Good morning, everyone, and welcome to the First Horizon National Corp. First Quarter 2019 Earnings Conference Call. All participants will be in a listen only mode. Please also note today's event is being recorded. And at this time, I'd like to turn the conference call over to Ms.
Zardi Bowman, Investor Relations. Please go ahead.
Thank you, Jamie. Please note that the earnings release, financial supplement and slide presentation we'll use in this call are posted on the Investor Relations section of our website at www.firsthorizon.com. In this call, we will mention forward looking and non GAAP information. Actual results may differ from the forward looking information for a number of reasons outlined in our earnings materials in our most recent annual and quarterly reports. Our forward looking statements reflect our views today, and we are not obligated to update them.
The non GAAP information is identified as such in our earnings materials and in the slide presentation for this call and is reconciled to GAAP information from those materials. Also, please remember that this webcast on our website is the only authorized record of this call. This morning's speakers include our CEO, Brian Jordan and our CFO, Pete Delosch. Additionally, our Chief Credit Officer, Susan Springfield, will be available with Brian and BJ for questions. I'll now turn it over to Brian.
Thank you, Artie. Good morning, everyone, and thank you for joining the call. I'm pleased with the start to 2019 and remain optimistic about the full year prospects. I'm also confident that our team is controlling those things that we can control. In the Q1, our balance sheet showed real momentum with 7 percent loan growth and over 10% customer deposit growth on a linked quarter annualized basis.
We achieved positive operating leverage and took action to position us better for ongoing improvement. Credit quality remained good, and we returned capital to our shareholders, taking advantage of attractive share prices to repurchase stock. We increased our common dividend by 17% in the quarter. As it looks now, today, this morning, this week, interest rates are likely to be somewhat more challenging than we might have thought 3 months ago, we recognize it's probably likely going to be further volatility. Given that, we do think our margins should be reasonably stable from where they are here over the remainder of the year.
We can't control interest rates. But as I said earlier, we can and are controlling those things that we can. We remain focused on achieving our strategic priorities laid out at our November Investor Day. We're making good progress and profitably growing our presence in key markets and maintaining strength in our core Tennessee franchise. Our markets are providing better than average growth opportunities.
We're seeing solid loan demand across our markets, particularly in our specialty lending areas. Deposit growth is excellent, helping improve our funding mix. We've been able to hire experienced bankers in new markets who are adding to our customer base and profitably building our franchise. During the Q1, we grew customer accounts in Mid Atlantic and South Florida very aggressively contributing to new deposit inflows. We're optimizing our expense base as well, maintaining good operating expense discipline, while continuing to invest in technology and business development.
During the Q1, we took new efficiency actions that will provide additional funds for reinvestment and lower our annual expense run rate. Vijay will give you more details in a few minutes. Looking ahead, we expect the economy and interest rates to be relatively steady for the rest of 2019. Our key markets should continue to grow at a faster than average rate, providing us good organic growth opportunities. While the interest rate outlook is moving around, we think it will be relatively stable in terms of impact on our margin.
And we do expect our loan and deposit growth to continue to be strong. While credit quality and net charge offs remain low, we expect if they do begin to normalize that our strong discipline in underwriting and our highly diversified balance sheet will help benefit us. Our capital position is also strong. We continue to control what we can control, focused on delivering profitable growth and strong returns for our shareholders throughout 2019. I'll now turn it over to VJ to go through the quarter, and then I'll come back with a few closing comments.
BJ?
Great. Thanks, Brian. Good morning, everybody. Thanks for joining us. I'll start on Slide 6 with our financial results.
For the Q1, our reported EPS was $0.31 $0.35 on an adjusted basis. In the quarter, we saw strong balance sheet trends for both loans and deposits, as Brian mentioned, improved revenue and good expense discipline. Our credit trends remain benign with net charge offs down to less than $5,000,000 with loan loss provision up modestly, reflecting loan growth in the regional bank that was somewhat offset by a provision credit in non strategic. Total revenues were up 6% linked quarter and 3% on an adjusted basis. Fee income in particular was meaningfully higher driven by a strong quarter from our fixed income business and fee income related to deferred compensation, only partially offset by lower NII in the quarter due to fewer days and expected lower loan accretion.
Total expenses were up 5% linked quarter and 3% on an adjusted basis. Restructuring charges, deferred compensation expenses and variable comp from higher revenues and fixed income were the drivers. All other expenses were down nicely $9,000,000 linked quarter, driven by strong expense discipline across the organization. In addition, you'll see on the bottom right of Slide 6 that we had about $12,000,000 of restructuring charges related to some actions we took in the Q1 to improve our go forward expense run rate. We will discuss those in a little more detail in a few minutes.
You will note that in both fee income and expense, there are fairly large, but offsetting deferred compensation related impacts. You may recall that we saw the same kind of impacts in the 4th quarter. This occurs when there are large swings in equity market valuations quarter to quarter as we saw with equity market declines and gains in 4Q 2018 and 1Q 2019 respectively. Finally, balance sheet trends across both loans and deposits were quite strong in the quarter with broad based C and I growth, particularly in some key markets and specialty businesses, as well as strong deposit growth in both consumer and commercial businesses. Looking at the loan growth a bit more on Slide 7, the strength clearly came from new business in our C and I portfolio as that growth more than offset the runoff from non strategic as we saw 7% linked quarter annualized growth in the total aggregate loan book.
Period end C and I growth for the quarter was a little over 4% or 17% linked quarter annualized and was up 9% year over year. In the commercial real estate portfolio, we did continue to see an elevated level of payoffs as borrowers refinanced that of our portfolio into the permanent market, and we saw some strategic exits as well. Consumer portfolio was down primarily to the continued strategic runoff as expected. And as I said earlier, the C and I growth was broad based across several markets and specialty businesses. So let's take a look at that a bit more on Slide 8.
As we discussed on the Q4 call, we started to see some really good customer activity and momentum in December towards the end of the year, and it certainly continued into the Q1. We saw good execution on our key priority of profitably growing our key markets and specialty areas, driven by that strong C and I growth. And overall, the regional bank posted total loan growth of 8% linked quarter annualized with increases in key markets such as South Florida, Middle Tennessee and Houston. Our specialty areas grew 14% linked quarter annualized driven by increases in loans to mortgage companies, our healthcare business and our corporate banking business. The focus on growing our specialty areas, which comprise 40% of the regional banking loan portfolio, remains a key growth opportunity and a differentiator for us.
Turning to the deposit side on Slide 9. We saw excellent growth across all our markets in Tennessee, in our mid Atlantic region and our Florida markets. As we discussed at our Investor Day, we have an opportunity to improve deposit and funding mix over time by reducing our higher cost market index deposits and transitioning into new customer deposits. As you can see, in the quarter, we replaced $1,000,000,000 in 100 percent beta market index deposits at 2.52 percent rate paid with lower beta new customer deposits at 191 basis points and approximately 60 basis point funding advantage. Over time, our plan is to continue to deepen those customer relationships, and we see further opportunity to reduce market index deposits and improve our overall funding cost and mix.
Even though we were able to reduce our market index deposits by about $1,000,000,000 by period end, average market index deposits only declined by 4% linked quarter. The combination of very strong customer deposit flows and excess market index deposits for much of the quarter led to a large excess cash position at the Fed, which has only a modest impact on NII, but reduced the net interest margin by about 6 basis points. We will continue to work these excess balances down. Let's shift to Slide 10 and talk about the drivers of net interest income and net interest margin for the Q1. Linked quarter, you see net interest income was down 8,000,000 dollars as solid balance sheet growth benefits were offset by fewer days in the quarter, about $4,000,000 as a decline and by lower accretion, another $4,000,000 as a decline.
The NIM overall declined 7 basis points as about 4 basis points of the positive impact of balance sheet growth were offset by the excess cash at the Fed that I just mentioned, which caused a 6 basis point drag on the margin and lower loan accretion quarter to quarter, which had about a 4 basis point impact. Moving on to fixed income on Slide 11. Activity in the quarter was strong as economic and interest rate dynamics benefited FTN and demonstrates the countercyclical benefit of this business. Average daily revenues in the Q1 were $729,000 up 48% with all trading debt seeing increases in the quarter. Fixed income's pre tax income increased $8,000,000 linked quarter from both the higher average daily revenues and the benefit of the fixed cost reduction efforts that the business has been making over the last several quarters.
This quarter's performance is a good example of 2 things: number 1, how quickly FTN can capture market and profit opportunity and number 2, the countercyclical nature of this business. We've showed the table in the bottom right before, but thought it would be a good reminder of how the market environment affects FTN. 3 of the 4 conditions for higher revenue for this business were present in the quarter: the direction of rates, market volatility and uncertainty about the economic outlook and the business was well prepared and took advantage of market conditions. Let's turn to expenses on Slide 12. While there were a few moving parts in the quarter, the underlying expense discipline is very evident as you can see in the chart on the bottom of this page.
If you look at that chart, starting with the 4Q 2018 adjusted expense of 270,000,000 dollars First, you will see a $13,000,000 increase quarter to quarter from the deferred compensation expense changes that I talked about earlier. Again, this is not actual payments, but changes in the valuation of the liability we have for deferred compensation participants. As noted in the chart, the deferred compensation net pre tax impact was about $1,000,000 linked quarter with that expense increase offset by fee income increases of $12,000,000 2nd, you'll see the fixed income expense increase for variable compensation related to the $14,000,000 of higher revenue in the quarter and thirdly, you'll see all other expenses in the company were down $9,000,000 linked quarter as we saw broad based declines across numerous categories as we continue to be disciplined about controlling expenses. In addition to some continued acquisition related expenses, the Q1 did include those restructuring charges of $12,000,000 and those actions that we took in the Q1 are expected to reduce the annual run rate by about $30,000,000 These actions were taken in a variety of areas across the organization in our regional banking group, FCN and our support areas to free up expense dollars to reinvest into strategic hires and customer facing technology, while maintaining lower levels of expenses to drive positive operating leverage.
Turning to asset quality on Slide 13. We see continued solid asset quality across our portfolios. In the Q1, our net charge offs were just under $5,000,000 down from $12,000,000 in 4Q 2018. The linked quarter provision increase was due to the solid loan growth within the regional bank. And as you can see, overall credit trends remained solid with linked quarter declines and 30 day delinquencies as well as overall criticized and classified loans in the commercial portfolio.
We continue to see steady credit performance with issues being more idiosyncratic or one off and do not see broad based deterioration in the book. Turning to Slide 14. As many debate how long the current economic expansion will last, this slide serves as a good reminder of just how much our balance sheet has evolved into a much higher quality portfolio over the last several years. As you can see, our loan portfolio has shifted from a real estate oriented portfolio a decade ago to a much higher quality commercially oriented portfolio. We now have a much smaller but much higher quality consumer portfolio with no subprime and minimal exposure to high risk consumer lending.
And relative to our risk profile and earnings power, our capital levels are strong. Looking at the most recent stress testing, in a severely adverse economic scenario, we show stronger credit performance and capital resiliency compared to our peers. First, we have significantly lower stress loss rates as our net charge offs are less than half of the average of all the DFAST peers in a severely adverse scenario. And our stress scenario CET1 decline of 90 basis points is well ahead of the DFAST period average decline of about 4.40 basis points. So on wrapping up 1Q 2019 highlights on Slide 15, we're seeing steady profitable loan growth, strong deposit growth across our markets and specialty areas.
We had good expense discipline and are taking additional efficiency to reinvest in the company and drive further earnings improvement. FTN performance was encouraging with higher levels of ADR. Credit quality stable with continued prudent underwriting, and we deployed capital effectively with share buybacks and the dividend increase. We are pleased with the execution across our key priorities and we're controlling what we control. What we can't control, as Brian mentioned, our interest rates and sentiment about the macro economy.
If you look at Slide 16, you'll see that while our balance sheet trends, expense discipline and credit quality remains strong and consistent with our expectations coming into 2019, the outlook for Fed rate actions and the subsequent changes in the forward curves over the last couple of months has moderated our view of our NIM and NII growth opportunities for 2019. Coming into the year, as you know, we had assumed 1 Fed funds rate hike and a corresponding increase in 1 month LIBOR over the course of the year, but the markets have clearly reversed that expectation. Therefore, our current expectation is for our net interest margin to approximate current 1Q 2019 levels over the course of 2019. That expectation now assumes no changes to Fed funds rates in 2019, a stabilization of 1 month LIBOR at current levels and steady declines in our Capital Bank related loan accretion. On Slide 17, while the balance sheet growth, fixed income and expense discipline show positive results, based largely on the macro rate environment, we've updated our full year outlook.
The changes made on each of these metrics are based largely on the change in our margin outlook with our views on operating performance related to balance and expense discipline remaining intact. We're encouraged by our solid performance in the Q1 and we remain focused on continuing to improve earnings power and profitability. With that, I'll turn it back over to Brian.
Thanks, TJ. Early second quarter signs continue to be good as well. We see good trends in the balance sheet and we're very optimistic about the quarter and the momentum going into the latter parts of the year. We are very encouraged about what we're seeing in our newer markets. Our bankers are now up to speed on the new products and services, and they're doing a great job of delivering those to our customers.
I'm also excited about our organic growth opportunity, and we believe that we are increasingly well positioned to maximize the opportunities in our market and the customer opportunities that we see out there. Thank you to all of our First Horizon colleagues for all of their hard work, all they're doing to grow our business and deliver customers exceptional experiences and differentiated products and services. With that, Jamie, I'll now open it up for questions.
Our first question today comes from Steven Alexopoulos from JPMorgan. Please go ahead with your question.
Hey, good morning, everybody.
Just to start
on the Capital Markets business, the surge seems to be much stronger than the environmental factors would have implied. Could you give more color there? And are you seeing this level of ADR continue into 2Q?
Yes. So, Steve, it's D. J. Yes, if you think about what's been going on the last couple of years with let's start with direction of rates. The bias has clearly been rates up, which means bond prices down.
And so that coupled with the flattening of the curve really dampened any fixed income activity over the last couple of years. What you started to see particularly towards the end of December and continuing into the Q1 this year is Fed signaling that they were on pause and the market sentiment potentially saying rates would be down. Rates down for the business means bond prices going back up and people taking advantage of an opportunity to maybe jump in and purchase bonds at lower price points. So we saw some of that activity. What was very encouraging to us as well is that it was more broad based than sometimes we usually see.
It was not necessarily very large trades, but we did, of course, have some of those. But it was across our different trading desks. GDL had a very good quarter, government guaranteed lending, our SBA business had a good quarter as well. So again, the broad based aspect of it and was very helpful. The last thing I'll mention is the sentiment on the economy.
Clearly, there was bullishness over the last couple of years. There is still some improvement in the economy to come, we believe, I believe, but there's a little bit more debate and questioning about that. And that market uncertainty leads to more activities and repositioning of portfolios. And again, fixed income took advantage of that. The last thing I'll mention that shouldn't be lost is the RFKN business and the leadership Mike Kisber has over there, that leadership team has done an excellent job taking fixed expense out of that organization over the last several quarters.
It's been hard to see with muted revenues, but you could certainly see the positive operating leverage that they created in this quarter with revenues up 14%, but expenses only up 4%. They really, really have done a good job taking as much fixed cost out while being able to take advantage of market opportunity when it comes back.
Steve, this is Brian. BJ did a good job summarizing. I would just add, 16 days into the Q2 is not a trend, but we do see average daily revenues on the same trend line as we saw in the Q1. So we're optimistic about at least how we start the Q2 and how that may play out over the rest of the year.
Okay. Thanks,
Brian. On the expense front, I want to make sure I understand the picture given there's so many moving parts to the quarter. So if I take the $278,000,000 adjusted and annualized that, then we take out the $30,000,000 from the restructuring, I'll give about a little over $1,000,000,000 $1,080,000,000 as the base. The question is, how should we think about growth from that base?
Yes. I think, Steve, it's BJ.
It's really the growth is going
to be related more to what fixed income does and the variable compensation from fixed income. I talked about our expectations for 2019 ex net interest margin being largely consistent with what we were saying at Investor Day, which was expenses flat to down for 2019, with the only delta being fixed income. So we still believe that. We're taking costs out of the organization. We're being very disciplined.
As Brian talked about, we are reinvesting some of it, but we expect that our expense discipline is going to be very good this year.
Okay.
Steve, this is Brian. I'm going to back up a little bit from the modeling and just talk about how we think about the expense base. If you go back and you start in 2,009, 'ten and you look at the trend line, we have taken and been pretty aggressive over the years looking for opportunities to gain efficiencies and to deliver on greater efficiency and then reinvesting that in the business. And we've done that over the years and updating our technology and so on and so forth. As we look out into the future, we think a couple of things are likely to be true.
One is what BJ about the interest rate environment that it's going to be more stable than seeing a significant run up in interest rates. And 2, that expense control is going to continue to be extraordinarily important. And I say extraordinarily because one, there is a lot of upward pressure on the expense base and I think on an industry wide basis as more technology is required, changes in technology accelerate things of that nature. And we believe very firmly that we need to get out ahead of that and we need to look for opportunities to continually redefine our expense base. So we can bring our aggregate cost levels down 1 and 2, that we can make the investments necessary to be competitive from a customer perspective.
And so what you see us doing is trying to get out ahead of those things that we think are going to be required investments in the business and at the same time bring down the aggregate cost levels in the organization. So we've taken some actions that I think get us ahead, and I think we see greater opportunities re align our business for greater efficiency, better products and services for our customers and delivering better shareholder results.
So, Brendon, when we think about not that I'm looking for 2020 expense guidance, but even at the Investor Day, I've been surprised that you guys continue to find areas to cut, right? We saw the 30,000,000 dollars benefit realized this quarter. But as you look out beyond 2019, I mean, are you running out of areas to cut expenses? Like at what point should we be expecting expenses to start
building the company? We're not going to defy the laws of gravity. Inflation will have some impact, but we think there could be another $40,000,000 $50,000,000 $60,000,000 of opportunity beyond what we've already talked about. So we still think that as we continue to work that we still have opportunity as we go into 2020. Since you're not asking for guidance in 2020, I'm not going to give it to 'twenty one, 'twenty two or 'twenty three either.
Fair enough. Thanks for all the color.
Our next question comes from Ebrahim Poonawala from Bank of America Merrill Lynch. Please go ahead with your question.
Good morning,
guys. Good morning. Good morning.
I just want to get a better sense in terms of outlook for spread income, BJ. So I get your guidance on the margin to be relatively flat around 3.3. Can you talk about just what you expect in terms of average earning asset growth? Like should we look at your loan deposit growth guidance as reflective of that? Or I'm just trying to understand the remix from the market index into core deposits and how that may play into sort of NII for full year 2019?
Yes. Really, Ebrahim, like I said, our expectations for everything that we can control, including earning asset growth, loan growth is intact. So we think that, that will stick. The only change material change in earning assets versus loan growth would be the level of cash that we would have. So we had very elevated levels of cash that obviously hurt our margin this quarter.
We expect to be able to manage that down, so that's going to actually dampen earning asset growth. But the core loan growth, we think it's still very solid and we expect that to continue.
Understood. And would you say that incrementally, like, so you talked about 190 basis points cost of deposits that's coming in. Is it safe to assume that your incremental balance sheet growth is accretive to the 3.2 margin ex accretable?
Yes, yes. I had to think about how you're asking that question, but yes, it is.
Understood. And just following up on Steve, I just want to make sure I understand the expense outlook correctly. So we were at 278,000,000 dollars Are we saying that the $30,000,000 that you outlined is all going to flow through and as a result at some point by late this year we should be closer to a $270,000,000 run rate ex cap markets?
So what we talked about, Brian said it, I said it is, we are looking to reduce our annual run rate in areas where we can't afford to have that cost and redeploy it into areas that we think give us better potential for revenue generation and profitability going forward. So I don't think that we will reinvest all of that money in 2019, but we will reinvest some of that money in 2019. So I wouldn't assume that it all drops to the bottom line, but we would expect that some of it does.
Our next question comes from Casey Haire from Jefferies.
I wanted to follow-up on some of the NIM commentary. So as you mentioned, Vijay, you're going to be working to looking to work down the excess liquidity, which obviously hurt the NIM this quarter. So and then you have mortgage warehouse seasonality on the comp. Why what's preventing the NIM from expanding in the second quarter here?
It could. It certainly could. I think what we've seen, just to step back for a second, Casey, If you look at these macro curves that we outlined on Slide 16 and you overlay our current forecast, So if you take that rate curve that we would have had at Investor Day, and that's the market rate curve, and you overlay what we're putting on in terms of our deposit and loan growth and how we're changing our mix, we would have actually ended up at the higher end of our NIM forecast. That's how well we are executing in terms of growing the business. Unfortunately, the sentiment on the curves has changed so materially that it's now down.
So what we've done is we've lowered our expectations. We want to be a little bit more on the conservative side if we can. But clearly, the 6 basis point drag in this quarter for excess cash, we think lifts off and comes off. The accretion will still be a net drag quarter to quarter as that comes down. But the way that we're remixing the deposits, the way that we see accretive loan growth coming on, we think that is certainly opportunity to move it up, but we don't we want to set the expectations at a place where we feel most comfortable.
Okay, understood. And then on the loan to deposit growth guide, you guys I mean through the Q1 here, you guys are tracking above your guidance and it feels pretty constructive, the tone on pipelines. So just curious why do you assume the loan growth to moderate from the Q1 pace? Or just why hold the loan and deposit growth guide here when you're tracking above it?
We feel really good about the pipelines and the momentum. I think period end growth to us is a really good indicator of what we're likely to see in the Q2, and that's really why we showed it, and we still feel very good about the business activity. So if we come in above those levels, I'm sure everybody on this call would be happy, so would we. But right now, early in the year, we're staying to the 3% to 6% range. And obviously, we're working to exceed it.
And we've started off great and hopefully, that will continue. Yes. We
think, Casey, if we get a few things that go in our direction, one example is if you look at commercial real estate, again this quarter, we continued to have a fairly high level of payoff refinance, either to sales or refinance, which is a healthy part of having a commercial real estate portfolio you want to see it turn. I think we had something like $232,000,000 of payoffs, paydowns out of a $3,000,000 portfolio. So if you annualize that, that's in ballpark a third of the portfolio on an annual basis. And if you look at it over the entire portfolio, it probably impacted growth a percent or 2. So if we can get a few things like that moving in the direction, it improves our confidence about the aggregate growth in the portfolio.
And I think we can't push the higher end of that range that BJ has articulated in the slides.
Our next question comes from Ken Zerbe from Morgan Stanley. Please go ahead with your question.
Hey, thanks. I just wanted to ask about the ROA and ROE, RCC guidance versus last quarter or your last updated this. And you said it
would come down a fair bit, about 1% or 2%
on the ROTCE and maybe 5 to 15 basis points on the ROE side. I want to make sure that we're not double counting sort of the restructuring costs. Like is the restructuring cost part of that? Like was this a surprise? Or is this truly a sort of your outlook is, I would say, meaningfully lower in terms of
the numerator of these ratios?
Yes. Ken, it's D. J. Really, what drives the difference between the current outlook and 1Q 2019 is the change in the macro rate environment and the margin outlook. So we've essentially flattened our margin outlook for the year, and that flows through all of these.
It's not any change in expense discipline. As a matter of fact, expense discipline, I'd say, is probably a little bit better. Fixed income activity is a little bit better. It's really the change in the margin outlook that is the NetEcon. On ROTCE, what I would say there is the tangible common equity is actually up fairly meaningfully because of the rate environment.
The value of our investment securities portfolio is much better and that is actually accretive to tangible common equity. So the driver of ROTCE is much more the denominator, higher TCE to TA than what we would have expected because of the change in rates.
That had something, what, 70, 75 basis points?
Yes. Relative to Investor Day, yes, about 70, 75 basis points. Got it. Okay. All right.
That helps. Thank you very much.
Thanks, Ken.
Our next question comes from Brady Gailey from KBW. Please go ahead with your question.
Hey, good morning guys. Good morning, Brady. So maybe just one more on the net interest margin and this time relating to levels of accretive yield just from the CDF deal. I think I remember it right, when we were talking 90 days ago, you all talked about how yield accretion levels should be coming down roughly $1,000,000 a quarter kind of from here on out. They came down a little over $4,000,000 this quarter.
And it feels like, Vijay, you're saying that they'll continue to decline from here. I'm just wondering, has something changed with your accretable yield forecast? And I know I thought I remember from the last earnings call, we talked about a $40,000,000 number for 2019. It feels like that's going to be a lot lower where we sit today.
Yes, Brady, it's P. J. So there are really two parts to the accretion. There's what's called scheduled accretion, which is normal payments on existing loans and then unscheduled accretion, which is payoffs. The second bucket is a little bit more lumpy.
And based on what we had seen over the first four quarters in 2018, we thought that there was a general cadence that we could reasonably expect for the unscheduled part. We saw more this quarter than we did early we saw more this quarter than we would have expected. We would have expected something like $1,000,000 a quarter. This was a little bit more. It doesn't necessarily mean it's a trend.
It could moderate and stabilize at this level. But to be conservative, we're assuming that it will continue to go down modestly from here.
Okay. And then just on the credit quality front, I know last quarter you all had a couple of net charge offs driven by some C and I loans, I think in Manufacturing and Financial Services. You had the 3 C and I loans that came into NPAs this quarter. So kind of a couple of quarters back to back with a little bit of credit noise, specifically in C and I. Are there any underlying trends that you're seeing that's driving the C and I credit noise?
Brady, these are still diversified and we're not very idiosyncratic as it relates to the 3 that went non performing this quarter and the couple that you mentioned from last quarter. So the 3 this quarter, there was 1 healthcare credit, an ABL loan with equipment back and an energy credit, All with again, not anything that we're seeing related to industry issues, just again, specific to those credits and borrowers.
Okay. And then last question for me. Brian, with the currency trading, how it's trading, I'm guessing M and A with you guys as a buyer is completely off the table. Is that the right way to think about it for you guys?
Yes. I think that's fair. You never say never, but in all likelihood, the same trends that I talked about last year that we continue to execute on capitalizing on the opportunities that we now have in the Carolinas and South Florida, continuing to build the business, continue to execute on controlling our cost base and reinvesting that and transforming our business. So in all likelihood, I expect that we'll continue to focus on delivering results day in, day out and M and A is likely off the table, yes. Great.
Thanks.
Our next question comes from Tyler Stafford from Stephens. Please go ahead with your question. Hey, good morning guys and thanks for taking the question.
I'm still a little confused on
the expense outlook. BJ, I was hoping you could just go over that one more time. Just the comments about the $30,000,000 of run rate expenses and how much of that will be reinvested. Is the $30,000,000 you talked about in the deck net or gross of however much will be reinvested throughout the year?
$30,000,000 is gross. Okay. And so like we talked about, I don't we're not going to specifically say how much is going to be reinvested or not. I think that the point is that we are not investing in the business as we need to, like Brian said, incrementally. We are trying to find costs that we can't afford anymore because we need to make strategic hires in Florida, let's say, or in some of our specialty businesses or invest in robotics or invest in customer facing technology that we need to compete as a $40,000,000,000 bank going forward.
So we think that these types of things are necessary. And as Brian said, we got $30,000,000 of annualized costs this quarter. There could be another $40,000,000 $50,000,000 $60,000,000 ongoing as well that we'll continue to look for to, again, largely reinvest but hopefully not totally reinvest.
Yes. Tyler, we firmly believe that we have room to bring our overhead efficiency ratio down over time. And as we've demonstrated in the past several years, we have the ability to get positive operating leverage. We think there are opportunities for us to continue to invest in South Florida, for example, or in the Carolinas. And so we look to make investments in people where we can grow our business.
And at the same time, we think that the pace of change in technology is going to require additional spending. The but is but we believe we need to pay for that out of our existing expense base. And so as BJ has described, we look for opportunities to reallocate resources from less productive areas to more productive areas. And that's always difficult because it impacts people in the organization, but we think it's an important part of making sure that, 1, we remain competitive 2, that we continue to grow our business and then finally, that we bring our overhead efficiency ratio down over time. So I think it's what we're signaling is, is we're looking to get out industry and making sure that we have the ability to remain competitive to grow the business and to deliver better results to shareholders.
Got it. Thank you, Brian. That's very helpful. Thanks for clarifying that. BJ, on the fixed income expenses, the $51,200,000 do you know how much of that was variable versus fixed offhand?
I don't. Let me think for a second. Our fixed cost base in that business is about $75,000,000 So let's say $18,000,000 is fixed and the rest is variable.
Okay. So 75%, not 75,000,000
dollars right? $75,000,000 in total expense for any given year is fixed expense, dollars 18,000,000 a quarter.
Okay. How much on the margin shift in there, how much more opportunities do you see this year to reduce the index deposits?
Fairly material. So you see that period end, they were down 19% from the prior quarter. If we continue to see the deposit growth that we saw in the Q1 and expect to see the rest of the year, we could let go another several 100,000,000 dollars is my expectation. So we're continuing to manage that down, not just because we're getting great deposit growth, which is the primary reason, but also we have alternative funding sources like Federal Home Loan Bank that are more just in time funding that we think might be more appropriate to use than holding contractual market index deposits as well. So we'll continue to remix it, but there's certainly an opportunity to continue to bring it down really meaningfully.
Our next question comes from Rob Placzek from Deutsche Bank. Please go ahead with your question.
Hi, good morning.
If I could ask one more follow-up on your NIM outlook and what this means for net interest income dollars. For the full year, where do you think net interest income shakes out? Do you think you can grow net interest income year over year, at least on a core basis ex accretion?
So right, if you take out accretion, right, based on starting with 1Q 2019 and looking at the positive loan and deposit growth that we're seeing and the pricing discipline that we have, I would expect that we could grow NII over the course of the year. Now what that what you assume there though is that rates, like we said, are stable, 1 month LIBOR is stable, those types of things. But the things that we can control around pricing discipline and growth, we think that we can continue to grow NII.
Got it. And then just separately, on commercial real estate, you continue to see elevated payoffs in this portfolio.
I'm just curious if you
could talk to your outlook for your commercial real estate portfolio from here.
Yes, we have probably have, as you've seen the last couple of quarters had maybe higher than expected payoffs. And I believe Brian said this last quarter, I actually view that really as a positive related to what the economy is doing. So the fact that some of our customers are choosing to sell properties and they get to the point when they're fully leased up, they're getting good prices for those. We've had a handful where we've passed them to either put in equity or refinance, those have been easily refinanced by others. So from a just from a pure credit perspective, when I see good payoffs like that, I think that indicates that we've got good underwriting and we're dealing with good borrowers.
All that being said, we do see continued good opportunities within commercial real estate really across all of our major markets. And we've seen good opportunities, well underwritten, good sponsors, good upfront equity, Charlotte, Raleigh, Houston, Memphis, Chattanooga, Nashville, South Florida. So there are opportunities there with good clients and we're again seeing equity still hold very well really, pricing coming under pressure in some categories. But I feel very, very good about the commercial real estate book that we've built. It's well diversified by product type and by geography.
So I think the outlook is good.
Okay, thanks.
Our next question comes from Garrett Holland from Baird. Please go ahead with your question.
Thanks for taking the question. Just a question on positive operating leverage. What is a reasonable level to expect over the intermediate term given the challenging spread income outlook with elevated investment spending?
Yes. So Jared, it's BJ. We always target at least 2x positive operating leverage is what we look to do quarter in, quarter out or year in and year out. So as we see opportunity to do that, we will make sure that we manage our expense base to be able to do that given the uncertain interest rate outlook. But we feel really good about what we're putting on the balance sheet, what kind of growth that that's going to give us going forward in terms of margin growth.
Our expenses are good, so we expect to be able to do that over time.
Thanks. And then just a follow-up on the technology investments. Just maybe as a percentage of revenue, where are technology costs now? And how would you expect that level to trend over the next few years? It seems like you are already spending pretty heavily on technology, but any insight on what new customer facing applications you're adding would be helpful.
Sure. So doing some quick math here. We spend about 10% of our revenue on technology today. That's everything from customer facing technology to back office technology to telecom and everything in between. That benchmarks fairly well with others, particularly in our peer group or even bigger than our peer group.
I think the difference is over time, as Brian alluded to, is that we've got to shift the mix of how we spend technology more towards customer facing technology and more towards, you want to call it machine learning or robotics or artificial intelligence or things that will make us more efficient in the back office versus what I might call traditional Investor Day, we had a specific section on transforming our customer experience. And a lot of what we're doing right now internally is looking at where those opportunities are to improve the customer experience, particularly from a digital perspective. And so we're continuing to spend money on our online banking, our mobile platforms, our treasury services on the commercial side and our onboarding and product offering set that we have there. I mentioned earlier robotics, particularly in our operations group, we're expanding our use of robotics to take out automated process or automate processes that are currently manual. All those things over time will make us a much more efficient company.
And our technology expenses may grow. But as Brian said, the way that we're looking to harvest existing expenses even within technology that we don't necessarily need and put it into more useful technology going forward will also benefit us for the long term. We think that
the trends in technology are going to accelerate. And it's going to be new feature functionality required in existing programs and applications. If you think about small businesses, for example, and even consumers, the likelihood that the industry will be expected to provide real time payments, for example, and technologies around that is an example. The other thing that we expect to happen is that the pace of change in technology is going to mean that you don't put in a website or a mobile app and that it's there 10 years from now, that the cycle times get shorter. The way I think about it is when I bought my first iPhone in 2007 or 2008 or whatever it was and paid $500, $600 for that phone, I thought it might last forever and I'm on my 5th version of the smartphone since then.
The pace of change is going to accelerate. So we're preparing ourselves to be in a position to face the competitive demand for table stakes technology and make sure that we're delivering that in the context of our community banking look and feel. And as BJ said, we have to reorganize our expense base over time to help accomplish that.
Our next question comes from Christopher Marinac from FIG Partners. Please go ahead with your question.
Thanks. Good morning. As you look at the opportunities from other bank mergers, large and small, in your footprint, do you see this year as one of heavy recruitment of additional lenders and other customer facing folks? Or do you see this simply taking your existing team and winning new business? Hey, Chris, it's Brian.
If you give me an option C and take both, I'll take both. I think it's an opportunity to do a little bit of both. Whenever you have a lot of change in the industry, it does present opportunities opportunities from a customer perspective and from a people perspective. And as we have been in the past and as we will be in the future, we're always going to be opportunistic looking for talented bankers who want to do business the way we do business to bring them on to our platform and to grow aggressively through that. I mentioned South Florida.
We've added a number of bankers in the past 6 months in South Florida. For those of you that were at our Investor Day, you'll remember Jeff Jackson got up and talked about what we're going to do there and he's doing a great job of investing and executing on that. But we also think that there'll be customer opportunities as well. And not that we wouldn't be equally aggressive in any environment trying to win new customer business. I think when you have a lot of change in the industry, it does facilitate more customer transition.
And so we will take option C, which is I think we can do both. Great. That's helpful. And does the expense that we see this year, again, from the outlook, does that anticipate additional hires as well? Yes.
Yes. Great. Thanks, Brian. Sure thing. Thanks, Steve.
Our next question comes from Matthew Keating from Barclays. Please go ahead with your question.
Great. Thank you. I just had
a follow-up on sort of the pace of the magnitude of the market index deposit remixing. BJ, if I heard you correctly, I thought you said several $100,000,000 across the balance of this year. Just wondering, was there anything special about Q1 that you're close to $1,000,000,000 there? And why is that moderating as we look at the balance of 2019? Thanks.
Yes. We were very pleasantly surprised by how much deposit growth we got from customers in the Q1. And I think as we've talked about what market index deposits are, they're contractual, right, which helps us when we need it, and it also helps the provider as well to know where they're going to place the deposits. And so even if we make a decision today that we're going to release those deposits, it will take anywhere from 3 to 6 months for them to actually go away. And so we had a plan coming into the Q1, we were going to let go some of those contracts and we talked about that in the 4th quarter.
I think we said something like $200,000,000 to $400,000,000 of contracts that we were letting go. But because of the great deposit growth that we got, we started to let go more and more contracts and try to get them out as quickly as we could, and it just takes a little bit of time. So again, average market index deposits
for the quarter were only
down 4%, period end was down 19%. And so we expect that 2019 to continue into the Q2 and will let them work contracts after that such that we're managing it down further. So I think it's a great problem to have. I don't like having a negative margin impact from excess cash, but it's liquidity is always a good problem to have for a bank and we'll manage it down appropriately.
And then maybe more broadly on the deposit pricing front, you mentioned that the change in sort of the yield curve and the rate outlook, right, has impacted the bank's overall net interest margin expectations. But what is the expectation in terms of deposit costs? Are you seeing your competitors sort of rein in deposit pricing pressures? Or how are you guys thinking about ex maybe mix shifts in deposits around deposit pressure across the balance of this year?
Yes. So I think deposit competition remains high. But with the Fed seemingly pausing on rates, we're not seeing the continued march higher in terms of deposit rates that are being offered out there. It's kind of flat lined at what was existing maybe a couple of months ago. And so competition is still that should be incrementally helpful.
There's always obviously a lag of what you're bringing in versus what's on the books now. So that doesn't mean that deposit rates paid will immediately flatten, but I think that should certainly help. One other thing that I would mention is we've got the market index deposit portfolio and that has had an outsized impact on our deposit rate paid in our deposit beta since the beginning of the rate cycle, but now we're having an opportunity let those go. If you look at our consumer deposit beta since the beginning of the cycle, it is only a 25% beta. And on the commercial side, ex the market deposits, it's only about a 40% beta.
So combined in the regional bank, we've got about a 29% beta ex those market deposits, which is very attractive. So I think our bankers, even in the face of competition on both sides of the balance sheet, have done a really, really good job of managing pricing and being very excellent. My team's job and our job is to then use that opportunity that the bankers have given us to reduce those higher cost market index deposits as quickly as possible, and we're working to do that. And again, as we've talked about strategically, that will remix our deposit portfolio, bring the deposit cost and the funding cost down and help us flatten that growth in deposit rate paid, maybe even a little bit more than others have an opportunity to do so. So that's exactly what we're focused on executing on and believe that we're doing a good job on it.
Our next question comes from Jared Shaw from Wells Fargo Securities. Please go ahead with your question.
Hi, good morning. This is actually Timur Braziler filling in for Jared. I guess my first question is, do you have the period end balance for loans to mortgage companies?
Yes. It is. In the back of our presentation, it is $2,300,000,000 and 4Q 'eighteen was 2.0
Okay. And then maybe looking more broadly at what's going on in South Florida, obviously, there's been a good deal of consolidation. Just wondering if you can speak generally to what the competitive landscape is looking like there and where you're seeing most success in either gaining market share or hiring?
I've been fortunate to meet and interview many of the people that we're hiring in South Florida. And largely the opportunities that we're seeing are coming from hiring strong seasoned bankers who've been in those markets for many years in terms of knowing companies and individuals who've been around who made it through different cycles. And we've got I think we've assembled a very good leadership team. They're continuing to recruit and hire relationship managers. So we're seeing opportunities in C and I, we're seeing opportunities in municipal, private client and selectively on commercial real estate.
So I think we've got a really, really good opportunity there to build a book of business that's sustainable through this cycle.
I'll pick up with that. It did disservice to all our markets to say that everything is not competitive and South Florida is equally competitive in both the pursuit of talent as well as the pursuit of customer relationships. And while there's a lot of change going on across the industry, we see it as a very good growth market for us. We start with relatively small shares there and we see the ability to build out the toehold or the footprint that Capital Bank had pre acquisition. And while it will be a competitive landscape, we do think with right people added to the team, the right base that we have there from an existing standpoint, we think we have a nice opportunity for growth.
And our last question today comes from John Pancre from Evercore. Please go ahead with your question.
Good morning. Good morning, John. All right.
Thanks for taking my questions. I know the call is going on long. Just a question again
on the efficiency side. Regarding your longer term targets, I know BJ you indicated your goal is still to get the overhead efficiency lower and then Brian, you said that. My question is around the medium term expectation for below 60% and then longer term below 59%. Have they changed at all just given the Fed and given the curve? And is there
or is there a reason
to move them from where you currently or where you last provided?
No. There's no reason to move them over the medium term or the long term. I mean, quarter to quarter, you're going to be impacted by things like rates, and you can't move as quickly in a 90 day period as you can in a 12, 24, 36 month period. And so we'll adapt and we'll adjust, and we'll figure out a way to continue to grow and provide positive operating leverage such that we can be at sub-fifty nine efficiency over time. And so that hasn't changed at all, and we'll manage the company to do that.
And in terms of how you view the medium term, can you give us an idea or even the longer term of the time frame that you consider when you say that?
The next couple of years, 3 years, 2 years?
That would be it for the long term?
That would be our goal. Yes.
Okay. All
right. Got it. Thanks, P.
J. Thanks, John.
And ladies and gentlemen, that will conclude today's question and answer session. I would like to turn the conference call back over to Mr. Jordan for any closing remarks.
Thank you, Jamie. Thank you all for taking time to join us this morning. We're very pleased with the results of the Q1 and encouraged about the momentum we see in 2019. Thank you again to all our First Horizon colleagues. If you have any follow-up questions or you need any additional information, please reach out to Artie, BJ, me, Susan or Brian Malone.
We'll be happy to try to fill in any gaps. Thank you again. Hope you all have a great day.
Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending. You may now disconnect your lines.