has been a very significant quarter for us. We closed our merger of vehicles with Iberia Bank.
We acquired the 30 branches from SunTrust, Truist, really excited about that. That integration was done in mid July. We've made significant progress during the quarter. We are very pleased with the performance of the organization, the great work that our associates did to serve their customers and their communities in what has been a challenging and trying time. We see good momentum in our business.
We proved out again the counter cyclical benefit of our businesses mortgage, mortgage warehouse lending and our fixed income business. Our balance sheet continues to perform well. As we've talked about over the last 10 or 12 years, we have really significantly restructured the balance sheet and to focus it more on C and I. We had net charge offs of 44 basis points during the quarter and we saw a slight tick up in non performing assets, but we ended the period with about $1,300,000,000 of capacity for loss taking, so very strong balance sheet. We had a good quarter in terms of deposit activity.
We had good customer inflows and the balance sheet feels good and we saw some progress made in adjusting our pricing to compensate for the lower interest rate environment. Also during the quarter, we made good progress on our expenses. We captured another $8,000,000 of run rate excuse me, a run rate in our Quest for $170,000,000 plus in expense savings. We feel very good about our progress and in controlling costs and our planning for the integration. There's a couple of good slides in the investor deck which you can reference that layout the expectations around expense efficiencies over the next couple of quarters in the year.
Our capital base continues to be strong. Very, very pleased with the positioning. We came in with a CET1 ratio of 9.15%. Our tangible book value dilution was very slight from the acquisition of the branches and the completion of the merger, largely offset by earnings during the quarter. Our planning around the integration continues to go well.
We expect that the significant integration work will be completed by the fall, early fall of 2021. We are on target and on track for completing that integration. We have a lot of work to do between now and then and we have associates all over the organization who are working to make sure that we do it in a seamless fashion and minimize absolutely minimize adverse impact on our customers and our communities. Finally, before I turn it over to BJ, I feel very strongly that we're well positioned for this somewhat uncertain environment. Clearly, the progress of the PPP programs, the fiscal stimulus has been positive to date on the economy, but there's still uncertainty.
I feel like we're well positioned in terms of a strong balance sheet, strong loss taking capacity, strong capital and also positioned with a tailwind in the sense that we have our non our countercyclical businesses and we also have the ability to realize a significant amount of cost savings over the next 18 months to 24 months. So, with that, I will stop. I'll turn it over to BJ and then we'll be happy to take questions later. BJ?
All right. Thanks, Brian. Good morning, everybody. If we could turn to Slide 5, our GAAP EPS totaled $0.95 $0.35 on an adjusted basis, which excludes the pre tax net notable items detailed here totaling $269,000,000 or $0.60 which are largely tied to the Iberia merger. We think it's important to note that the impact of merger accounting on our financials are overall in line with the estimates we provided you during the Q2 call and in the pro formas release during the quarter.
We've provided the detail on the marks and other impacts related to the merger in the appendix for your review. On Slide 6, we provide a summary of our adjusted financials for the quarter compared with FHN standalone adjusted results in the prior quarters. So, obviously, the trends here largely reflect the net impact of the Iberia merger and the branch acquisition. Moving on to Slide 7 for a look at net interest income and net interest margin. We generated net interest income of 5 $32,000,000 in the quarter, up $227,000,000 linked quarter driven by the impact of the merger.
NII remained fairly stable with 2nd quarter combined levels despite the impact of the challenging rate environment. 3rd quarter results included a $44,000,000 benefit from accretion or about 12 basis points on the NIM, which was modestly higher than we originally expected given higher prepayments. Reported NIM came in at 2.84 in the quarter, down 6 basis points, reflecting the impact of low rates and continued elevated levels of liquidity somewhat offset by accretion. We also continue to take action to improve our deposit pricing profile. Our deposit rate paid was down again this quarter with interest bearing deposit costs down to 36 basis points.
Our goal is to manage down interest bearing deposit costs towards the levels we saw in the prior zero interest rate cycle back in 2015 of around 24 basis points. This quarter, we plan to align our deposit pricing across the expanded franchise, which should provide additional benefit as we enter 2021. Our NIM also continues to reflect the impact of much higher levels of liquidity. We estimate excess cash lowers the 3rd quarter margin approximately 12 basis points. We averaged about $3,000,000,000 of excess cash, which grew to $4,500,000,000 at quarter end.
As you know, while this excess cash position lowers the margin, it does not impact our net interest income. We continue to look opportunistically for more attractive reinvestment alternatives going forward and expect to put more of that money to work over time. In the Q4, we expect to see additional margin pressure, likely in the high single digit to low double digit range, but expect that level to represent the bottom for NIM going forward. Moving on to slide 89, I would note that here we have provided our results versus prior period combined results for FHN and Iberia. We delivered solid performance in fee income again in the 3rd quarter with relatively stable results on a linked quarter basis and a 23% year over year increase as the benefit of our countercyclical businesses and fixed income and mortgage banking helped to mitigate COVID related pressure in some of our more traditional banking fee income streams.
Fixed income results came in as expected with relatively stable results linked quarter and $33,000,000 increase year over year given average daily revenues of 1,500,000 dollars Mortgage Banking again delivered standout results with a $13,000,000 increase linked quarter and almost $40,000,000 year over year. Secondary originations of $1,200,000 were up 3% from strong second quarter levels, while gain on sale margins expanded over 100 basis points to 3.93%. As we look into the 4th quarter, while we expect a seasonal slowdown in volumes for both of these businesses, we do expect overall market conditions to remain favorable for both for the foreseeable future. As you can see on slide 9, we continue on our commitment to expense discipline. Linked quarter expenses were down $15,000,000 as a reduction in personnel expense and other non interest expense was partially offset by an expected increase in intangibles amortization from the merger and branch acquisition.
Salaries and benefits increased $7,000,000 driven by the alignment of benefits across the combined platform, the addition of personnel from the 30 acquired branches and an increase in healthcare costs following the pandemic driven slowdown. This increase was more than offset by a reduction in revenue based incentives and commissions, as well as lower deferred comp costs. Our results this quarter also reflect the benefit of $8,000,000 in net merger cost saves, giving us a year to date total of $18,000,000 We understand the importance of remaining incredibly focused on utilizing cost control as a lever in this environment. We have unique advantages to be able to do so given our merger, and we'll continue to look for further expense reductions beyond our targeted merger savings. Turning to slide 13 14, you see a review of our loan growth and funding profiles relative to combined First Horizon Iberia results.
As expected, period end loan growth was modest as customer demand remains muted, payoffs continue and utilization rates have returned to more normal levels. Bright spot in the quarter was continued strong mortgage warehouse demand, which drove loans to mortgage companies up $1,600,000,000 on a spot basis and approximately $430,000,000 on average. Similar to fixed income and mortgage banking originations, the loans to mortgage companies function as a countercyclical, high return specialty business for us and we expect continued strong performance. On the liability side, period end deposits were up $2,300,000,000 driven by the branch acquisition primarily, as well as continued strong customer inflows, which enabled us to run off higher cost non customer balances. Given current levels of excess liquidity and our enhanced market presence, we expect to continue to move our interest bearing deposit costs lower, particularly as we move to align our pricing strategies across the footprint.
We also further improved our funding profile with $1,200,000,000 reduction in borrowings from 2Q combined levels as we leveraged our excess liquidity to pay down legacy Iberia Federal Home Loan Bank advances. Turning on slide 12, we'll cover asset quality over the next few slides. Clearly, our results this quarter reflect the impact of the merger with a lot of moving parts. But if we step back, broadly speaking, overall asset quality continues to remain fairly benign so far outside of energy despite the impacts of COVID-nineteen. Net charge offs came in at 44 basis points, up from 20 basis points for legacy FHN, driven by energy related losses, and we saw a relatively modest 6 basis point increase in NPLs to 75 basis points of total loans despite the impact of the merger.
On slide 13, you see we continue to add reserves this quarter as the impact of the merger and branch acquisition added 475,000,000 to the allowance for credit losses. Outside of merger math, we also built reserves by a modest 13,000,000 dollars Therefore, we ended the quarter with reserves of $1,100,000,000 which is equivalent to 2.15 percent of the loan portfolio, excluding the low risk PPP and loans to mortgage companies portfolios and about 4 times annualized net charge offs. When you also factor in the unrecognized discount on acquired loans, we have total loss absorbing capacity of 1,300,000,000 or over 2% of total loans. On Slide 14, we provide an update of our view around the portfolios have been most focused on in terms of impacts from the pandemic. We continue to do very detailed portfolio reviews of industries currently affected and in the quarter we reviewed in detail $9,000,000,000 of loans in the commercial portfolio across these various sectors.
As a result of that, as well as other broader portfolio reviews, we believe that just under 11% of our total loans should be and are subject to a heightened level of monitoring. We've shown the subsectors of the portfolio that may be more stressed, such as real estate lending, energy, retail trade and the non fast food portion of our accommodation foodservice portfolio. It's important to note that other sectors such as essential services, recreational goods, manufacturing and home improvement are continuing to perform well. And additionally, our higher quality consumer portfolio is performing well as well with a weighted average FICO score of 7 50 on a refreshed basis. As we've mentioned to date, customers are proving to be more resilient than originally feared and overall stress appears to be declining.
We've provided data in the appendix on the reserve coverage across our portfolio as well as on deferrals, which have now declined meaningfully to around 2.4% of total loan balances from a peak of almost 13%. Overall, we continue to feel very comfortable with our risk profile and reserve levels, particularly after going through the very detailed process of marking the Iberi loan book, which represents about 45% of the portfolio. Moving on to capital and tangible book value per share on Slide 15, as we mentioned, TBV per share of $9.92 remained relatively stable the 2nd quarter as strong earnings were offset by the impact of the Iberia merger and the Truist branch acquisition and the CET1 ratio ended the quarter at 9.15. Near term, we expect to continue targeting a CET1 ratio in the 9 to 9.25 range. Turning to Slide 16 for a merger integration update, we continue to be very energized, as Brian said, by the opportunities ahead of us in connection with our merger of Equals.
In the year since we announced the deal, we've established a strong merger integration framework to help ensure that we capitalize on the opportunities in a highly efficient manner even in the face of the pandemic. We've already done a great deal to align our cultures, processes and systems to ensure a successful integration. We've completed much of HR related integration by identifying leadership and converting payroll systems. And on the customer side, we've built out our go to market and organizational models, as well as finalizing our customer experience dashboard. We are on track to convert various other platforms and are currently planning for the full systems conversion to occur in the fall of 2021.
Again, as Brian said, in the Q3, we delivered $8,000,000 of cost savings, bringing the year to date total to 18,000,000 dollars And in the table on the right, we provided a modestly updated view of our expected saves over time. We continue to be highly confident in our ability to deliver at least $170,000,000 of annualized savings in 2022, but the path of the saves has shifted by a quarter or so. This largely reflects the fact that we now believe it's prudent to target a September October system conversion versus a previous view of a late second quarter conversion. In the table on the right as well, we provided the estimated timing of our merger savings on an annualized basis. In Q3 2020, our annualized expense base, excluding incentives and commissions, totaled about $1,520,000,000 dollars And based on our expectations for the timing of the merger sales, we believe that our 2021 expenses, excluding incentives and commissions, should reflect a low single digit decrease.
Wrapping up on slide 17, we believe we are well positioned to capitalize on the benefits of our more diversified business model over time and through our Arberia merger and the branch acquisition, we now have an expanded franchise across some of the most attractive markets in the South. As we've demonstrated this quarter, we have a revenue mix that helps us offset NII pressure from the low rate environment. We also have the advantage of merger cost saves. And through prior acquisitions and efficiency initiatives, we've proven our commitment to expense controls. Our prudent approach to risk management should help us mitigate credit losses going forward and we have the benefit of the marked loan book and significant loss absorption capacity.
While the economic environment remains challenging and loan demand is muted, it gives us the ability to focus on merger integration for the next year. And we believe our business model will result in outperformance and shareholder value creation in the quarters years ahead. Since I know they're listening, I want to give a quick shout out to all those on our various teams across IR, accounting, finance, credit and technology, in particular, that have done extraordinary work and spent long hours getting us to this point. This is my 47th quarterly earnings call with First Horizon. Now, I've seen a lot over the years, but the complexity and uniqueness of this quarter and the year take the cake.
Thanks to all of you for your efforts. So with that, I'll turn it back over to Brian.
Thank you, BJ. We believe our strong balance sheet capital and liquidity will serve us well in this difficult operating environment. We've maintained strong underwriting standards and built a diversified portfolio focused on profitability and performance in a downturn. Despite the economic headwinds, we are uniquely positioned to capture merger opportunities with enhanced scale, better efficiency and improved earnings power to create significant shareholder value. We are incredibly committed to continuing to assist our associates, communities and customers in efforts to overcome the impact of COVID-nineteen and revitalize the economy.
Thank you to all of our associates for their outstanding commitment in helping us and helping our company and our communities navigate this unprecedented landscape. Again, we're very well positioned. I'm very, very excited about the combination of Iberia Bank and First Horizon and we think we have unprecedented opportunities ahead of us. With that operator, we'll be happy to take any questions.
Thank
Our first question comes from Jared Shaw with Wells Fargo. Please go ahead.
Hi, good morning everybody.
Hi Jared. Good morning.
Hey, maybe just starting on the on credit, I guess, first, what's the credit mark specifically on the energy portfolio beyond just the provision?
Yes. If you we've got about a 7.almost7.5percent coverage allowance coverage for the energy portfolio. That's detailed on Page 19 in the earnings guidance.
I guess, in addition to the allowance, what's the 1:41 hour mark on the acquired portfolio?
The mark on the energy portfolio, I'm not sure I have that in front of me in detail. But like Susan said, we had energy charge offs in the quarter. We replenished the reserve on a combined basis and the reserve on the energy portfolio remains at about 7.5%. So still very healthy reserves.
Yes, for sure. Okay, great. Thanks. And then it looks like you used the August economic baseline in calculating the provision and allowance this quarter. Given that September October have improved, could we view this as a high watermark for the allowance ratio assuming all else equal?
Yes, it's a great question. I would hope so, but we're hoping for the best, but still pretty cautious about what could occur particularly around the election and entering the fall and what could happen with COVID-nineteen, etcetera. So, So, obviously, we feel very comfortable with our reserve levels. We feel very comfortable with the marks that we've made. We continue to take a cautious approach to particularly releasing reserves.
You'll see we had just a very modest build on our reserves, despite the fact that, like you said, the outlook has certainly gotten better from Q2 and even from the August scenarios that we use. So, we're going to continue to be cautious about holding on to reserves for a while, But at some point, clearly, you're going to see that if the economy continues to improve, which we sure hope it does.
Hey, Jerry, this is Brian. If you had asked us 6, 8 months ago and said, how would you feel going into the second 6 months maybe the next 12 months of pandemic, how would you feel about things? I don't think we would have said things would look as good as they do right now. And so we're pleased with the progress. I pointed out earlier the significant impact of the fiscal programs that Congress has put in place.
Vijay mentioned some of the uncertainty that still exists in the environment. And we still believe, I believe very strongly personally that in certain sectors of our economy, consumers and some of the more severely impacted industries associated with social distancing and the fallout of the pandemic needs some targeted fiscal support. So I believe strongly that the next several weeks, days, maybe, but weeks, months of how Congress deals with additional fiscal support is going to set the direction for the next several quarters. I'm optimistic today. I think they're making progress.
But as BJ said, with the uncertainty, we think it was appropriate to maintain strong reserves going into the Q4 and the turn of 2021.
Okay. That's great color. Thanks. And then I guess maybe just a bigger picture question. Do you feel like you're able to maybe more immediately go on the offense and take advantage of some of the market disruption in your markets from either larger competitors or larger deals that have happened?
Or are you still more focused on integration first and that more of an offensive stance would be end of the year I'm sorry, end of next year?
Well, depending on how you define offense, Jared, I would say, I think we are very front footed in terms of taking an opportunity in the market to pick up new relationships. And while I didn't mention it earlier, we're seeing the beginnings of very nice revenue synergies between the 2 organizations Iberia Bank and First Horizon. It is very it's an environment that is somewhat unique and that you've got to be cautious as you look at what you put on the balance sheet and how you use the balance sheet, but we're looking for opportunities to take advantage of this dislocation and we've seen benefits from the PPP program and we think there'll be additional opportunities down the road. If it relates to further M and A, that's not really in our frame of reference today. We're focused on the merger and the integration that we have in front of us.
I said earlier, I'll repeat, it's a tremendous amount of work between now and early September of next year. As BJ said, our teams are working really, really hard and doing a great job and I'm excited about what our associates are going to get accomplished, but that's most important and then we'll figure out what's next after that.
One thing I would add to the question about opportunities for the offsets, we are seeing what I would call some generational opportunities with prospects that our bankers have been calling on in various markets for, in some cases, years that are really great opportunities to bring those into the fold to become clients. So these are businesses that have survived through many cycles that we know well, and opportunities to bring those over. But we are being selective, as you can imagine, at this time. But we do remain open for business for the right profile, the right industry and the right client selection, which has been important really to both legacy banks for many, many years.
Our next question comes from Ebrahim Poonawala with Bank of
America.
Vijay, I guess if you can just start with net interest income, I think you gave the and the margin, 1, in terms of your margin guidance for, I guess, down 10 basis points plus or minus. Is that on a do you expect that decline in the core margin? And then when we look at the $454,000,000 in core NII, do you expect that number to go higher or lower in Q4 and beyond?
Yes, so let's see, let's start. When I said high single digit, low double digit, that was more on the reported NIM side. I think we can be a little bit better on the core NIM due to opportunities around further deposit rate paid reductions, some of the opportunities that we're seeing in higher yield portfolios like loans to mortgage companies, putting excess cash to work and those types of things. So, I feel pretty good about that. Clearly, as you know, in merger accounting, we had a higher level of accretion this quarter, which we expect to be modestly lower in the 4th, which is driving a lot of the decline in the reported NIM.
But as I've said, we expect the NIM to bottom out in the 4th quarter and then into next year be relatively stable to hopefully modestly improving as we do some of the things that I just mentioned.
And the core NII for $54,000,000 do you think that goes higher from here or lower?
Yes. So, like I said, if the margin is if the core margin, I think, is relatively stable, maybe down a little bit into the 4th, but bottoming out, then it's going to be a question of how do we put the excess cash to work, improve the deposit rate paid and see what kind of loan growth that we can have in terms of opportunities into 2021. So, I guess, to your question, I see it kind of bottoming out and then being able to hopefully improve into 2021 if the economy gets better.
Got it. So we should expect some decline in Q4 in line with your sort of core NII core NIM decline, but from then on, it should stabilize as we look into the first half of next year. Is that reasonable?
Yes. So, I'd say, you know, the core NII, we think, could be flattish going into the Q4 and then hopefully improving with opportunities going into next year.
That's helpful. I'm sorry to ask so many questions on that. I think there's just a big divergence in terms of expectations around NII next year. So it's helpful in terms of the color you provided. And just in terms of expenses, so thanks for the update on what the cost savings tied to the integration.
Both First Horizon and Iberia had a pretty strong track record in terms of expense management. We are seeing banks kind of take another look at real estate costs, other expenses coming out of the lockdowns. Just talk to us in terms of what's the opportunity like in terms of expense savings meaningfully exceeding the $170,000,000 that you laid out?
Yes. So I think you've heard Brian use the term $170,000,000 plus. I use the term at least $170,000,000 So, clearly, we are very confident in our ability to get the $170,000,000 and that's not even an issue for us. We are looking beyond that to find further cost reduction, which we're highly confident that we can capture. We want to make sure that we get all the 170 in the numbers, but we are working on things like customer behavior changes and the impacts on branches and how customers want to do business with us.
We have 5,500,000 square feet of office space and branch space that we certainly think that we can optimize further over time, given changes due to the pandemic. And we are working very hard as we put our systems and processes together to find opportunities to use the systems upgrades and new systems that we're putting in place to find further process improvements and do a lot of work around RPAs and so on, which Anthony and Randy and their teams have great expertise at. So, we are confident that the 170 is going to happen. It's a question of how much higher. And so, we'll come out further in the 4th quarter and into 2021 talking about further plans that we have to continue to get cost saves.
But this is a journey, not a destination, particularly given this environment, we're highly confident we'll be able to deliver as we have before.
Ebrahim, this is Brian. To add to BJ's comments, I think he's exactly right. You have to keep in mind that we have a lot of moving parts right now with the integration and we want to be thoughtful about how we put the 2 organizations together and not do things that damage the customer franchise while we integrate. So we're being thoughtful about expenses. That said, BJ is absolutely right.
We think we can do and we'll do more than $170,000,000 and we don't think we should try to pin the tail on that number today, but we will sometime in the not too distant future. It is clear to us that the effect of the COVID-nineteen experience and the pandemic has changed customer behaviors probably for the long term, it has changed our work habits, it has changed a lot of things, then we believe very firmly that we need to factor all of that into how we put these 2 organizations together, how we look at expenses, what our branch, our banking center coverage looks like. And BJ went through a lot of the important details that we're looking at. So it's a work in progress. Committing to doing more than $170,000,000 We'll be back to you with how much down the road.
Got it. Thanks for taking my questions.
Yeah.
Our next question comes from Steven Alexopoulos with JPMorgan. Please go ahead.
Hey, good morning, everyone.
Hi, Steve. Good morning. Hi, Steve.
So first, just a follow-up, BJ, on your comments for the core NIM to hold stable in the Q4. It seems that excess cash is going to build, right? So you're going to have even more weight on the NIM in 4Q. It's a thought that at least in the short run, you realign deposit costs. I don't know if it's a 4Q event that you get to the mid-20s and that's the near term support.
And then from there, you deploy excess cash and that's what provides further support to them because it would appear core NIM would go down in the Q4 based on just the cash
phenomenon? Yes. So Steve, good question. Our current expectation is that we are able to put more of the excess cash to work in the Q4. So, we did see it increase into the end of the period from some of the averages, but the strategies that we're contemplating now, including letting contracts expire on market index deposits, some of the things we're thinking about to soak up the excess cash around either loan portfolio or securities portfolio and other things, we think that we can move the excess cash position down.
The other is, we still think that there is opportunity in loans to mortgage companies as well, which is a very efficient use of our excess cash. And so, usually, seasonally, that business can be down, but given the very strong environment that we're seeing today in the mortgage space, we think that it could hold up in terms of balances in the Q4.
Okay. That's actually very helpful. And then on the reserve, I hear the comments, right, you're still cautious given we are still in the middle of a pandemic. But when we look at the reserve, right, it's $1,000,000,000 it's 1.8 percent ex PPP and that's on top of the credit mark. If and if you have strong loan growth in mortgage warehouse, you don't really need reserves for those.
So if the rest of loan demand is somewhat muted, why would you need provide any additional provision over the next few quarters?
I hope you're right. I think, as I said in the beginning, we're taking a pretty cautious stance at this point, right. It's a lot easier to be conservative at this point and hold reserves and then release them as opposed to be too quick to let reserves go and then see a reversal of the improvement in the economy and have to build reserves again. So, I'm highly confident again in where our reserves are and our loss absorption capacity and I do think that eventually we will release reserves, but we think it's a little too early to make that call at this point.
Okay, thanks. And then finally, you guys are pointing out that the 3 year plan is finalized are getting finalized in the Q4. Brian, should we expect anything material from that terms of revenue or additional expense initiatives? What should we get out of that? Thanks.
Well, yes, I don't think that in the short run you should expect any significant shift in our business. This is really bringing together the combined organization. The team has done and Anthony Restell has done a good job leading, but the team has done a great job pulling the strategy together and what I think that you will see out of it is where we're going to focus in markets and product set and it's about how we have combined focus as an organization. Then and as we said a couple of different ways, clearly expense control will be an element of that. But what we're really trying to focus on is beyond the integration, what is it that we need to be executing on to be on the ground running through the integration and then most particularly to really pick up momentum when we get that completed in September of next year.
So it's got a strong focus on markets and where we invest, where we put people and product, how we work on our cross sell opportunities, the revenue synergies that exist by bringing the combined product set together. And we believe given what we've seen on a macro basis in the U. S. That the states that we do business in, the markets that we do business in are going to be very positively impacted by the migration of people and businesses and opportunity and we just want to be positioned to make sure that we take full advantage of that. Great.
Thanks for all the color.
Sure thing. Thank you.
Our next question comes from Brock Vandervliet with UBS. Please go ahead.
Thank you. Just I guess piling on to Steve's question on the reserve, Vijay. I mean, what do you need to see to tap that reserve? Because I think the point here is that relative to peers, you're very well set up. Is this something that a Moody's outlook would reveal where you'd have the confidence?
Or is it, hey, you just doubled the size the bank and give us a couple of quarters, but we get it, it's coming down. Any further color there?
Yes. So, the way these models are built, as you know, is that the quantitative part of the models are driven largely by our historical loss history as well as what the forward view is as informed by the Moody's scenarios. We then create qualitative overlays, particularly in stressed portfolios and sectors where we have a little bit more concern or uncertainty around it. And as you might imagine that if the outlook continues to get better, which we certainly hope it does, the quantitative models are going to tell us to release reserves and at some point, we're going to be comfortable that the qualitative that we have aren't needed. So, again, I think we are well reserved.
I do think reserves will come down into next year. It's a question of timing and we just think at this point, given continued uncertainty that it's better to hold it as opposed to release it. But we are confident that we are well reserved and we'll be able to do so.
And regarding the, I believe it's 2.4% deferrals, what do you see is the end game there? Are most of these going to return to normal P and I payments and a chunk restructured with very little real breakage or for something different? How does that how do you think that plays?
Brock, based on even what we've seen of when it was at a higher level a couple of quarters ago, many are returning just returning to making their payments. Some of them were cautious in the beginning and just said, if I can take a deferral, I will. There will be some clearly that we will work with to restructure, but at this point we're seeing very, very few clients ask for that, what I would call a 3rd round of deferral, which I think is very good, which is why the active deferrals have come down so dramatically. But we are, as you saw on one of the pages where we talked about our perceived updates on areas of perceived risk, I think that was Page 14. In addition to overlays by portfolios as a whole, we continued we did it in Q2, Q3, we'll do it in this quarter and as long as we need to with any sort of uncertainty around COVID, we're also doing deep dives with individual clients.
So we've got really good insight. And one of the things that I continue to feel very good about is the fact that our prudent underwriting in the beginning, the client selection and seeing our business owners, guarantor sponsors working with us during this time, we've seen a lot of think, positives around that. So you'll see your question was what are you going to see? I think you'll see some of all of that. You'll see some that will just return to normal.
You'll see some that we'll have to work with on a longer term basis. And so we stand ready client by client to make that happen.
Okay, great. Thanks for the color.
Our next question comes from John Pancari with Evercore ISI. Please go ahead.
Good morning.
Good morning, John.
Hey, John. If I could just kind of beat the dead horse a
little more here on the reserve, if I could kind
of go about it this way,
and can you just maybe give us a little bit of the granularity of your credit details behind what may have influenced your thoughts on reserve, particularly do you have your criticizing classified asset trends for the Q3?
Yes, we do. Hey, John, this is Susan. So overall, our criticized went from 2.7 to 3.3. Now that's on a obviously combined basis for Q2 to Q3 with both banks. So you did see some increase of about $400,000,000 that moved into the criticized category.
We in terms of the portfolios where we looked at doing a qualitative overlay, there's a portfolio as you would imagine that we would. And if you look at the areas of perceived risk, we have an additional overlay for energy, additional overlays for hotels, for retail and for some of the non profit and also the casual dining full service. So those are areas where I think Brian and BJ have said that on many of these questions. We do we're seeing some things loosen up. We're seeing some trends that we like, but we just think it's too early to be thinking about releasing reserves.
But based on what we know now, we should be able to do that in a quarter or 2 if we continue to see good trends.
Hey, John, this is Brian. To use your phrase, there are a lot of ways to come at beating this dead horse. And at the end of the day, CECL implies a heck of a lot more precision than actually exists in reality. And we sort of look at this as a bit of an art and we apply these overlays mainly because it is too early and it is a degree of uncertainty about what will happen in terms of fiscal stimulus and how the pandemic plays out, how far away are we from therapeutics, how far away from a vaccination. There is no intended signaling whatsoever that we see something about the portfolio that causes us to just keep them up other than we believe that we will lean into the art.
We remain conservative as it's been our practice over many years and we will continue to evaluate it. We're as I said optimistic about how things are positioned today on October 22 or 23rd whatever the day is. And we think this can play out very, very well. And when it does, we'll release these reserves and they'll come back.
Okay. Got it. Thanks, Brian.
And then separately on the expense side, BJ, are you can you kind of just repeat the expense guidance for 2021? I think you had indicated, did you say a low single digit, did you say decrease including incentives and commissions?
Yes, John, thanks. So what I said was that our expense base excluding incentives and commissions, which as you obviously know are going to rise and fall with revenue related fee income, We expect that expense base ex incentives and commissions to be down low single digits.
Okay, got it. And
that is on a full year 2021 versus full year 2020 basis?
Yes. And as you noted I'm sorry, go ahead, John. Go ahead.
No, go ahead. I'll ask after you.
I was just going to add quickly, if you look at our press release and the supplement, we did reorganize the expense line items a little bit to make it easier for you all to explicitly see the incentives and commissions broken out from the rest of the expense base, such that it's easier for you to visibly see the expense discipline and the merger cost saves as they come through.
And John, it's Ellen. Just one thing I want to clarify. So if you we gave you our 3rd quarter expense base excluding incentives and commissions at the 1.52 because remember the first half of twenty twenty excluded AbbVie KC. So you got to utilize that 3rd quarter annualized base.
Right, right.
Okay. And does the base also exclude the charitable contribution and merger charges as well?
Yes. That's the adjusted basis number that I just that we just referenced.
Yes. Got
it. All
right. That's it. Thank you.
Thanks, John. Thank you.
Our next question comes from Ken Zerbe with Morgan Stanley.
So thanks for pointing out all the one time items. But aside from the 3 or 4 notable items that you guys called out, were there any other line items in the income statement that were impacted by, I'm just going to say volatility that might not recur in future quarters?
Well, I think we mentioned the true up of the IBKC benefit. So from a linked quarter perspective, there was an initial step up there that will persist, but you shouldn't see a repeat of the step up.
That's right. Yes, Ken, I can't think of anything that we would specifically call out for all of you. I think, broadly speaking, what John just asked about our expense base from 3Q 2020 annualized versus 2021, it would all be captured in there. We wouldn't call anything else out other than the notable items.
Got it. Okay, perfect. Go ahead.
I was just going to say, you'll see over the course of coming quarters, you'll see normal seasonal variability in certain line items.
Got it, of course. I guess I was just looking and so the next question is, but I was looking at the mortgage banking line, which is obviously very strong this quarter, certainly well above sort of Iberia's run rate basis. Just with mortgage banking, like how do you see that playing out? I mean, obviously, it sounds like 4th quarter is going to remain strong, but where does that sort of normalize when we think about 2021?
Yeah, Ken, we still think that for the foreseeable future and I can't exactly put a fine point on foreseeable future, but we think that the countercyclical businesses are going to remain strong. I mean, if you look at mortgage origination volumes and home price demand, it is still very, very strong. And so, we are benefiting from that. And so, we expect that that's going to continue for both the mortgage origination side as well as the loans to mortgage company side. I would say that we had, if you look in our information, very strong gain on sale percentage this quarter.
We still think that volumes are going to be high. Gain on sale was probably higher than what it would normally be going forward. We expect that to moderate a little bit. But in aggregate, we expect that these businesses will continue to drive outperformance and help us offset some of the NII headwinds that we see.
All right, great. Thank you.
Sure.
Our next question comes from Brady Gailey with KBW. Please go ahead.
Hey, thanks. Good morning, guys.
Hey, Brady. Good morning. Good morning.
I wanted to start with loan growth. I know when we talked about it last quarter, you said to expect kind of modest loan growth at best. It seems like loan balances, if you back out the acquisition noise, were up a little bit organically in the Q3 from the mortgage warehouse. But as you look forward, how do you think about loan growth? A lot of times when you do big acquisitions like this, there is some loans that tend to run off.
So do you expect to see kind of some near term loan shrinkage in 4Q? And then just how do you think about loan growth as we look into 2021?
Yes. So, I will start and Brian and Susan can jump in. But there are a few areas of growth that we think can certainly help us going into 2021. Loans to mortgage companies, of course, we continue to think could be strong. There are specialty businesses beyond loans to mortgage companies, like asset based lending, like equipment finance, that are very strong today and we expect those to continue going into next year.
We don't have any portfolios aside from what we are doing to manage our exposure to energy, of course, but more broadly speaking, we don't have any other portfolios that we are actively managing down or managing off. So, I don't expect any material step downs in terms of other areas of portfolio. But traditional loan demand broadly across consumer and commercial portfolios is, like we've said, pretty muted at this point. So, we do have pockets of opportunity that can offset some declines. So, we don't have very high expectations for loan growth going into 2021.
That's not because we don't want to look for new opportunities. As Susan said earlier, we are and we will, but it's just the nature of the environment right now that we've got to pick our spots.
Okay. So not a ton of growth next year. If you look at, I heard you guys say that common equity Tier 1, the targeted range is 9% to 9.25%. You're at 9.15% now. I mean, with decent profitability and not a lot of growth, that ratio, I'm guessing, is going to move higher pretty rapidly.
So how do you think about buybacks seem off the table this year, but as we look into next year, 2021, how do you think about share buybacks as your common equity Tier 1 moves over the top end of that targeted range?
Yes, Brady, this is Brian. It's clearly our desire to put capital to work in organic growth opportunities. And so, we're always looking for that is the first way to leverage our balance sheet. And we'll know a whole lot more about what 2021 loan growth looks like when we get past the turn of the year. We're very conscious of maintaining a strong capital base.
The dividend and the buyback are clearly vehicles for repatriating capital to shareholders that we can't put to use in the balance sheet. So I don't want to get out in front of our board and the discussions there. I feel very, very good about where our dividend is. I it's unlikely in the near term that we start the repurchase program, but we're constantly looking at how that capital ratio builds and how it fits into our expected usage in the balance sheet. This problem that we all sit here with today and it's universally true of the financial services industry, there are more known unknowns than we've ever experienced and we'll all be smarter in 90 days.
And so we'll have a more clear view of where we think that capital goes. But to your basic point, we think that capital will accumulate that we will see growth in not only our Tier 1 CET1, but we'll also see growth in our tangible book value.
Okay, great. Thanks guys.
Sure.
Our next question comes from Christopher Marinac with Janney. Please go ahead.
Hey, thanks. Susan, when you talked about the criticized assets being at 3.3, does that include the higher risk items that are on Slide 14?
Yes, that's the total that's total criticized. Okay. All criticized in class risk. It's 3.3%.
Not everything in the higher risk category is a criticized
asset. Yes. Yes.
It's a subset of the 3.3.
Those are just the
That's one one.
The ones we highlighted for you on page 14 are just ones that areas that we're paying very, very close attention to and are a big part of these portfolio reviews that we're doing. And I'll go ahead and say this, there are things on this page that I think we're even being conservative calling as a higher risk because of how we've underwritten and things we're hearing about from our clients. So, we wanted to kind of give you the full list, but I would say within some of these things, I'll give you an example. Our CRE Retail is very much a value oriented. Many are grocery anchored.
We've seen variable issues there With the most recent portfolio review we did, we saw very few problems in that portfolio. So I just wanted to tell you, I think even this list, this perceived risk is we're on the conservative side, but I
believe that's how we want
to be. You've heard Brian and BJ say that on other questions on this call. We just want to be prudent and cautious during this time until we kind of get through things like the election, potential vaccines, etcetera, and see how the economy as it continues to open up. But we are pleased with what we're seeing even in some of these areas of procedure.
No, that's helpful background. Thank you both for that. I just I was just curious if the trend would be to see more migrates on to criticize or could it possibly go the other way or perhaps it's too soon to tell?
Yes, I think, I mean, again, we are again touching these every quarter. Could you see a few of them go criticize? You could, but based on what we know now, we've got them graded the way we believe they need to be graded. The other thing is, we are actually seeing some upgrades too. So there are pockets of industries that are doing We point out an example of that, within the hotels, and we're in some of these markets.
We've been in these markets a long time that are doing really, really well with the mountain areas, beach areas where people can drive. We've talked to clients who were having, even within hotel portfolios, their best year ever. And it's a combination of people wanting to just get away. They can still work from there and these hotel operators are able to do it with a lower expense base. Same thing with quick serve restaurants.
Many of them still are just drive through only and their expense base is down. So what's dropping to the bottom line is even better than 2019. So that's what I think is so important, the fact that we've gone in and done this portfolio review, we're talking to individual clients. But again, still being cautious and wanting to highlight for all of you the areas that we continue to look at quarter over quarter during this COVID situation.
Our next question comes from Jennifer Demba with Truist Securities. Please go ahead.
Thank you. Good morning.
Particularly hotels? Thanks.
Jennifer, this is Brian and a word no. We feel good about the quality of the portfolio. We are very confident in what we know about it and it doesn't seem to make any sense to me or to us to sell it at a significant discount so somebody else can profit on the performance of that portfolio. So we'll have a few problems here and there, but overall we feel good about it. We feel good about our reserve levels and we don't have any interest in selling any of it.
Okay. Thank you.
Sure.
Brian,
this is a more longer term question. What are your thoughts about remote working for your employee base going forward? Is the new normal going to be some combination of in office and remote working for almost everyone? And how do you maintain corporate culture with more remote working? Thanks.
Yes, that's a I think a fantastic topic and I think it's a we framed it very well. We spent a lot of time talking about that very thing and Vijay mentioned the 5 +1000000 square feet of space that we have. We think people are going to work differently. There's no doubt about that. Customers are going to perform differently and it is going to be different.
I worry more about the downsides of managing corporate culture, the conversations that don't happen because you don't get an elevator ride with somebody you thought about, hey, I need to next time
I see them, I need
to say this or have this conversation. I think it's really a big downside in the sense that if you onboard new people, when you bring in new bankers, how do you bring them into the culture? How do you mentor people? How do you develop people? So I think we've got to find sort of a balance and I think we'll end up as you suggested in a bit of a hybrid environment where people work more remotely for a portion of their time and we figure out how we spend the time we have together in a more quality fashion, so that we don't just assume everybody is going to see everybody every day.
So I don't think anybody on our side believes we've got it figured out today, but we're paying a lot of attention to it. And I think while we could go cut out a lot of office space and do things remotely because we've proven with technology that it works, you really have a hard time as you said maintaining corporate culture in a 2 dimensional framework of a WebEx or or Zoom conference call. So it's something that we're clearly paying attention to.
This concludes our question and answer session. I would like to turn the conference back over to Brian Jordan, CEO, for any closing remarks.
Thank you, operator. Thank you everyone for joining us this morning. As we've said a number of different times this morning, we're optimistic about how we're positioned. We're optimistic about what our combined organization is capable of doing. We're optimistic about the opportunities we see in our markets with expanded customer product set as well as the ability to bring the full suite of products of the combined organization to bear on existing relationships.
If you have any questions or any additional follow-up, please let any of us know. We're more than happy to provide you additional information. Thank you again for interest in our company and I hope everybody has a great weekend. Take care.
The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.