Good morning, and welcome to the First Horizon National Corp. 2nd 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 so much. Good morning, everybody, and thanks so much for joining us. We know it's the end of what's been a really busy week. On our call today, our CEO, Brian Jordan and CFO, BJ Loesch will provide an overview of our results and then we'll be happy to take questions. We're really pleased to have Susan Springfield, our Chief Credit Officer, with us to assist in that effort.
Our remarks today will reference the earnings presentation, which is available at ir.fhnc.com. I should note that we will make forward looking statements that are subject to risks and uncertainties, and you should review the factors on Page 2 of our presentation and on our SEC filings that may cause our results to differ from those 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 should absolutely review the GAAP information in our supplement and on Page 3 of our presentation. And with that, I'm going to hand it over to Brian.
Thank you, Ellen. Good morning, everyone. Thank you for joining our call. In this most unusual environment pandemic related economic slowdown, we've had a very good quarter and I'm very proud of the work that our team has accomplished. On July one, we closed our MOE or merger of Equals with Iberia Bank.
This merger creates a leading Southern franchise with strong demographics and the ability to drive efficiency and create significant shareholder value. Given the disruption created by the COVID-nineteen pandemic, our associates across the expanded platform have been working to tirelessly support clients and communities by originating PPP loans, providing loan deferral assistance, waiving fees, all while effectively managing risk. At the same time, they have continued to ensure that execution on the Iberia integration as well as the branch acquisition remain on track. Our expanded franchise strengthens our geographic reach and depth, provides improved ability to better serve our customers and community, provides enhanced growth opportunities and gives us scale to compete more efficiently. This quarter, we delivered solid results with strong P and R growth driven by strong fee income performance and good expense discipline as our countercyclical businesses help mitigate environmental headwinds.
Our fixed income business delivered strong results and NII remained relatively stable as we grew average loans led by loans to mortgage companies and the PPP portfolio. During the quarter, we built our loan loss reserve by $93,000,000 raising our allowance to loans coverage to ratio to 1.6% or 2% excluding lower risk loans to mortgage companies and the PPP portfolio. We are continuing heightened monitoring and review of the loan portfolios in order to evaluate the impact of COVID-nineteen on our customer base and ensure that we are prudently managing risk while helping support customers and the economy overall. Vijay will give you details about economic assumptions supporting our reserve level, but I believe that we are taking appropriately cautious view. In the quarter, we further bolstered our capital with debt and preferred share issuances.
As expected, our CET1 ratio increased over 70 basis points linked quarter to 9.3%, which positions us well as we look toward the second half of twenty twenty. While we acknowledge that the microeconomic backdrop and industry landscape remain very challenging, we believe our combined company remains well positioned to drive enhanced shareholder value over the medium term. With that, I'll turn it over to BJ to take you through the details. BJ?
Great. Thanks, Brian. Good morning, everybody. Happy Friday. As I'm sure you know, but as a reminder, our MOE with Iberia closed on July 1.
Therefore, the 2Q results I'll be discussing are for First Horizon's standalone. Later, I'll give you some highlights of Iberia's stand alone results for the quarter as well as some key Legal Day 1 impacts from the merger closing that you should expect to see in our 3Q results. With that, let's start with some highlights of our 2nd quarter adjusted results. As Brian mentioned, we delivered strong PPNR growth, which was up 13% linked quarter and 2% year over year. Despite the challenging interest rate environment and macroeconomic back drop, revenue was up 7% in the quarter and 11% year over year driven by strong fee income growth with stable net interest income results.
We think this quarter in particular really highlights the benefits of our countercyclical fixed income and mortgage warehouse lending platforms that are helping mitigate some of the headwinds that we are seeing across the banking industry. We generated nice balance sheet growth and continue to manage our deposit costs down. And given the environment, we continue to be highly focused on expense discipline. Of course, CECL is the factor driving provision costs higher for the banks overall. And as we updated our models for the further downdraft in the economic outlook compared to March, we built our loan loss reserves by an additional $93,000,000 or $0.23 a share.
Moving to Slide 7, you can see that solid loan growth and disciplined deposit pricing helped us generate modest NII growth in the quarter despite a 26 basis point decline in the margin. As a reminder, our asset sensitivity is most highly correlated to 1 month LIBOR, which was down 105 basis points on average during the quarter, putting significant pressure on loan yields. In addition, because of strong customer liquidity, the NIM was pressured further by excess cash balances, which created an additional 9 basis point drag on the margin. At the same time, we continued to lower our deposit costs overall, which were down 40 basis points in the quarter, and the margin benefited from the addition of over $2,000,000,000 of PPP loans and the associated fees, which helped offset some pressure from lower accretion. As we look forward, while it will be challenging offset the additional headwinds from the rate environment, we will continue to look for opportunities to bring deposit pricing down further and more efficiently manage the balance sheet while still maintaining a prudent stance on liquidity given the uncertainty in the overall landscape.
Looking forward, we could see the NIM compress further possibly in the mid teens range primarily due to the addition of the Truist branches. Those branches will provide about $2,000,000,000 of additional excess funding, which will further improve our liquidity profile, loan and deposit ratio and profitability over time, but will temporarily depress the margin while we find ways to put the excess funding to work over the next few months. Briefly on Slide 8, fee income was up 18 partially offset by lower deposit card and other bank fees given impacts from COVID. While our more traditional banking fee income lines were challenged in the quarter as others have seen across the industry, given that some of our markets have begun reopening, we did start to see some improvement at the end of the quarter in debit card and ATM volumes as well as a pickup in wealth. Fixed income revenue in particular was up 19% linked quarter and 77% year over year as we saw strong sales activities and a turnaround in trading results following the challenging conditions that occurred in March.
As a result, the team delivered average daily revenue of $1,600,000 during the quarter compared with $1,300,000 in the first. Given the overall landscape, we believe the fixed income business remains very well positioned to capitalize on its extensive distribution platform and experience sales force to drive continued solid results. On Slide 9, quickly cover expense trends as we remain committed to a highly disciplined approach to managing the cost base. Given the swing in market valuations, we saw an increase in employee compensation costs driven by a $20,000,000 increase in deferred comp related to market changes, which is offset by increases in other income. Outside of this, our results benefited from lower stock based compensation, Size 91 deferrals and lower operating costs overall largely tied to the impact of the shutdown.
Importantly though, we were able to take an additional $3,000,000 of costs out in connection with our Iberia merger during the quarter as was Iberia. So overall, we have achieved a total of $10,000,000 in merger savings between the two companies over the first half of this year, meeting our expectations we set back in November when we announced the transaction. We continue to be very confident in our ability to generate the merger cost savings of $170,000,000 over the next 18 months. On Slides 1011, we provide a view of our loan growth and funding profile. As I mentioned, we generated healthy average loan growth of 11% linked quarter and 18% year over year driven by loans to mortgage companies, which were up on average $1,700,000,000 linked quarter, reflecting strong refi volume due to low rates.
We also picked up $2,000,000,000 in PPP loans as well. And the balance of the C and I portfolio saw declines tied to lower line utilizations from the peak that occurred in early April as commercial customers' position started to improve in the wake of government programs and reopenings resulting in a reduction in the defensive draws that we saw in the end of the Q1. As Brian mentioned, customer sentiment remains cautious, and we do expect only modest loan growth at best for the second half of twenty twenty. At the same time, we've continued to work to further enhance our funding mix in capital stack. Deposits were up 11% linked quarter, driven by strength in DDA and savings.
In the regional bank, we saw customer deposits rates paid decreased to 24 basis points from 59 basis points. Overall, we lowered our interest bearing deposit costs 52 basis points in the quarter to 38 basis points. And while the mix of our deposit base will be a little different going forward than in the last rate cycle with the addition of Iberia and the Truist branches, we do think it's helpful to note that in the Q3 of 2015, our interest bearing deposit costs ended at 15 basis points. We also felt that in the face of continued economic uncertainty, it was important to continue to augment our capital and liquidity stacks. Since April, we've issued $1,250,000,000 of senior sub debt and preferred securities.
We issued $800,000,000 of Holdco senior debt, prefunding a $500,000,000 maturity coming due in December, $450,000,000 of bank sub debt and $150,000,000 of holding company preferred. On Slide 12, you'll see that as expected, we had a nice bounce back in our capital position from unusually low first quarter levels that were driven by outsized period end loan growth, primarily from loans to mortgage companies. The CET1 ratio was up over 70 basis points to end the quarter at 9.3%, while total capital increased 170 basis points to 12.5%. Our strong PPNR, sub debt and preferred issuances and a reduction in risk weighted assets drove our capital levels higher and give us ample cushion as we prepare for the future. While there will be many moving parts next quarter, obviously, as we close both the Iberia transaction and the Truist branch acquisition, sitting here today, we would expect our CET1 ratio to be in the low 9s in the 3rd quarter.
Additionally, on slide 13, you can see we ended the quarter with really healthy levels of reserves. Allowance for loan losses totaled $538,000,000 or over 8 times annualized net charge offs. We built the reserve by $93,000,000 entirely attributable to anticipated further deterioration in overall macro trends. We think it's important to note that while our model is most heavily weighted the Moody's May 27 baseline scenario, we supplemented it with alternative scenarios and did very detailed portfolio reviews of industries currently affected by the pandemic. We also incorporated additional factors such as the reemergence of COVID cases, additional geographic data, impact of stimulus programs and overall economic uncertainty.
For your reference, we have a detailed table in the appendix that shows reserve coverage by portfolio. Our coverage, again, excluding PPP and loans to mortgage companies, which have exceptionally low to no loss content in them, stands at around 2% on a stand alone basis. Moving to Slide 14, you can see that overall the asset quality picture still remains relatively benign. While we continue to monitor our loan portfolios carefully, the net charge off to average loans ratio came in at 20 basis points with the losses this quarter driven primarily by 2 credits, one loan in energy and the other in the franchise finance portfolio. We've given some details on deferrals at the bottom of the page.
And as you can see, total deferrals of both commercial and consumer portfolios were at $3,800,000,000 representing low percentages of customer accounts overall. Interestingly, more than 40% of customers that asked and received deferrals have made at least one payment since being on deferral status. We will continue to work proactively with these and all of our customers and monitor the portfolios carefully. Let's shift now to Slide 15 and look at Iberia results and expected impacts from the closing of our MOE. 1st, we provide Iberia Bank's standalone second quarter financial highlights on Slide 15.
We plan to file pro form a financials for the combined company later in the quarter, but thought it was important to provide some information to continue to illustrate the power of the new expanded and more diversified franchise. Iberia Bank also delivered solid PPNR, which was up 7% linked quarter. Net interest income was relatively stable as loan growth of 7% linked quarter was more than matched by 8% deposit growth helping to mitigate some of the interest rate headwinds. Iberia generated record fee income, up over 30% from the Q1 and over 45% year over year fueled by strong momentum in mortgage origination income with a healthy mortgage pipeline at the end of the quarter. Of course, provision expense in the quarter was up significantly as well given the impact of the updated outlook to the macro environment.
But now let's move on to cover our expectations for the impact of the merger accounting on Slide 1617. As of July 1, we updated our estimates for the marks on the portfolio based on the current landscape and a detailed review of those portfolios. You can see on Slide 16 that we expect to record a total of $720,000,000 or 3% of loans, including total marks of $560,000,000 for credit and interest rateliquidity and $160,000,000 of non PCB double count. The $720,000,000 of total initial marks will show up as follows: approximately $460,000,000 of it will go into the allowance for loan losses approximately $260,000,000 $160,000,000 related to the non PCB discount and the $100,000,000 of interest and liquidity mark will be an initial reduction of capital, but will accrete back through net interest income over time. And at the bottom of the slide, we have laid out for you of you can see that we now currently estimate total credit of the total credit marks that a little over half or about $12,600,000,000 of the portfolio will be considered purchase credit deteriorated, PCB, with the remainder of the portfolio designated as non PCB.
It's important to note that the PCB designation as defined by CECL does not mean that the loans are bad it's not intended to be an indication of perceived loss content associated with the portfolio. So the initial marks will reduce our CET capital by about 20 basis points at close. On Page 17, you can see the current estimate of the merger accounting adjustments, which will result in a roughly $500,000,000 non taxable gain that will be recognized through the income statement in our Q3 results with a roughly $2,800,000,000 addition to tangible common equity. On Page 18, we provide a reminder of the $170,000,000 in expense savings that we are targeting for the combined company in connection with the merger. And as I mentioned earlier, we have achieved around $10,000,000 so far in the first half of the year with $6,000,000 in this quarter alone.
We expect to have an exit run rate at the end of 2020 of 25% of our targeted cost saves, and we are well on our way to achieving that. Our integration efforts are on track, and we are confident in our ability to deliver on the savings and the benefits of the merger with the strong belief that we will be able to exceed our targets. So with that, Brian, I'll hand it back over to you.
Thank you, BJ. With our strong balance sheet, business mix, including our countercyclical businesses, our strong capital base and liquidity, they will all serve us well in this difficult environment. We have maintained underwriting standards that are very strong and built a diversified portfolio focused on profitability. Despite the economic headwinds, we are uniquely positioned to capture with enhanced scale, better efficiency and improved earnings power to create shareholder value. We will continue to assist our associates, communities and clients' efforts to overcome COVID-nineteen's impact and revitalize the economy.
Thank you to all of our associates for your outstanding commitment and efforts in dealing with these unprecedented times. With that, Andrea, we'll now take questions.
We will now begin the question and answer session. And our first question will come from Brady Gailey of KBW. Please go ahead.
Hey, thanks. Good morning, guys.
Good morning, Brady. Hey, Brady. Hey, Brady.
If you look at loan growth, excluding the mortgage warehouse and excluding PPP, I think period end balances were down a little late quarter. Maybe just comment on I saw utilization went down. Maybe just comment on 2Q's loan growth kind of ex warehouse and ex PPP. And then, B. J, I heard you say you expect modest loan growth at best for the back half of the year, but maybe just a little more color on how you're thinking about loan growth going forward?
Hey, Brady, this is Brian. I'll start and then Susan or BJ can pick up. The loan growth on an absolute basis outside of PPP and mortgage warehouse was down a little bit. Most of that was driven by what you saw in the significant line draws that occurred late in the Q1 in the March timeframe when the economy started shutting down more broadly, those lines paid down. If you look at the loan growth through the Q2, you could characterize it as BJ did earlier is reasonably modest.
Most of the new loans were to existing customers and tended to be, at levels that would be very low relative to say the last 18 months or 2 years. So that's our expectation is that we will have some activity that the line draws have sort of worked their way through the system that we'll continue to support customers, both existing and opportunities to take on customers in the marketplace. But we don't expect a tremendous amount of loan growth throughout the rest of this year, at least until we get to the other side of this pandemic.
The only thing I would really add, Brady, is we remain very focused as we always have on full relationships. And so continuing to work with our clients and some prospects that we brought in through the PPP program, but we remain as you can imagine, very prudent in our underwriting, have a higher level of review for new extensions of credit. But we do believe that there could be some limited opportunities. But as Brian said, we'd expect loan growth would remain in the lower range certainly compared to the last 18 to 24 months.
Yes. I would just add one more thing. I mean, Brady, we're definitely open for business. It's not that question. It's just lower activity from clients looking to extend credit because of, like Brian talked about, the pandemic.
There's just obvious caution across portfolios, but we'll look we'll continue to look for good opportunities to continue to grow customer relationships.
All right. That's helpful. Then next on your common dividend. I think there's been some investor focus on your dividend post when we saw the CCAR results. You didn't earn the dividend last quarter.
You earned it this quarter, but the payout ratio was pretty high. If you include the $500,000,000 gain next quarter, you will earn it by multiples. But how are you thinking about the stability of your dividend going forward?
Hey, Brady, this is Brian again. The Board considers the dividend every quarter and we've looked at the rules that have at least been publicly made available from the Fed and our modeling and our outlook indicates to us that we be in a position to continue to recommend our dividend to the Board of Directors. I would say that as a backdrop, while we are confident in it, we don't know what we don't know about this economy and it's important that the Board not only looks at dividend, but looks at capital and capital adequacy long term. So that could change. But based on our modeling, based on our outlook, based on our understanding of the rules and the Fed framework, we feel Board that they consider continuing the dividend at the current levels.
Okay. And then finally a quick one. Vijay, it was helpful to have the forecast for the yield accretion for the next few years. That is just probably the scheduled yield accretion, right? That doesn't include any unscheduled.
So reality is with some payoffs, you'll probably see numbers a little higher than that. Is that the right way to think about that?
Yes, that's correct. Yes, it's going to be based on this is based on our assumed timing. And you're right, if there's an acceleration, then there could be a change, much like we've seen in other transactions, Brady.
Our next question comes from John Pancari of Evercore. Please go ahead.
Hi. This is Rahul Patil on behalf of John. I just had a question around the loan mark. So I know in mid April, you had provided an update around the loan mark. And I believe the total mark around that time was around $500,000,000 to $550,000,000 And one could argue that the macro has kind of worsened since mid April through the deal close in July.
How come that didn't influence the credit mark? Because I'm looking at the total mark at 560 right now. How come that didn't influence the credit mark? And then also, it looks like the rate mark of 40 bps is sort of consistent with the level that you had announced back in November 2019 and obviously rates have come down quite a lot since then. And I'm just wondering like how did that not influence your rate mark, because it looks like that also stayed at 40 bps.
So just a couple of clarification questions around that.
Sure. So it's BJ. So it's been a wild ride on trying to estimate marks between November of last year and today. And so like you said, we gave interim updates during the course of that. So if you recall back in November, we would have had credit marks assume that announcement of 1.2% and interest rate mark of about 40 basis points.
So that would have been 1.6%. The interim that you're referring to would have captured a little bit more of a credit mark, but a substantially higher interest rateliquidity mark. And I would put more emphasis on the liquidity mark. So when we put out that disclosure back a couple of months ago, it was at the height of the liquidity crisis and the fear in the markets before the Fed programs had fully been rolled out. So the assumption was much higher on the liquidity and interest rate mark.
Subsequently, markets have gotten a lot more liquid. That liquidity and interest rate mark has come back down, but our expectations around the future outlook on credit have deteriorated. So all in all, our credit mark is higher by probably 40% than what we would have thought back in November. Interest rate liquidity mark, interestingly enough, kind of landed in the same place. But as you can see in the table, the mix of the PCD and non PCD has changed materially as well.
So lots of moving parts in here. But the bottom line is we feel very comfortable that our teams have done great extensive work on the valuation that we're building very healthy reserves that go into the allowance and we've got additional loss absorption capacity that will accrete back through income over time to the tune of about $260,000,000 So we're very comfortable with the estimates that we've got.
Okay. And then just a question on the on First Horizon's standalone expense base. So I believe it was like 6 months ago, your expectations for First Horizon's expense base was around $280,000,000 to $285,000,000 $1,000,000 per quarter. And I'm looking at 2Q numbers on a core basis, it came in around at $318,000,000 So that $30,000,000 differential, obviously, partly driven by this stronger fixed income business performance. But how much of that differential in your expense base do you expect to normalize in coming quarters?
Or should we kind of expect like that $320,000,000 is like the normal sort of run rate for First Horizon assuming fixed income kind of is strong?
Yes. So how I describe it is the increase that you're talking about is all related to 2 things. One is, as you mentioned, fixed income variable compensation, which comes with additional revenue that we gain. So there's a 50% net positive benefit to our pretax income from that additional expense. And this quarter, we had deferred compensation expenses that were up quite materially in the quarter as well.
We don't expect those to continue. That's that will certainly moderate. So we still believe that we'd like to see fixed income remain strong, which we think it will. So I would, if I were you, take out the deferred compensation impact in this quarter. And then once we start to look at our companies on a combined basis, start to layer in the merger related cost saves, and we expect to see meaningful declines over time in our expense base.
Vijay, one more that I would add to that list is the provision for unfunded credit, which was $11,000,000 this quarter, dollars 9,000,000 last quarter visavis a year ago, it was essentially 0. Yes. Those 2 are fairly significant. They're pandemic related in the sense that they're related to credit potential credit losses for unfunded commitments that just happens to flow through our expense base.
Yes. That's a great point. I just want to bottom line reiterate, we have done an excellent job of managing our expenses. And so the increases here are all related to either support of additional revenue and pre tax income or the two things that Brian and I discussed. And we are continuing to focus very, very strongly on expense discipline.
Our next question comes from Jared Shaw of Wells Fargo. Please go ahead.
Hi, good morning.
Good morning, Jared.
Just looking at the margin, I guess, to start and the growth in cash and with the expectation for additional cash growth from the Brainshield and the IBKC deal, What how should we be thinking about sort of the deployment of that cash into either securities or I guess securities or the your expectation for customers deposit use? So as we go forward through the next few quarters, how should we be looking at that sort of net cash position?
Yes. So as I said in my earlier comments, we think that initially in the Q3, the addition of the net $2,000,000,000 of funding from Truist is going to depress the margin maybe in the mid teens range. And over the next few to several months, figure out ways to deploy that in terms of either securities, loan growth, managing down other higher cost deposits, etcetera. So we expect that to be a temporary type depression of the margin. And so said a different way, if the Truist acquisition was not being completed in the quarter, we would think the margin would be relatively stable to just down modestly as opposed to down in the mid teens because of the addition of the excess cash.
Okay, great. And then can you talk a little bit about the deferral extension process as that initial 90 day period ends, how are you approaching extension there? And do you expect to be able to get either additional credit enhancements or any type of beneficial term restructuring as those go forward?
Hi, Jared. Related to the deferrals, we are really getting to the end of the 1st round of 90 day deferrals requested by our customers. And we are really on a case by case basis with our commercial customers asking questions about other sources of cash, sponsor and guarantor support, etcetera. And oftentimes, we are getting some additional, whether it's a guarantee, asking a guarantor owner to put in more equity, potentially looking at other structural elements. At this point and we've had deep portfolio reviews as D.
J. Mentioned in his remarks on our slides with a number of related to specific loans in a number of portfolios. In fact, we covered over 70% of some of the higher risk portfolios. And we were talking with our bankers about what their clients are telling them. We don't at this point, we're not anticipating nearly the number of second round deferrals as we had in the 1st round.
Really only in 2 real industry pockets do we expect potentially 2nd round deferrals to be maybe near what they were in 1st round and that would be some of the restaurant franchise finance companies and some of our hotel borrowers. Otherwise, based on feedback we've received over the last really 30 to 45 days, we're not hearing of a big increase. Obviously, we're watching that closely, as things continue to be very dynamic around the COVID situation related to various states. But many of our customers are reporting good liquidity, good cash reserves, a combination of they're operating at lower expenses, the benefits of the government programs including the PPP program, the EIDL program, the CARES grant programs. So again, we were glad to be able to assist
round. That's great color. And then just finally for me on as we look at going forward, if we do see additional macro deterioration based on the Moody's models, should we assume that you all are more willing to use qualitative overlays with the additional credit protection from the MOE? Or should we expect to see that the macro impact from any future deterioration would be a similar impact?
So actually for the Q2 and we did it in the Q1, but even more in the Q2, in addition to the Moody's baseline, we actually did apply a good bit of qualitative overlay on a number of portfolios that either or have the potential to have some effect from COVID. So as an example, or some of the portfolios that where we had an additional qualitative overlay included not for profits, senior living like nursing homes, assisted living, health care and then even a more significant qualitative on some other areas which you would expect things like restaurants, entertainment, hospitality, retail. And then And then energy, we even we took a very, very strong look and did touched a great deal of the clients there as we went through borrowing base redeterminations, looked at hedge strategies, etcetera. And so we did deploy a good qualitative overlay in the Q2 and we'll continue to do that as we evaluate CECL. At this point, we feel like we're well reserved for the portfolios that we have and we'll continue obviously to evaluate that next quarter or I guess for this quarter, Q3 as we get near the end of the quarter.
But we feel like we've got a good robust process and have taken both, as I said, the Moody's process, but then the subject matter expertise and that qualitative lay based on information we gleaned from the deep dives that we did.
And I would add to what Susan said that as we evaluated the loan marks on the Iberia portfolio, we did the same thing. We used qualitative overlays where we needed to, particularly around stress sectors, as Susan outlined. So we feel like we had fulsome marks, and we have very healthy reserves on the First Horizon standalone side.
This is Brian. It's an interesting time to be estimating loan loss reserves and we're all trying to figure out how CECL works in the real world. And in many ways, it is I'll stick with ill timed and overly burdensome. But if you sort of step back from the loan portfolios and you look at the various components, you're seeing some places where there are trouble emerging and Susan did a good job enumerating those places. But there's a disconnect between, call it, $17,000,000 in net charge offs and $540,000,000 in round numbers of loan loss reserves.
And we fully expect what borrowers are doing today that there are a lot of places that this economy can go and what happens if we have more shutdown or reshot down, what happens if the Congress and the administration don't put together a fully helpful another round of stimulus, what happens if Fed liquidity programs change? Right now, the economy is doing better than you might think and borrowers are doing better than you might think given the economic environment we're in. We attribute a lot of that to the great work that the Treasury and the Fed have done with programs like Main Street Lending, which has not really been used, but in place, liquidity programs, PPP, the stimulus payments, consumers are still relatively strong, credit card volume has been picking up since the economy started reopening. So all in all, we've got a sober and cautious outlook on what happens over the remainder of the year. But when you talk to individual borrowers and you go through individual elements of the portfolio, things are doing much better than you might expect at this point in time.
And you take the restaurant business, if you're in the quick serve restaurant business, you're back to where you were pre pandemic, largely speaking. And in some cases, your comps are up 10%, 20% depending on the business you're in. So it is a tale of many stories out there right now and it's just an odd time to be trying to flashback what loan loss reserves and life alone losses might look like.
Thanks for the color.
Yes, you're welcome.
Our next question comes from Steven Alexopoulos of JPMorgan. Please go ahead.
Hey, good morning, everybody.
Hey, Steve.
Brian, just to stay with the reserve conversation, this being an odd time, based on everything you're looking at now, do you think
clearly from an accounting perspective, we take the information we have and we book what we think are life of loan losses. And so if the economy plays out consistent with that set of assumptions, yes, I think so. But as I said earlier in talking about the dividend, we don't know what we don't know about how this virus plays out. It's a medically driven crisis and until we get a solution to that, it's hard to know how it plays through the economy. But I think we have based on all the information we have available to us, book sufficient reserve to cover losses in the portfolio as it stands today.
And as we get to the second half and some of these deferrals start transitioning into defaults, is it likely you'll then need to establish a specific reserve or is the plan to start using these qualitative overlays that you're building into the reserve today?
Well, I think clearly that we've built some of these reserves and the qualitative reserves in anticipation of specific problems. So our intent would be to use those as they evolve, yes.
Okay. And then thank you. And then shifting direction to fixed income, it was nice to see ADR above the prior range. It's been a while. I'm curious, how did ADR trend through the quarter?
And do you think it's sustainable at these levels?
Yes. ADR transitioned or trended positively throughout the quarter. We finished the quarter very strong, and I would say a very good start to the 3rd quarter as well. We do think it is sustainable. And some of it is sort of the extension of the comments we made about loan growth.
To the extent macro loan growth is not good across the industry, there are more opportunities for securities and securities portfolios and financial institutions. And the question came up about cash on balance sheet. That's happening across the industry. So that's good for the business. The average daily revenue this quarter was impacted a little bit by the reversal of what we call negative splits in the end of the third excuse me, end of the Q1 being reversed.
Another name would be portfolio gains or trading gains and losses that occurred. But average daily revenue has looked good, the trends look good, and our outlook for the remainder of the year is that our fixed income business will continue to serve as a or the countercyclical buffer that we've always believed it to be.
Okay, great. Thanks for taking my questions.
Yes, you're welcome. Thank you.
Our next question comes from Barak
It's nice to see some of the clouds begin to part here. Following on Steve's question, I do worry about FHN Securities because the performance has been so good, it's repeatedly beaten all our expectations and wanted to just go back to your comments, Brian. And I mean, is this more of a kind of flat from here sort of set up into the back half which should still be very, very strong or do you think you could actually climb it out from here?
I think my outlook would be that you sort of if you were going to forecast it out, wouldn't show a lot of growth and you wouldn't show it declining a whole lot. It'd be sort of in the area of sort of the average of where it's been in the last couple of quarters.
Okay. And, and BJ, one of the areas where the clouds kind of remain is around the net interest margin. I know you've taken a crack at defining that a bit. You've got PPP, you've got the branch sale or the branch purchase coming in. As you look and IBKC, of course, maybe as you look at year end Q4, what kind of a core NIM should we be looking at?
Yes. So by the way, I don't know why Brian gets the good question on strong fixed income and I get the tough question on NIM. So I would expect that the core NIM continues to be pressured through the back half of the year. I mean, we've got hopefully loan yields stabilizing a bit. We still have some room, as I talked about earlier, on deposits and deposit rates paid.
We still think that we can bring those down. But the reality is we're going to continue to have a high class problem of excess liquidity that we're going to have to work through. So that's going to be the depression of the margin. I wouldn't translate that into material declines in overall NII because we've got accretion coming through even if the margin is compressed by excess liquidity, it goes into excess balances at the Fed and that's largely a wash. So it's again, continued it's going to be challenged, but we've got opportunities to mitigate it both in the net interest income line as well as what Brian just talked about, the countercyclical businesses that we've got a fixed income loans to mortgage companies and as a combined company, the mortgage origination platform that Iberia has, which had a record quarter in the first quarter and then soundly beat that record quarter in the second quarter.
So we have multiple levers that we think can offset some of these headwinds and we'll work hard to mitigate as much as we can.
Great. Thanks for the color.
Thanks, Brock.
Our next question comes from Ebrahim Poonawala of Bank of America Securities. Please go ahead.
Good morning, guys.
Good morning.
Good morning.
Good morning.
Just wanted to follow-up on the NIM. P. J, you earlier mentioned that ex Truist, we expect the NIM would be relatively stable to going down modestly. So just wanted to put some numbers around to make sure we get this correct. The quarter is $284,000,000 you expect a mid teens decline, so let's call it about $270,000,000 Is that a decent place when we reflect Truist, reflect Iberia, we reflect PPP for now in terms of where the core NIM should be around that $270,000,000 and then maybe it might have some upside as you deploy that liquidity as PPP runs off or is there more downside to that core name relative to a $270,000,000 number?
Yes. So I had said mid teens and our core NIM is 280 in the quarter. And when I've been speaking about what I thought the second half of the year looked like, I'm obviously contemplating not just standalone, I'm contemplating the Iberia merger, the Truist acquisition and the puts and takes of those. So yes, I think it's mid teens primarily from the liquidity, the excess liquidity that we'll see from Truist.
Sorry, Ann, I missed Wilkshire, so about 265,000,000 and then what's your view on PPP running off? Do you expect most of this to be forgiven by the end of the year?
Yes, we do. Yes.
Got it. And would you have like what the pro form a earning assets or what the quarter end earning assets were for both the balance sheets? Just trying to get a sense of what we should expect in terms of the size of the balance sheet looking out into 3Q with all these things added?
So pro form a earning assets at June 30?
Yes.
Pro form a loans for both First Horizon and Albire together, if you look at 6 $30,000,000 without PPP, is about $55,000,000,000 And so I know you asked for all earning assets, but I thought I'd go and give you the loans. Obviously, that's without PPP. We had a combined PPP portfolio of about 4 a little over 4 about $4,100,000,000 So if you include PPP total loans on a pro form a basis at the end of June are about $59,000,000,000
Yes. I've got Ebrahim, I've got earning assets at roughly
$74,000,000,000 $74,000,000 That's helpful. And just one separate question, I guess for Susan, so you've talked a lot about credit and what we've done and the uncertainty on the macro. At this point, like when you looked at the loan portfolio, are you still making decisions based on portfolio level details, as you mentioned, the restaurant finance hotel? Or would you say you have a good handle on granularly looking at these loans customer by customer? I think Brian alluded to it.
Just trying to get a sense of is this still a model based exercise? Or do you have a good sense around and comfort around customers' ability to withstand if things don't get materially worse, which would imply a decent drop off in terms of credit provisioning relative to what we've seen in the first half?
Right. So we in addition to portfolio levels that we're looking at and we're looking at information loan by loan, our bankers are updating loan by loan information based on customer feedback. We're also looking at a lot of market information around what's going on with various franchises in the franchise finance space, what's going on with hotel occupancies and ADRs. But then again, looking at that on a customer by customer basis. So we will continue to do that.
Just as a reminder, we talked about this last quarter, but we feel very good about the disciplined underwriting that we've had since the last financial crisis. And I would say this applies to both legacy First Horizon and Legacy Iberia, as it relates to things like in the commercial real estate book, hospitality, average equity is in the 40% range. And so it gives us a lot of cushion, our customers a lot of cushion when you have something unprecedented like a COVID pandemic. Maybe a data point that some customers saw this was when things were starting to open back up. Brian alluded to this on the restaurant side.
We clearly saw it on the restaurant side, but also in the hotel portfolio because our hotel portfolios tend to be smaller driving distance type hotels that cater to family travel, some business travel. We have very limited exposure to convention large hotel business. And we heard from clients that Memorial Day, ended June through July 4, some of them had were fully occupied. We also saw, as Brian said, average restaurant checks went up as more people did takeout. They were buying more than they would if they went in because they were thinking about I might want some later.
So we just we are seeing that both in the market data that we get on all of our industries and study, but also talking with individual customers about what they're seeing. So we will continue to look at both. But again, I was pleased with the resiliency that I saw out of our clients when you had the complete shutdown and then things open back up, we saw dramatic increases pretty quickly. But as Brian and BJ said, we're also watching there's some additional shutdowns that have occurred. But again, resilient customers, prudent underwriting.
And so we believe we've got a reserve for what our lifetime losses will be based on what we know today.
I'd add to the resiliency. Customers have been very creative in the way they've adapted to an unusual set of circumstances, and you see adapting their business, our customers adapting their business model to meet changing circumstances. And it really is amazing. And if nothing else, it is a testament, an overall testament to the strength and creativity of the economy in the U. S.
Our next question comes from Garrett Holland of Baird. Please go ahead.
Good morning. Thanks for taking the question. I just have a near term one on expenses. What's a good range for core expenses as you think about Q3 over the back half of the year?
Standalone or combined or?
Combined would be
great. Yes. I think I'll defer and have our IR folks follow-up with you on that because there are so many moving parts to what we've got in terms of merger related one times and those types of things that I think it would be better to give you that in a different format.
Understand. I guess just bigger picture, I know the deal just closed, but you sound very positive on its potential and clearly the environment has changed though since you announced the transaction. Just how would you recast earnings power or advise thinking about the return potential for the combined company in this type of environment?
Well, I think the way I would characterize it is short term, I think we and everybody else are focused on safety and soundness, right? Healthy reserves, strong capital levels, strong liquidity and funding profiles. Beyond that, it's controlling what we can control. And what we can control is, particularly in this environment, our support of our countercyclical businesses, our deposit pricing discipline, and a huge lever, of course, for us is taking costs out of our combined organization in a very material way over the next several quarters. So I think those things will position us very well in terms of our ability to maintain profitability over the next several quarters.
Beyond that, we are very convicted and optimistic about the opportunity we have long term as a combined organization. We've got the cost saves that will come in. We are in very attractive markets. To build diversified business mix with countercyclical businesses. Our enhanced scale will help.
So over the medium and long term, we still feel like we can generate top tier profitability over the long term, and we're building a company to position us well-to-do that.
Hey, Garrett.
Thanks, Pete.
This is Brian. Look, I think this is it's hard to sort of model what was in the numbers in November and what's in the numbers today because CECL changes everything. But as we talked about today, both businesses are seeing strong PT and R. We're seeing very good activity in our franchise. We think that there is a great deal of leverage.
In fact, we're seeing in the 1st couple of weeks of merger post merger timeframe, referrals of business that are going to our asset based lending business. So we haven't modeled in any of the synergies, but those synergies will be there on the revenue side. The one thing I'm certain of is we have the ability to hit our commitments $170,000,000 plus. I think we have the opportunity to upsize that over time. And I can't understate how important a lever that is in an environment like this.
These are costs that we couldn't get at on an individual basis by combining the 2 organizations in a no premium merger of equals, we have the ability to create $170,000,000 pre tax plus of run rate savings on an annual basis that you can annuitize. And so that's a big deal and that will be a big driver over the next 18 months. So as BJ said, longer term, I think we're going to be in a position with the markets that we're in, with the bankers that we have on the playing field, the team that's out there covering our customer base and our strength of balance sheet, we're going to have superior growth opportunities. And in the short run, we're going to have levers to pull with our countercyclical businesses and our cost savings that are going to be meaningful in terms of creating shareholder value.
Our next question comes from Jennifer Demba of SunTrust. Please go ahead.
Hey, Jennifer.
Good morning, Jennifer. Good morning, Jennifer. Good morning.
Could you talk about your criticized loan trend from sequentially and where you're seeing the most increase? And then can you also talk about what you're expecting in terms of near term net charge off levels over the next 6 months? I know that they stayed quite low in the Q2. Thank you.
Jennifer, as it relates to criticized loans, when we talk about First Horizon standalone, then I've got some information on a combined basis as well. If you look at Apologies. Jennifer seems to have placed us on hold. Would you like to move to the next questioner?
Why don't you go ahead?
I'll go and answer the question. Yes. So Jennifer asked about criticized loan changes. And so for First Horizon standalone, we saw about $100,000,000 added to criticized loans quarter over quarter. Iberia added just under $200,000,000 So we had about $290,000,000 added quarter over quarter in the criticized loan, of which about $190,000,000 was energy related across the two portfolios.
I would say that both companies took a very conservative approach as we look through our energy portfolios and took the appropriate action we needed to on upgrading those. So on a percentage basis of criticized loans, First Horizon standalone went from about 2.8% of the portfolio to 3.5%. By the way, these numbers exclude PPP loans on the percentage of loans. And then on a combined basis, again, pro form a end of the quarter, criticized loans were about 3.2% of the portfolio, up from about 2.4% you looked at it at the end of the Q1. So we did see some increase in criticized loans.
Well, I don't have a specific forecast for net charge offs. We are obviously looking at some increase in the criticized loans Based on what we know today in the economy, I would expect that we would have some net charge offs in the 3rd Q4. At this point though, I don't really have a forecast because there's a good bit of uncertainty. But as we mentioned earlier, because of how CECL works, we believe that we've got we're well reserved for lifetime losses in the portfolio based on what we know today and to complete really the deep dives that we did on the portfolio and specifically the higher risk portfolio.
Yes. And I would say, just to add, Susan talked about that the majority of the increase being energy and energy being one of the near term portfolios that we would obviously be most focused on, our coverage of the combined energy portfolio will be around 8%. So we significantly increased the reserves on those portfolios through both the marks and on the standalone side. So that's one of the places that we leaned in along with the other sectors that Susan talked about earlier.
Our next question will come from Casey Haire of Jefferies. Please go ahead.
Yes, thanks. Good morning, guys. So the you guys gave us an update on the fixed income business, but the mortgage warehouse, unless I missed it, what's the how what's the outlook there? It seems like it could have legs given where mortgage rates are going. And any color on the split between refi and purchase as well as where yields are today?
So mortgage warehouse refi purchase is about 65% refi in the second quarter, which is kind of what you would expect with rates. We keep thinking they hit their low points and go down again. So there's been some good activity there. Yields in the second quarter were about 3.6 $1,000,000 for that mortgage warehouse portfolio. So as we've we have over the last 3 years added customers to the customer count in mortgage warehouse.
But I'll let BJ talk maybe about the outlook for mortgage warehouse.
Yes. Casey, I would I think as you remember in the Q1, we had a very significant run in the last 5 weeks of the quarter and period end balances top ticked at around 5,800,000,000 dollars They stayed pretty elevated because of strong activity through the quarter and you saw average balance is actually up pretty materially in loans to mortgage companies 1st to 2nd. But period end balances were down more in the $4,000,000,000 range, right? So the business does ebb and flow based on the flow of mortgage originations and the mix of purchase and refi. Going into the Q3, we see continued strength in the business.
And so we expect it to grow from the period end balances of $4,000,000,000 and likely be in the range of the average balances we saw in the Q2.
Great. Thank you. Brian, just big picture question for you. When you guys announced this deal in early November, obviously, it was a much, much different world. Things seem to be tracking at least from a capital perspective and cost save perspective per plans.
But is there anything strategically either on the First Horizon or the Iberia side of the house, loan vertical or securities portfolio strategy change that you guys are thinking about just given how different the world is today versus November?
Well, there are not any significant changes, no. We're still equally convicted about the merits of the transaction. And I am extraordinarily pleased with the way the team has come together. It has been remarkable and while we had the 1st 4 months to bring people together in a face to face environment, since March, we've been doing it by WebEx and Zoom and all the other electronic virtual means that you can come up with, but the team has come together and doing very, very well. And as I mentioned, we're seeing some opportunities to leverage portfolios or businesses across both organizations.
I mentioned ABL, BJ mentioned the mortgage business and the title business that Iberia Bank brings to the table. So we still see a lot of that. We'll fine tune some things. 1 of the if you look closely at the numbers, you'll see, for example, the commitments in energy were down a little bit this quarter. It represents on a combined basis about 4% of the portfolio.
So we're willing to trim our sales as the economy continues to adjust to the pandemic and then the post pandemic world. But on a macro basis, we're still equally convicted about opportunities of bringing these 2 organizations together. And I'm glad we're beyond the starting line and the hard work is in place. So it's an exciting time to get that done. And I think as I said earlier, we're going to see a lot of shareholder value created when we combine these two companies over the next 18 months.
Thank you.
You're welcome. Thank you.
Our next question will come from Christopher Marinac of Janney Montgomery Scott. Please go ahead.
Thanks. Good morning. How are you? Just wanted to focus on the branch acquisition and sort of strategically, Brian, does that do you look at it any differently than you did last fall, just given where we are and also the high liquidity that BJ had addressed earlier?
Well, I think you raised an accounting and an economic point that excess deposits today are sort of different in a zero rate environment. But from a strategic standpoint, I think it is a home run transaction for us and we're very, very pleased with that transaction. As BJ mentioned earlier, that conversion and acquisition is going on this weekend, so those customers and those branches will be converted over the weekend. And what it will do is overnight, we'll do 30 years of branch building in the Carolinas in terms of average branches with call it $80,000,000 in deposits and give us meaningful share in the middle part of North Carolina. And back to what we said in 2017 when we merged with Capital Bank, it was we wanted to have a meaningful presence in the Carolinas and to pick up a top five presence in the Triangle excuse me, in the Triad area, Greensboro, Winston Salem, High Point and to pick up meaningful share in Durham and Chapel Hill, the Triangle area in North Carolina is significant.
And so from a strategic standpoint, if we started building these 30 branches, we couldn't create branches of this quality in 20, 25 years. This is just a quality franchise and we were lucky to partner with SunTrust, BB and T, now Truist that acquire these branches. So we're proud of what we're building in Virginia, Carolinas and Georgia with this transaction.
Okay, great. Thanks for that.
And I guess when you have the systems fully converted, you can do more with those branches too, right? So we can still think of it in that context.
Yes, absolutely. But the systems will be converted Sunday morning. So everything will be done this weekend. So it's soup to nuts this weekend on a branch acquisition. So we'll hit the ground running.
People have worked really, really hard over the last few months and it's one of the reasons we deferred. We wanted to be in a position to do adequate customer communication, adequate training. We've got ambassadors in all of these banking centers from the First Horizon perspective who will be helping with systems and technology and things like that over the next couple of weeks. But we're going to hit the ground running and these branches, financial centers, banking centers will be part of 1st Horizon franchise this weekend and we'll hit the ground running Monday morning.
It really does help. I mean, obviously, having additional banking centers improves our ability not only to reach additional consumers, but small businesses and middle market companies still like to see a branch presence. And so it enhances the work that our bankers have already done in calling on and bringing in business from all the areas where we'll have expanded presence and in a few situations presence that we didn't have before. So we look forward to that in addition to serving consumers, but also the business side.
Great. Thank you for the additional feedback. I appreciate it from both of you.
All right. Thanks, Chris. Have a good weekend.
This concludes our question and answer session. I would like to turn the conference back over to Brian Jordan for any closing remarks.
Thank you, Andrea. I appreciate all the hard work that our associates are doing and as I mentioned the branch conversion, but there's an awful lot of merger planning and integration and most importantly taking care of our clients and our communities. So thank you for your hard work. Thanks everybody for joining us on the call this morning. We appreciate your interest in our company.
We are very well positioned and we're going to create a tremendous amount of shareholder value with the consummation of the branch transaction and our merger of Equals. If you need additional information or have any further questions, please feel free to reach out to any of us, Ellen Taylor or Artie Bowman, and let us know. We'll be happy to help you. I hope you all have a great and wonderful safe weekend. Thank you.
The conference has now concluded. Thank you for attending today's presentation and you may now disconnect.