Good morning. Welcome to the First Horizon National Corporation fourth quarter 2018 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Aarti Bowman, Investor Relations. Please go ahead.
Thank you, Gary. Please note that the earnings release, financial supplement and slide presentation we will 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 and on 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 the earnings materials and in the slide presentation for this call and is reconciled to GAAP information in 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, Bryan Jordan, and our CFO, BJ Losch.
Additionally, our Chief Credit Officer, Susan Springfield, will be available with Bryan and BJ for questions. I will now turn it over to Bryan.
Thank you, Aarti. Good morning, everyone. Thank you for joining us. The fourth quarter in 2018 were very good. I am very proud of the work that our team did. 2018 was a transformative year for our organization. We completed the integration and the merger with Capital Bank, greatly expanding our markets and really into very attractive markets. In our November Investor Day presentation, we laid out sort of the key drivers of the business in 2019 and beyond and the differentiation in our markets and our business. I think the fourth quarter did an excellent job of highlighting those. You saw good growth across our new expansion markets. You saw good customer acquisition. I think you saw the foundation or the opportunity to see the foundation that will drive strong performance in 2019 and beyond.
In the fourth quarter, across all of our markets, we saw good customer acquisition, both in our consumer and our commercial banking businesses. We start the year 2019 with very strong momentum headed into this quarter. We saw good progress, easy for me to say. We saw good progress made on our merger cost saves and our expense trends. We're very optimistic about our ability to continue the realization of our cost saves in the first quarter of this year and continue to drive efficiency across the organization. Our asset quality continues to be very good. NPAs and delinquency trends were steady to down. Our credit quality on the whole continues to look good. I'll come back and talk in a minute about the economy and a little bit of the outlook.
In the fourth quarter, we saw a 3% increase in our tangible book value per share. We also bought back, as the market corrected in bank stocks, we bought back $80 million of common stock, bringing our total for stock repurchases to the year to around $100 million. While doing that, increasing the tangible book value and buying back the stock, we also saw a steady common equity tier one ratio at 9.8. Strong capitalization in our business and the opportunity to continue to lever that capital in the future. Our economic outlook as we transition into 2019 is still very optimistic. There's nothing that we see, particularly in the economy, that has transitioned or taken effect at this point that causes us concern about the economy in 2019.
Clearly, there's some opportunities for clouds on the horizon with trade disputes and/or shutdown in Washington or even policy mistakes or much higher interest rates. At this point, we don't see those becoming problematic. Customers continue to be very optimistic. We see customer balance sheets continuing to be very strong and customer activity continuing to be strong, as evidenced by what we saw in loan and deposit growth in the fourth quarter. As we look into this year, we're still very optimistic about the operating environment. Could it be off a little bit from 2018? In all likelihood, it probably will be a little bit softer from the strong growth we saw there. We still are optimistic about growth in 2019. All in all, we think we're very well positioned for a strong 2019. We have very good markets.
We've improved those markets with the integration of Capital Bank. We've got good momentum and good demographics to build on. I'm very optimistic about how we're positioned. With that, let me turn it over to BJ, let him take you through the numbers. I'll come back with a few closing comments before we answer any questions. BJ?
Great. Thanks, Bryan. Good morning, everybody. I'll start on slide five with the financial results. In the fourth quarter, as Bryan talked about, our reported EPS was at $0.30 and $0.35 on an adjusted basis. Our full-year results reflected the successful execution of our Capital Bank deal, as Bryan talked about, as well as solid performance in our core franchise. In 2018, our reported EPS was $1.65 and adjusted was $1.41, up 26% from 2017. You'll see on page five that our fourth quarter notable items were $13 million of acquisition-related items, which included a $2 million fair value mark associated with a loan sale. We also had a $9 million pre-tax impact related to the return of excess fees from Capital Bank debit cards. I'll talk about that a bit more in a minute.
On an adjusted basis, linked quarter revenue was down due largely to a few factors. First, you'll see in the fee line an $8 million decline in deferred compensation related to the equity market volatility in the fourth quarter. It's important to note that this was also offset in expenses. Second, you may recall we had a $4 million gain on a sale of trucks loans in the third quarter that did not repeat. We did not have any similar sales of any other kind either in the fourth quarter. Third, we had a slight decrease in NII because of lower accretion and a seasonal decline in our higher-yielding loans to mortgage companies portfolio. Not much change overall in the fixed income business in the fourth quarter. Revenues remained muted, and we saw a slight average daily revenue decline from the third quarter.
We did see higher ADR in the month of December as the business benefited from the market volatility, but activity overall is still at relatively low levels. On the expense side, we saw a quarter-to-quarter decline from that deferred compensation offset, which I discussed in the fee line, which was about $8 million, as well as the benefit of decreased FDIC surcharge, which was about $3 million. We remain disciplined overall on expenses, with flat expenses in the rest of the business, and expenses will continue to be a heavy focus in 2019. Circling back on the notable item around debit fees that I mentioned earlier. During year-end reviews, we discovered we had been receiving excess fees related to interchange on Capital Bank debit cards. The $9 million reflects the cumulative amount of excess interchange fees we returned to the vendor.
We have corrected this going forward, absent volume increases, we will see lower debit card fees of about $2.5 million per quarter. Before getting into the rest of the details on the quarter, I want to make the connection between what we outlined as our strategic priorities during our Investor Day in November and what we saw in the quarter and the momentum we see going into 2019. As a reminder, our four key priorities are, number one, dominate Tennessee, number two, profitably grow key markets and specialty businesses, number three, transform the customer experience, and number four, optimize the expense base. Particularly as it relates to the first two priorities, we are very pleased with what we saw at the end of the fourth quarter in terms of customer activity and acquisition, specifically around deposit gathering and commercial lending in new markets.
Starting with deposits on slide six, you see that period-end deposits were up 5% linked quarter and up 3% on an average basis. Deposit trends were excellent in the quarter across the board in both consumer and commercial, as well as across all markets in Tennessee, in the Mid-Atlantic, and in Florida. As you can see in the bottom right chart, Tennessee was up 5% linked quarter, Mid-Atlantic was up 4%, and South Florida increased 10%. Our new customer acquisition emphasis and marketing efforts are making a difference already. As we discussed at Investor Day, we are confident in our ability to build a differentiated business model in our newer markets over time. We have been placing a heavy emphasis on new customer acquisition in both consumer and commercial banking, as well as putting marketing behind our efforts, it's already showing positive results.
Turning to the lending side on slide seven. While average loans were roughly flat linked quarter, we saw very strong bookings in December. We saw particular strength in core commercial loan growth, which was up 5%, with broad-based increases across our Tennessee markets, the Mid-Atlantic, and the South Florida regions. We also saw continued positive growth in specialty areas such as correspondent, healthcare, and asset-based lending. In the fourth quarter overall, our net loan growth was dampened by loans to mortgage companies being down seasonally as expected, as well as a large volume of payoffs in commercial real estate as borrowers completed projects, transitioned properties to the permanent market, and chose to exit deals through sales. Good news is that our CRE pipelines are strong, and we should be able to profitably replenish those balances over the next several quarters. Turning to NII and NIM on slide eight.
Our NIM declined due largely to the higher excess cash balances from the strong deposit growth we saw. Those excess cash balances were driven by both strong customer deposit inflows, as I discussed earlier, as well as higher market index deposits as brokerage customers moved more money out of equities into cash. While relatively neutral to NII, the excess cash compressed the margin by four basis points in the quarter. You will remember both at our Investor Day and over the course of the last 12 months or so, we have been talking about gathering customer deposits in our newer markets of Florida and the Carolinas at lower overall deposit costs and betas and replacing the market index deposits.
This quarter was the first where we could confidently start to reduce our contracts on some insured network deposits based on strong customer inflows. You see that we canceled about $200 million of funding and expect to exit more in the coming quarters as deposit growth in the business continues. NII was down modestly as the positive impacts of the deposit growth we saw were offset by seasonal declines in our higher-yielding loans to mortgage companies business. However, we are encouraged by the growth we saw in the fourth quarter, which we believe will have a positive impact on NII going into 2019. As you can see on slide eight, expense trends were solid, and we demonstrated positive operating leverage and efficiency ratio improvement over the course of 2018.
As I discussed a few minutes ago, total expense declines one quarter from decreases in the FDIC expense, professional fees, employee compensation, and deferred compensation. The decrease in deferred compensation was related again to the valuation declines from market volatility and is offset in non-interest income. We remain disciplined overall on expenses, with flat expenses in the rest of the business. Expenses will continue to be a focus in 2019. As you know from our Investor Day, one of our key priorities is optimizing our expense base. We are continuing to look for expense savings to reinvest in growth opportunities across the franchise. Turning to asset quality on slide 10, overall credit trends remain stable. Annualized net charge-offs at 17 basis points for the quarter and six for the year continue to be at historically low levels.
We did have an increase quarter-to-quarter in net charge-offs related to two C&I credits, one that was fully reserved for and one that had a modest net impact on the provision. The provision overall remained low at $6 million, as overall PD grades in the commercial portfolios remained stable and 30-day delinquencies were down. Wrapping up on slide 11, we are pleased again with how we performed in 2018 and are proud of all of our employees and what they did to make our company successful last year. We're also very pleased with the momentum we see going into 2019. You'll recognize this slide from our November Investor Day. We continue to be focused on doing what we say we will do and building a sustainable long-term business model. Our returns are solid, profitability strong, credit quality stable, and our opportunity for capital deployment is attractive.
On that last point, as Bryan talked about, we were very opportunistic with our share repurchases in the quarter as we saw meaningful stock declines across the industry and in our own stock. We're confident in our business outlook and therefore bought back $80 million of shares in the fourth quarter alone, $100 million over the course of 2018. At the same time, we kept our capital levels relatively stable. Our balance sheet and capital position are strong, and we have continued opportunities to deploy capital profitably in 2019. With that, I'll stop and turn it back over to Bryan.
Thank you, BJ 2018 was a solid year, and we're delivering on our strategic priorities of deepening our core Tennessee relationships, profitably growing in key markets and specialty areas, optimizing the expense base, as BJ mentioned, and deploying capital effectively. We're excited about the opportunities ahead of us, and we will continue to execute and deliver for long-term profitable growth. As BJ did, I want to also thank our colleagues for all of their hard work this year and in the fourth quarter, and we're counting on them to deliver another strong year in 2019. Gary, with that, we'll now take any questions.
We will now begin the question and answer session. To ask a question, you may press star then one on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question comes from Steven Alexopoulos with JPMorgan. Please go ahead.
Hey, good morning, everybody.
Morning, Steven.
Good morning.
I wanted to start on the loan growth. You guys had the strongest core C&I loan growth quarter in many years. We've had other banks also talking about a strong December. Can you give more color on what you saw in December? Were middle-market companies stepping up the pace of investment? What drove this?
We're seeing loan growth opportunities on several fronts. Steve, there are companies that are making additional investments, capital expenditure investments. We're also seeing some M&A activity amongst our customers, and that can be an opportunity for us to work with clients who are buying other companies. We're seeing that it's not any one thing. I think it's across the board. We specifically, as you know, saw an increase in production from second quarter to third quarter and additional third quarter to fourth quarter related to being post-merger and our bankers being out calling on both customers and prospects. It was really a kind of a broad-based loan growth.
Okay. That's helpful.
In our case too, Steve, it was also very strong new-to-bank growth. We saw a significant pickup in new to bank to accentuate Susan's point about our bankers being refocused on outbound calling on prospects in addition to helping customers through the conversion process.
That's right. In the fourth quarter, on the wholesale side, about 55% was increases, but 45% was new to bank. Really great work on both fronts.
Yeah. I think just to add to that, our new to bank commercial loan production for the year was up more than 20%. Really once we got past our integration, our folks have done an excellent job really getting out and building new bank relationships, and we started to see the bookings late in the year.
BJ, is that in the newer markets that you guys entered with the Capital deal, or is that Tennessee?
That is overall in the franchise, I would say it's disproportionately related to the newer markets.
Hmm, okay. Thank you. Just on the NIM. The way we think about NIM, you'll see a benefit in 1Q because of the December hike. Assuming the Fed pauses from here, BJ, how do you think the margin will progress after the first quarter?
Yeah. We have still assumed one in June of 2019, which we think would incrementally help. If there are no rate increases going forward, we would be thinking more about NIM stability and trying to manage the NIM to stable. It's been interesting, though, to look at our asset liability position over time, particularly as deposit competition has heated up. Whereas before we used to be very asset sensitive, we started to float down towards moderately asset sensitive, and we're pretty darn close to neutral now. I think the volume growth that we're seeing and the new production we're getting will be incrementally helpful to the margin. I think loans to mortgage companies, particularly given the back up in the 10-year that we saw in the fourth quarter, could be helpful going in to next year.
That could certainly be a tailwind to us, less rate increases because of the net position of our asset liabilities could be a modest headwind. All in all, you saw that we're at roughly the same outlook as what we had November Investor Day in terms of the 3.40%-3.50% overall NIM, and that's what we're shooting for.
Okay. Just final one. In terms of 3.40%-3.50% NIM guidance, you had $13.7 million contribution from the CBF accretion. What's a reasonable range for accretion in 2019, which would be in that guidance?
I'd say maybe $40 million in aggregate. I think it'll come down, $1 million or so a quarter, is what our current forecast is.
Terrific. Thanks for all the color.
Our next question comes from Jennifer Demba with SunTrust. Please go ahead.
Morning, Jennifer.
Good morning. Question. What industries were the two C&I charge-offs in this quarter?
Yeah, Jennifer, one of the ones is the one we talked about last quarter that we had taken non-performing and put a reserve against. It's a non-bank financial services company. The other is a manufacturer of paper products.
Okay. All right. Question just on your fixed income business outlook. Could you give us a little more detail on what you're expecting in 2019?
I'm sorry, Jennifer, could you repeat it?
Sure.
I'll start. Fixed income outlook. We expect maybe modest improvement from where we were in the fourth quarter. Actually, Steve asked about interest rates and outlook. The market reset interest rates after Jerome Powell made some follow-up comments to the FOMC meeting. There's been more participation in the fixed income markets in the early part of the first quarter. We expect it to be just modestly better. I wouldn't say significantly. Probably the mid 500s is probably a reasonable range to think about it. The other thing that I think is a little bit of a factor and we have to pay attention to as well is, one of the impacts of the government shutdown is that it has shut down the flow of SBA activity. That'll have a little bit impact on FTN Financial.
Not that the trading environment is there's still no flow of SBA loans to pool and to securitize. That might have a little bit of impact. On the whole, our outlook for first quarter in 2019 is probably slightly better than the run rate that we had in the fourth quarter of this year.
Thank you very much.
Sure.
The next question comes from Brady Gailey with KBW. Please go ahead.
Hey, good morning, guys.
Hey, Brady.
I understand how the expense base was impacted with the lower stock price and the $9 million reduction in deferred comp. Maybe just talk a little bit about how that impacted fee income by $8 million.
Yeah. You're going to test my accounting skills, aren't you, Brady? Really, deferred comp, people can choose to defer compensation, which is then put into Rabbi trusts. Those assets are invested on behalf of those participants. The asset side shows up in fee income in terms of the fluctuation in the value of what those assets are appreciating or depreciating. On the expense side, we have a liability because we owe that to those participants at any given time. When the markets go down, like they did in the fourth quarter, the value of the assets go down, the fee income is then a contra fee income, our obligation to pay them out over time is obviously less. They largely mirror.
I don't know why the accounting rules are such that that's not netted, I would suspect that you would see that from other banks going forward. Again, they largely offset. Visibly, they cause an issue, it's an offset.
Okay. All right, also in fee income, if you look at deposit fees, they were $25 million. If you add back the $8.7 million kind of one-timers, that gets you back up to about $34 million. You're saying to expect a reduction of around, I think you said $2.5 million per quarter going forward. Does that get you down to kind of a $32 million quarterly run rate, maybe a little less as we start in 1 Q 2019?
Absent volume increases, that's probably reasonable.
All right. Just finally on the buyback, it was a big number in the fourth quarter. The stock's even cheaper today. I know y'all gave a fairly wide range on the payout ratio for 2019, I've got to think with the stock trade and how it's trading, you're going to be towards the upper end of that range.
Hey, Brady, this is Bryan. We go into a blackout period around earnings, as we've noted in the past and noted through our actions in the fourth quarter, when we think the stock is undervalued, we will buy it. Having follow-up to this earnings release, if the stock, in our view, is undervalued, we're going to take opportunities to repurchase it. As BJ has indicated, we expect to repatriate a significant portion of our earnings in 2019. With strong earnings, strong capital ratios, we think with undervalued stock, it's a great opportunity to buy some.
Got it. Thanks, guys.
Sure thing.
The next question comes from Ebrahim Poonawala with Bank of America Merrill Lynch. Please go ahead.
Good morning, guys.
Good morning.
I just wanted to clarify on expenses. The deferred comp adjustment, that's going to reverse in the first quarter. Should we expect both the fee and the expense impact reversing in one go, or does it stay here if there is no move in the stock?
Yeah, it'll fluctuate again based on equity markets and asset valuations. Yeah, it should just normalize.
Okay. If we look at the expense base, BJ, at $270 million in the fourth quarter, and you mentioned multiple times the focus on expenses, where's that $270 million headed as we think about 2019, absent any sort of capital markets revenue upside?
Well, we talked about at Investor Day that we are focused on managing expenses down from 2018 levels. 2018 levels, I think, would be more in the low $280 million range. That's what we're focused on doing.
Got it. Separately, just in terms of credits, obviously, you have a pretty benign outlook for credit in terms of charge-off guidance. Your previous, I think going back to the Bonefish for normalized charge-offs of 20 basis points- 60 basis points, do you still think that would be a range if and when credit normalizes next year or over the coming years?
Ebrahim, actually for this year, we think it's going to be on the low end of that and could actually be lower than the 20 basis points low end guidance. Based on what we know today. I would say through the cycle, we still feel good about that 20 basis point- 60 basis points as a range of charge-offs based on the strength of the portfolio that we've built.
Got it. The way the portfolio is today, like ex seed capital, reserves are somewhere around 90 basis points. Is that reserve level appropriate, or do we still expect the reserve ratio to run off from here?
I think so. I know we're adequately reserved today. Based on what I know today, I think we'll probably see that coverage stay pretty steady. Obviously, if we started seeing anything in our portfolio or in the economy, you could see that build. As you saw this quarter, we are seeing slower reserve releases from non-strategic as it runs off. All things being equal, based on the positive outlook that we have today, I would see coverage remaining pretty steady.
I'm going to test BJ's accounting knowledge too. I think as a matter of accounting math, as the Capital Bank portfolio runs down naturally and is replaced by new originations, that ratio will move up over time simply just by accounting math.
That's right. I know he talked about that, having it back here. Yeah.
All right. Thank you very much for taking my questions.
Bye.
The next question comes from Tyler Stafford with Stephens. Please go ahead.
Hey, good morning, guys.
Good morning.
Good morning.
Thanks for taking the question. On the loan growth guidance for the year, the 3%-6%, can you help us understand the moving pieces within that? For example, just how much mortgage warehouse growth would you expect in there, and just the non-strategic runoff continuing?
We had year-over-year in loans to mortgage companies, we had 2% growth. We added a good amount of new-to-bank customers in mortgage. We're optimistic that we could see some mid-single digit growth in the loans to mortgage company business. As we talked about going into the end of the quarter, we saw really strong growth in commercial, we saw strong growth in several specialty businesses, and the overall growth was dampened by large payoffs in commercial real estate, which I talked about the pipelines being strong to replenish over time. On one of our pages, page seven, we show you that regional bank had 4% annualized loan growth in the quarter, even including the seasonal declines in mortgage warehouse increase.
We're still optimistic that based on what we're seeing, based on pipelines, based on customer activity, as Bryan talked about earlier, that that range is something that we can certainly hit.
Got it.
And we continue to see, I'll add something to what BJ said. We continue to see the positive momentum of the synergies with the Capital Bank transaction as it relates to loan opportunities and really in both the wholesale and the consumer business. Based on what we're seeing in the pipeline today, the synergies that we expected will be exceeded.
One last point to add. You mentioned the mortgage warehouse business. BJ started with that. I think it's important to keep in mind when you look at our headline loan growth numbers, you have to think about it through an annual cycle. The mortgage warehouse business has seasonality in it. People don't move as much in the fourth and the first quarters. As the refi activity has naturally come down over time, that it's driven more and more by purchase money mortgages. We'll see the seasonal effect in the fourth quarter, which we saw first quarter ought to be fairly stable relative to that, then we ought to start to see the growth in the second and third quarter.
The wild card is always what the 10-year treasury is doing and what effect it's having on mortgage rates. They've come down a bit, whether that spurs activity is yet to be seen. The bottom line is, when you look at our headline loan growth numbers, you have to factor in, or it's helpful to factor in anyway, the inherent seasonality and volatility that the mortgage warehouse business has. It's a very profitable business. We're very appreciative of the contributions that it makes to the business. We're willing to tolerate the seasonality of it does affect from quarter-to-quarter the headline growth numbers.
Yep. Okay. Thanks for that. Of the $13.7 million of accretion this quarter, do you have the breakdown between just what was scheduled and what was prepay?
Tyler, we'll have to get back to you on it. I don't have it off the top of my head. I'm sorry.
That's fine. Just last one for me on the margin. Maybe I'm missing something here, and I can totally appreciate how the higher liquidity negatively impacted the core margin this quarter. Just liquidity aside, cost of funds were up 12 basis points, but core loan yields were only up five. I'm struggling to figure out how we're going to see a bounce back of the core margin from here, just given the earlier commentary about the asset sensitivity and not being as what it once was with future rate hikes. How does the moving pieces with the core margin move higher from here?
Yeah. Loan yields, I was a little surprised when I saw it at first as well, that it didn't expand more because we had been seeing more loan yield expansion. I think a couple different things happened. The CRE payoffs were one, and the loans to mortgage company seasonality was another, right? Those are a little bit more higher yielding in certain aspects. When you look at the loan mix, we just didn't see the yield expansion that we thought. I think the cost of funds was right as we would have expected. The deposit betas have continued to come down from the beginning of last year when, again, we made a strategic move to shore up our deposit costs for existing relationships. That beta has continued to come down, but it's a very competitive environment.
As we said at Investor Day, we manage the totality of the margin. When we see opportunities for loan yields, when we see opportunities for mix, we'll take advantage of those. When we have to defend deposits and deposit margins, we'll do that. Over time, our focus is to maintain stability and grow the margin in a profitable and sustainable way. As I talked about earlier in terms of what I see on the outlook for this year, that's what we're going to be focused on doing, is being in that 3.40%- 3.50% range if we can.
The next question comes from Rob Placet with Deutsche Bank. Please go ahead.
Yeah. Hi, good morning.
Good morning.
Just on your deposit growth in your new markets. I was just curious what the mix of the new deposits growth in each of the Mid-Atlantic and Florida looks like. The average cost of deposits you highlighted on slide six, is that a fair representation of what the cost of new incremental deposit growth in each of those markets look like?
Hey, Rob. It's BJ. Couple different things I will say. Number one is, the majority of what is coming in on the consumer side in the new markets are, as you might imagine, it's money market, it's CDs, with a little bit of checking. Over time, obviously, what our focus is to bring those money in and then cross-sell them, not just in deposits, but obviously other banking services. Even at the levels that we're bringing those money markets and CDs in, they are better costs than the market index deposits that we currently have that we are, as I talked about, letting go. I think that's going to be a very good trade for us and for our margin over time. On the commercial side, we are seeing very good success building commercial deposits.
I would say probably two-thirds of it to three-quarters of it was on the interest-bearing side. We are seeing very good activity on treasury services. As a matter of fact, in the Mid-Atlantic region, so our Carolinas region, our results in the second half of 2018 were excellent. Our closed sales were up 61% in treasury. The new business pipeline's up 300%. Client calls were up 200%. That's starting to flow through the margin and the deposit growth. Over time, that's going to really help us continue to sustain momentum there. All in all, we're very pleased at the pricing and the mix of what's happening. We have to turn it more into core checking, which we absolutely plan to do. We like the activity that we see.
Okay. Just related, just on the market index deposit side, I guess, just given the increase this quarter, was curious to get an update on the timing of kind of the runoff or reduction in those deposits from here. Just maybe where you see balances trending over the next few quarters. Thanks.
Yeah. Rob, what I mentioned earlier was that because of the deposit growth we saw, we gave notice on two contracts, which are roughly $200 million. We're looking at several other contracts, over the next several months, that we would let go as we continue to see deposit growth. Our market index book was $4 billion. We said at Investor Day that over the next several years, if we could replace half to three-quarters of that with core deposits in Mid-Atlantic and Florida and elsewhere, that'd be great, and that'd be helpful to our margin and better for our deposit mix overall. $200 million in the first quarter is a really good down payment on that, and I expect it to continue.
Okay. Thank you.
The next question comes from Garrett Holland with Baird. Please go ahead.
Thanks for taking the questions. Most of the topics have been covered, but just curious, to what extent is the improving Capital Bank RM productivity reflected in the 2019 outlook?
It's hard to specifically say RM productivity in the outlook, but short answer is, it's a big part, right? If you look at what we've talked about with the Mid-Atlantic and South Florida performance that we've seen so far, particularly on the deposit side, if you remember back to Investor Day, our productivity per RM on the lending side from Capital Bank versus First Tennessee was relatively in line. Capital Bank was a little bit lower. On the deposit side, we had a huge opportunity. Some of those metrics that I just talked about, for example, in the Mid-Atlantic, about the second half of the year with treasury services and commercial deposit sales are indicative of the momentum and productivity that we're seeing from our Capital Bank colleagues.
The 3%-6% growth in aggregate obviously is very dependent on us doing what we say we're going to do to grow our newer markets, and fourth quarter was a good start on that.
That's helpful. Just one quick follow-up. The end of period C&I growth was encouraging, very strong. Just curious, you guys seem very optimistic on growth heading into 2019, just curious if there is any verticals or geographies where risk-adjusted returns are looking a bit less attractive.
It's a good question. I'm not sure that there's anything, I'm looking at Susan as well, that has turned down lately. There's some pockets of lending that we've been watching for a while that are still those that we're more cautious about, like multifamily lending in certain markets, retail, commercial real estate pockets, those types of things. Generally speaking, we're not seeing significant stress, maybe leverage lending, but we don't do a large volume of that.
In fact, our leverage lending is actually down year-over-year. We're not a big leverage lender. It was less than 4% of the commercial portfolio a year ago, it's now less than 3%. Fairly conservative there. As BJ mentioned, we always do talk about, are we seeing any emerging risks? That's part of what we do. There's nothing that we've put the brake on. As he said, I think we always watch commercial real estate, certain segments, franchise finance with rising labor costs, those types of things that we just watch as normal course of managing the business in a good way.
Yeah, I think at this point, we're pleased with the growth and particularly the mix that we're seeing. It's kind of a Goldilocks moment, I think. You don't want to be too hot on growth. You don't want to be too cold. I think what we're seeing is core commercial loan growth, which is very solid, great credit quality, good risk-adjusted returns, and does well through multiple cycles. That's where we're seeing a lot of our growth coming from right now, and so we're pleased to see that coming through.
The good thing with the core commercial loan growth is it's higher opportunities for full relationships, deposits, and treasury. As BJ noted, the great work in Mid-Atlantic with the increased treasury management, I think, is an example of that focus on core commercial in our key markets.
Thank you. I appreciate all the detail.
The next question comes from Brock Vandervliet with UBS. Please go ahead.
Thanks for taking a question. I just want to circle back to a couple of the themes that Ebrahim touched on. In terms of the expenses, could you help us a little bit on that? Would you be willing to kind of put a stake in the ground in terms of an efficiency ratio or a figure that we should really consider? I understand the focus on expenses, but should we read this to mean efficiency ratio could break below 60% in the next couple of years? How should we look at that?
Hey, Brock, it's BJ. I think I'd just point you to slide 11, which is our outlook and kind of what we're talking about for 2019. You see that from an efficiency ratio perspective, we expect to make pretty good progress on continuing to improve that efficiency ratio over time. As we talked about at Investor Day, Capital Bank plus ongoing expense discipline has meaningfully reduced our efficiency ratio over the last two years. We know that that's a critical ratio for us to continue to improve, to be able to improve profitability. Discipline on expenses, as we discussed, coupled with some incremental revenue growth is going to be the formula to get there. Slide 11 kind of tells you where we think our outlook is for 2019, and we're intent on delivering that.
Brock, this is Bryan. In addition to what BJ said, in the out years, we don't see 60 as a floor. BJ has talked about, and we focus an awful lot on operating leverage. We look to grow revenue faster than we're growing expenses. It is our desire to continue to leverage our expense base for outsized revenue growth relative to that. In all likelihood, does it push below 60 at some point in the future? Yes, in all likelihood, it should.
Okay, great. Thanks. Just separately on credit, you've had a long period of recoveries, especially from non-strategic. Can you give us a sense of when that may be tailing off, and how does that kind of feed into your credit guide?
Brock, as we've said, we know that non-strategic is going to continue to run off. We could still have some small provision releases in any given quarter out of non-strategic. Again, as that runs off, we're not going to have the opportunity there. For the regional bank, as Bryan started out the call in terms of economic outlook and our portfolio, I feel very good about it. As you noticed, our delinquencies were down, I think, eight basis points overall quarter-over-quarter. Non-performing loans stable. PD grades in the commercial portfolio were stable and strong. Weighted average FICO very strong at over 750. The two charge-offs that we had this quarter were isolated, kind of idiosyncratic types of situations. We feel very good about the portfolio and the outlook for credit absent any big change in the economy that could affect really any portfolio.
The next question comes from Christopher Marinac with FIG Partners. Please go ahead.
The market index deposits. BJ, is there anything you can do to influence customer behavior there, or are you more at the whims of kind of how it goes, puts and takes on the quarter, just like you explained at the very beginning of the call?
Yeah. The way these things work is there are multiple contracts that we enter into. We ladder them, obviously, based on what we anticipate our needs are from those types of deposits. You enter into contracts, and those contracts have a range of balances that they will deliver to you at any given time. That's obviously helpful for asset liability planning. When something like what happens in the fourth quarter happens, there's a significant influx of cash into brokerage accounts, which is where these things come from, and you float towards the higher end of the range on all your contracts. It's contractually that you're obligated to take these. We certainly tell them and try to work with them around what our needs are, and we don't need more at any given time, et cetera.
The reality is sometimes you get more inflows. Like I said, during the NIM commentary or the NII commentary, it doesn't really hurt our NII because we just turn around and invest it at the Fed overnight. It does dampen your NIM. We'll continue to optimize this over time, and I'm confident that we can do that and replace it with customer deposits, and I think it'll build a stronger deposit base and a balance sheet.
Great. Thanks for that color. Susan, just a quick one for you. Can you give us any more color on sort of what's happening in terms of classified and criticized, but below the charge-offs that were one-time this quarter?
We really saw criticized loans remain stable in terms of percent of the portfolio quarter-over-quarter, and way up, I've looked back over the year, have been relatively very stable as a percent of the portfolio. You always have some movement in and out. Things get upgraded or paid off, and you have some things move in. We're still seeing kind of the normal ins and outs that we've seen in the overall level, as I said, to remain very steady over the last four or five quarters.
Great. Thank you very much for the additional background.
Thanks, Chris.
The next question is a follow-up from Ebrahim Poonawala with Bank of America Merrill Lynch. Please go ahead.
Hey, guys. Sorry for getting back in. Very quick question. BJ, I just want to clarify we are thinking about the margin correctly given the inflows and outflows with the market index. Is the rate on the market index at 235, is that done going higher if the Fed doesn't raise? Is that fair to assume, or could that go lower if some of these higher cost contracts go away?
Yeah. They're all based on Fed effective plus a premium is what they charge. Depending on the contract, it's probably anywhere between five basis points and 25 basis points, Fed effective plus five to 25. Depending on the contracts that we cancel, it'll impact what the weighted average rate is. Again, those are 100% beta, right? If the Fed does actually lower rates at some point, those rates will get lower as well. Again, they're not customer deposits. We like customer deposits, and we'll continue to be focused on replacing them.
Understood. To the extent, I appreciate the 2019 guidance, but the margin was at 338, the excess cash, do you expect this to rebound closer to that midpoint of your 340-345 range in 1Q?
I'm not sure I would say in 1Q, but over the course of 2019, we are focused on being in that range.
Understood. Thank you so much.
Sure. Thank you.
This concludes our question and answer session. I would like to turn the conference back over to Bryan Jordan for any closing remarks.
Thank you, Gary. Thank you all for joining us this morning. We appreciate the time you spent with us and your interest in our company. If you have any follow-up questions, please reach out to us. We'd be happy to try to gather the information and respond to them. I hope everyone has a wonderful weekend and a Happy New Year. Thank you very much.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.