Thanks, welcome to the Huntington Bancshares fourth quarter earnings call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mark Muth, Director of Investor Relations.
Thank you, Melissa, welcome. I'm Mark Muth, Director of Investor Relations for Huntington. Copies of the slides we will be reviewing can be found on our IR website at www.huntington-ir.com or by following the investor relations link on www.huntington.com. This call is being recorded and will be available as a rebroadcast starting about one hour from the close of the call. Our presenters today are Steve Steinour, Chairman, President, and CEO, and Mac McCullough, Chief Financial Officer. Dan Neumeyer, our Chief Credit Officer, will also be participating in the Q&A portion of the call. As noted on slide two, today's discussion, including the Q&A period, will contain forward-looking statements. Such statements are based on the information and assumptions available at this time and are subject to changes, risks, and uncertainties, which may cause actual results to differ materially. We assume no obligation to update such statements.
For a complete discussion of risks and uncertainties, please refer to this slide and material filed with the SEC, including our most recent Forms 10-K, 10-Q, and 8-K filings. Let's get started by turning to slide three and an overview of the financials for 2016. Mac?
Thanks, Mark, thanks to everyone joining the call today. As always, we appreciate your interest and support. 2016 was a transformational year for Huntington. As you know, we closed the acquisition of FirstMerit in the third quarter, much of our effort since close has been focused on ensuring a smooth and seamless integration. We are extremely pleased with the progress we are making in bringing the two companies together as one. As evidenced by fourth quarter results, we are already seeing significant benefit in our efficiency ratio and return on tangible common equity. We are looking forward to introducing the distinctive Huntington brand to the Chicago and Wisconsin markets later this quarter, helping to accelerate our long-term growth rate. All of our colleagues are engaged and excited by the opportunities in front of us in 2017 and longer term.
Before we move to the detailed financials, I want to provide a few quick comments on the integration. As Steve will discuss later in the call, we are ahead of schedule as we completed a number of significant milestones in the fourth quarter. Our new colleagues are embracing our fair play philosophy and welcome culture, and they are excited to have access to Huntington's more robust product set and capabilities. We are very pleased with our progress thus far. We know the work is not yet finished. We are focusing on achieving flawless execution with the conversion, resulting in minimal disruption for our customers and the acceleration of our long-term financial goals. With that in mind, let's move to slide three and discuss the full year 2016 financials. As I mentioned, 2016 was a transformational year for Huntington. There were acquisition-related significant items which affected bottom-line results.
I want to emphasize that legacy Huntington performance, including our net interest margin, operating leverage, and balance sheet growth, continued to meet, if not exceed, our expectations in 2016. We delivered core revenue growth well within the range of our long-term goal, positive operating leverage for the fourth consecutive year, and a NIM greater than 3% for each quarter of 2016. As I walk through our results for full year 2016 and the fourth quarter of 2016, please note the comparisons to previous periods are inclusive of FirstMerit. Huntington reported earnings per common share of $0.67 for full year 2016. This is inclusive of $0.20 per share of significant items related to the FirstMerit acquisition, which also impacted the financial metrics that I will highlight on this slide. Tangible book value per share decreased 7% from the year-ago quarter to $6.41.
Return on tangible common equity was 10.2%, while return on assets was 0.82%. Full year revenue increased 18%, which included 11% growth in non-interest income. Full year non-interest expense grew 24%, although after adjusting for FirstMerit acquisition expense, full year non-interest expense growth was 13%. Average total loans grew 18% for the full year, while average core deposit growth, fully funded loan growth, also increasing by 18% year-over-year. Credit quality remained strong in 2016. Consistent, prudent credit underwriting is one of Huntington's core principles. 2016's financial results continue to reflect that. Net charge-offs were 19 basis points of loans, relatively flat from 2015, while remaining well below our long-term financial goal of 35 to 55 basis points. The NPA ratio decreased seven basis points from year-end 2015. We manage the bank with an aggregate moderate to low risk appetite. Our results illustrate this disciplined focus.
Finally, our capital ratios declined mid-year as we effectively deployed capital via the acquisition of FirstMerit. Assisted by the balance sheet optimization strategy that we detailed on the third quarter earnings call and that was completed in the fourth quarter, we have strengthened our capital ratios since acquisition close. As of year-end 2016, our CET1 ratio was 9.53%, well within our 9%-10% operating guideline. Moving to slide four, let's take a look at some of the financial metrics for the fourth quarter of 2016 compared with the year-ago quarter. Fourth quarter earnings per share was $0.18, inclusive of $0.06 per share of significant items related to the FirstMerit acquisition. Also including the impact of significant items, ROA was 0.84%. Return on tangible common equity was 11.4%.
Compared to the fourth quarter of 2015, revenue grew by 39%, with net interest income up 48% and non-interest income up 23%. Non-interest expense increased 45% from the year ago quarter, although adjusted for significant items, non-interest expense growth was 29%. Our reported efficiency ratio for the quarter was 65.4%. However, FirstMerit-related acquisition expense added 8.8 percentage points to the efficiency ratio in the quarter. The reconciliation for this number can be found on slide 18. The efficiency ratio also benefited from $7.5 million of net hedging activity on mortgage servicing rights, a $5.6 million gain on our November auto loan securitization, $5 million of gains on the sale of loans resulting from our balance sheet optimization strategy, and a $6.5 million benefit from the extinguishment of trust preferred securities, as well as the impact of normal fourth quarter seasonality.
Moving on to the balance sheet, average total loans for the fourth quarter grew 33% year-over-year. Average core deposits grew 40% year-over-year, once again, fully funding loan growth. Fourth quarter net charge-offs were 26 basis points, up eight basis points from a year ago. This remains below our long-term financial goal and is consistent with our outlook of gradual reversion to our long-term range of 35 to 55 basis points. Turning to Slide 5, let's take a closer look at the income statement. Fourth quarter revenue was up 39% from the year ago quarter, primarily driven by net interest income, which was up 48%, reflecting the addition of FirstMerit and disciplined organic loan growth. The net interest margin was 3.25% for the fourth quarter, up 16 basis points from a year ago, and up seven basis points on a linked quarter basis.
Purchase accounting had a favorable impact of 18 basis points on the net interest margin in the fourth quarter. For the fourth quarter, net interest income increased 23% year-over-year. Non-interest expense increased 45%, but adjusted for significant items, non-interest expense in the fourth quarter grew 29% from the year ago quarter. For a closer look at the details behind these calculations, please refer to the reconciliations contained on pages 16 and 17 of the presentation slides or in the release. While we're on the subject of expenses, I want to reiterate our confidence in achieving the $255 million in total annual expense savings that we communicated when we announced the FirstMerit acquisition. All the cost savings have been identified, and we have already realized roughly 50% of our cost savings goal.
We expect to realize the majority of the remainder of the cost savings during the branch and systems conversion over Presidents' Day weekend next month. In total, we plan to consolidate 103 branches at conversion, or roughly 9% of the combined post-divestiture branch network. Recall that there is a significant amount of overlap in the two branch networks, as 39% of legacy FirstMerit branches are within one mile of Huntington branches. In addition, in connection with our normal periodic review of our distribution network, we will be consolidating nine legacy Huntington branches unrelated to the FirstMerit acquisition during the first quarter. Slide six shows the expected pre-tax net impact of purchase accounting adjustments on an annual forward-looking basis. We introduced this slide at a recent conference, and we think it will be useful in helping you think about purchase accounting accretion going forward.
It is important to note that the purchase accounting accretion estimates on this slide are based on current scheduled accretion and do not include any projected accelerated accretion from early payoffs or renewals. Since in reality, we are likely to experience some level of early payoffs and accelerated accretion, just as we already did in Q3 2016 and Q4 2016, you are likely to see the accretion revenue in the green bars pulled forward as early payoffs occur. Some of the accelerated accretion may be offset by provision expense as acquired FirstMerit loans renew and we establish a loan loss reserve in normal course. We intend to provide regular updates of this schedule going forward until the majority of the purchase accounting accretion has been recognized. Slide seven illustrates the achievement of positive operating leverage for full year 2016.
We talk about this every quarter and stress how important annual positive operating leverage is to us as a company. In 2016, we enjoyed our fourth consecutive year of positive operating leverage, realizing adjusted revenue growth of 17.8%, which outpaced adjusted expense growth of 13.1%. Annual positive operating leverage is one of our long-term financial goals. We continue to target positive operating leverage on an annual basis, and we have budgeted to meet this goal for the fifth consecutive year in 2017. Turning to Slide eight, let's look at balance sheet trends. As you look at the left side of the slide, you can see that the addition of FirstMerit has not had a material impact on our earning asset mix. Recall that last quarter, we announced certain actions to optimize the balance sheet in order to improve capital efficiency and flexibility.
During the fourth quarter, we completed a $1.5 billion auto securitization and invested the proceeds into 0% risk-weighted securities. We also repositioned approximately $2 billion of higher risk-weighted securities into 0% risk-weighted securities. We sold almost $1 billion of non-relationship C&I and CRE loans. Completing all announced actions during the fourth quarter added approximately 41 basis points to CET1 at year-end, positioning us well for the 2017 CCAR cycle. Average earning assets grew 41% from the year-ago quarter. This increase was driven primarily by a 54% increase in average securities and a 37% increase in average C&I loans. The increase in average securities reflected the addition of FirstMerit's portfolio, the reinvestment of cash flows, and additional investments in liquidity coverage ratio Level 1 qualifying securities.
The increase in C&I loans primarily reflected FirstMerit, as well as increases in the automobile floor plan and corporate banking loans. Average auto loans increased 17% year-over-year, with the acquired $1.5 billion FirstMerit portfolio essentially offsetting the impact of the $1.5 billion securitization. Average new money yields on our auto originations were 3.25% in the fourth quarter, up five basis points from the prior quarter and up almost 35 basis points from the year-ago quarter. Turning to the right slide of Slide eight, I want to call attention to the trend in funding mix, particularly the increase in low-cost DDA. Average total deposits increased 39% from the year-ago quarter, including a 40% increase in average core deposits. This reflects the addition of FirstMerit's low-cost deposit base. It has been almost two full quarters since the acquisition closed, and we are extremely pleased with customer and deposit retention.
Our net interest margin was 3.25% for the fourth quarter, up 16 basis points from the year-ago quarter. The increase reflected a 23-basis point increase in earning asset yields, balanced against a seven-basis point increase in funding costs. On a linked-quarter basis, the net interest margin increased by seven basis points, driven by an eight-basis point improvement in earning asset yields. Purchase accounting contributed 18 basis points to the net interest margin in the fourth quarter. After adjusting for this impact, the core NIM was 3.07%, up one basis point from the third quarter of 2016, also adjusted for the impact of purchase accounting. In addition, similar to what we have seen in recent quarters, the fourth quarter NIM includes one basis point favorable impact related to one large interest recovery. Recall, our core NIM included two basis points of favorable impact last quarter from interest recovery.
Slide 10 illustrates the progress we've made in rebuilding our regulatory capital ratios following the FirstMerit acquisition. CET1 ended the quarter at 9.53%, down 26 basis points year-over-year, and up 44 basis points from the previous quarter. We mentioned previously that our operating guideline for CET1 is 9%-10%. We are very pleased to have reached the midpoint level only one quarter following the close of the FirstMerit acquisition. Tangible common equity ended the quarter at 7.14%, down 68 basis points year-over-year and flat linked-quarter. Moving to Slide 11, for the fourth quarter, we booked provision expense of $75 million, compared to net charge-offs of $44 million. The higher provision expense was due to several factors, including the migration of FirstMerit loans from the acquired portfolio to the originated portfolio growth, and transitioning the FirstMerit portfolio to Huntington's reserving methodology.
Net charge-offs represented an annualized 26 basis points of average loans and leases consistent with the prior quarter, which remains below our long-term target of 35-55 basis points. The ACL as a percentage of loans increased to 1.10% from 1.06% at the end of the third quarter, while the non-accrual loan coverage ratio remains stable at 174%. Asset quality metrics were largely favorable in the quarter. The NPA ratio remains flat at 72 basis points. The criticized asset ratio increased modestly from 3.54%-3.62%, driven largely by risk rating calibration within the FirstMerit book, which increased our OLEM loans in the quarter. Importantly, substandard loans, the most severe category of problem loans, actually decreased in the quarter due to paydowns and refinancings. Also of note, 58% of our non-performing commercial loans remain current.
Other indicators of credit quality include very low 90-day delinquencies at 19 basis points and lower NPA inflows in the quarter. Let me now turn the presentation over to Steve.
Thanks, Mac. Moving to the economy, slide 13 contains what we believe to be some of the more meaningful economic indicators for our footprint. A footprint that has outperformed the rest of the nation during the economic recovery. The bottom left chart illustrates trends in the unemployment rates across our eight core Midwestern states. As you can see, despite a leveling off of economic growth during recent periods, the majority of our footprint remains at or below the national unemployment rates relative to the national average. The charts on the top and bottom right show coincident and leading economic indicators for the region. I want to call particular attention to the bottom chart, which shows leading indexes for our footprint as of November. This is the chart we look to for insights into expected future growth within our footprint.
As you can see, the chart shows that all eight states in our footprint expect positive economic growth over the next six months. Turning to slide 14, it also focuses on trends in unemployment rates, but specifically for our largest metropolitan markets. Many of the large MSAs in the footprint remain at or near 15-year lows for unemployment as of the end of November. The auto industry remains a major economic contributor within our footprint. Housing markets are strong as well. Home price stability and affordability are some of the best in the nation right here in our footprint, and we continue to see broad-based home price growth in all of our footprint states. The labor market in our footprint has proven to be strong in 2016, with several markets, such as here in Columbus, where we are at structural full employment.
We are seeing wage inflation in our expense base. Our customers are too. State and local governments continue to operate with surpluses. The election is behind us. Many of the businesses in our footprint have expressed optimism about a new business-friendly environment expected from the new administration and regulatory regime. Overall, the underlying trends and fundamentals remain strong. We are confident in our footprint Midwest economy based on the sustained job growth and economic production. With that, let's turn to slide 15 for some closing remarks and important messages. We remain focused on delivering consistent through-the-cycle shareholder returns. This strategy entails reducing short-term volatility, achieving top-tier performance over the long term, and maintaining our aggregate moderate to low risk profile throughout. As you heard Mac mention earlier, the acquisition and integration of FirstMerit provides an opportunity to achieve significant cost savings and improve our overall efficiency.
We are progressing as planned toward realizing our targeted $255 million of annual cost savings from the acquisition, with a significant portion of the planned savings, roughly half of them, already implemented. The majority of the remaining savings will be implemented during the branch conversion this quarter over the Presidents' Day weekend. We continue to win new customers through a strong, distinguished brand with differentiated products and superior customer service across all of our businesses. Our new customers provide a deeper pool to deliver our value proposition and to fuel our growth. We are now five months past the close of the FirstMerit acquisition. We've seen little attrition from the FirstMerit accounts. This is a testament to our emphasis on customer service and the progress of our combined teams coming together. We've maintained momentum in our core businesses throughout the integration.
We've invested and will continue to invest in our businesses, particularly within our customer-facing teams and in mobile and digital technologies, as well as data analytics. Importantly, we continue to manage our expenses appropriately within our revenue outlook. We always like to include a reminder that there's a high level of alignment between the board, management, our employees, and our shareholders. The board and our colleagues are collectively amongst the largest shareholders of Huntington. We uphold the retirement requirements on certain shares and are appropriately focused on driving sustained long-term performance. We're highly focused on our commitment to being good stewards of shareholders' capital. Looking towards 2017, we expect total revenue growth in excess of 20%. This includes an expected benefit from one rate hike around mid-year of this year. We continue to target positive operating leverage on an annual basis.
We'll grow the average balance sheet in excess of 20%. We expect to fully implement all the cost savings from the FirstMerit acquisition by the third quarter of 2017. We believe asset quality metrics will remain near current levels, including net charge-offs remaining below our long-term target of 35 to 55 basis points. Finally, we continue to be extremely pleased with the integration with FirstMerit and with the outstanding colleagues we've dedicated to a seamless conversion. The divestiture of 13 branches, primarily in the Canton, Ohio market, was completed during the fourth quarter of 2016, and we've completed the onboarding and initial training of our new colleagues and fully implemented the organizational changes for the combined entity that we announced last summer. 103 branch consolidations will occur coincident with the branch conversions in February, and our system conversion efforts continue to progress well.
As you can see, it was an exciting quarter and indeed an exciting year, and we're very focused on the future we are building. We have a lot of momentum across our businesses, and we're ready to build on the hard work that got us to this point. I'll now turn it back over to Mark so we can get to your questions. Thank you.
We'll now take questions. We ask that as a courtesy to your peers, each person ask only one question and one related follow-up. If that person has additional questions, he or she can add themselves back into the queue. Thank you.
Thank you. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove yourself from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from the line of Jon Arfstrom with RBC Capital Markets. Please proceed with your question.
Thanks. Good morning, guys.
Hey, Jon.
Sounds like things are going well on the integration from the expense side, and I guess what I was curious about was the revenue synergy piece. I know that you did not include that in the accretion guidance initially from the acquisition, but in your important messages, you're saying that you're executing on the revenue synergies. Maybe give us an idea or an update in terms of how that's going so far.
Yeah. Jon, it's actually going very well. We're continuing to make investments into a number of areas including SBA lending, home equity, and home mortgage origination. The other fact is that we're seeing really good acceptance and interest in capital markets products with the FirstMerit customer base, interest rate derivatives, foreign exchange, those types of things. Really good traction there as well. As we take FirstMerit's RV and marine portfolio and capabilities and expand that into our markets and further, we think that's a great growth opportunity. If you add to that just the performance that we've seen from a customer retention perspective, a deposit retention perspective with FirstMerit, I would tell you that's really hitting on all cylinders there.
Okay. The other number that you laid out was a % of revenues from non-interest income. If you raise the FirstMerit average to your average, that there's more accretion in the acquisition. Anything that you see right now that would prevent you from hitting that corporate average?
No. We think that there's probably close to $100 million of revenue if you normalize FirstMerit's fee income to the total revenue to ours.
We really have that identified in terms of where we think that's coming from, and we've got the incremental expenses and capabilities built into 2017 and 2018. We feel pretty comfortable with achieving that number.
Okay. All right. Thank you.
Thanks, Jon.
Thank you. Our next question comes from the line of Ken Usdin with Jefferies. Please proceed with your question.
Thanks. Good morning, guys.
Good morning, Ken.
Just a question on cost and efficiency progress to your peer points about getting to the cost saves run rated by the second half and the third quarter, and then also with this planned accretion runoff. Just wondering if you can help us understand how you expect the efficiency ratio to traject. You've got that long-term goal, 56%, 59%. Just wondering if you think you can get inside of that by the end of next year. How are you thinking about exiting 4Q 2017, to your point about still committing to positive operating leverage, but with a lot of these moving parts back and forth? Thanks.
Yeah. Thanks, Ken. We're very comfortable with the range we put out there of the 56% to 59% longer term. Clearly, as we start to see increases in interest rates, we do think that's going to help us get towards the bottom end of that range. We do go through system conversion branch closures in the February timeframe, and we'll see the expense come out in the second quarter. There might be a little bit that'll come out in the third quarter as well. I would expect that in the fourth quarter of this year will be a run rate that will certainly reflect the range that we've signed up for longer term.
Oh, you think you can get into the range. I guess, you've given the 20% revenue outlook on the top line, and I'm just wondering, I think we're all wondering just what that magnitude of operating leverage is that you're thinking through. Is there any way to help us understand, like you did for the fourth quarter, just around what you think the rate of expense growth will be versus that 20% plus on the top?
Well, we've come out and told you what we expect the fourth quarter expense number to be at our regional conference in the fourth quarter. That's $609 million.
Okay. That's still on track?
That's still on track. That gets us to the $255 million cost takeout we've signed up for, growing at 3% and achieved in the fourth quarter of 2017.
Okay, got it. Thanks very much.
Thank you. Our next question comes from the line of Matt O'Connor with Deutsche Bank. Please proceed with your question.
Good morning.
Morning.
Morning, Matt.
Obviously, some moving pieces on the NIM. The purchase accounting accretion was a lot better this quarter, but it seems like the core NIM was also better. Wondering if you can help us shape what both components could look like in the first quarter of 2017.
Yeah. Matt, there are a number of moving parts here. As we discussed, the core NIM is 307, 306 if you exclude the interest recovery that we saw in the quarter. We do think the core NIM is going to expand from this point. We are 6% asset sensitive. We're going to continue to see the swap book on the asset side roll off. We have about a little over $3 billion in asset swaps that will come off by the end of the year. That will increase asset sensitivity by probably another 0.7, 0.8. We did see some impact from the December rate increase.
I would suggest that it's going to be difficult to project the NIM because of the purchase accounting impact and some of the accelerated accretion that we do expect to happen, that we have seen happen in both the third and fourth quarters, but feel good about the core margin expanding from this point.
Can you help size the impact of, call it, the 25-basis-point increase in rates that we saw in December? Obviously, the industry is not experiencing a lot of deposit repricing. I think we're seeing more NIM lift than expected from the first couple of rate increases. Maybe just size how much benefit you expect to get from December's hike.
Yeah. We're assuming probably a 40%-50% beta on that change. I think as you play that through, it really is going to depend a lot on what happens with competition and how we see pricing change in the environment. I don't think the impact of this first increase is going to be hugely material, but certainly it will be a positive to the core margin going forward.
Okay. All right. Thank you.
Thanks, Matt.
Thank you. Our next question comes from the line of John Pancari with Evercore ISI. Please proceed with your question.
Morning.
Hi, John.
On the auto side, wanted to see if you can give us an update on some of the dynamics you're seeing there in the industry, just given that we've been seeing some of the auto lenders see some volatility there. Just curious about the competitive dynamic, your appetite for ongoing growth there, maybe your growth outlook, as well as credit trends, how they're moving along. Thanks.
Yes. This is Dan. I would say in terms of the credit trends, we feel very good, as we've stated in the past. What goes on in the market isn't completely relevant to what we're doing since we haven't adjusted our origination strategies in terms of FICO, LTV, term, et cetera. We're still a super prime lender, and our results have been quite consistent. A lot of noise in what's going on in the market, but I think that relates more to those who are in the sub-prime or near-prime space. We still see good originations. As Mac noted earlier, we actually saw some margin expansion. We think on a risk-adjusted basis, we are in a great spot. Trends are good. Delinquencies remain well controlled. On the whole, very solid outlook. We continue to plan for more growth, but very steady origination strategy.
Our expectation, John, is the dealers will continue to have a good year, roughly in line with last year. We're very well positioned in that regard, both on the direct side floor plan, the indirect, and to finance some of the supply base. All that's broken out for you on the different schedules that we provide.
I would add that there are a couple of items this quarter that are worth noting. We do have the FirstMerit portfolio included. When you look at the charge-off numbers on page 46, we provide a table that outlines, they do have a higher charge-off rate. Part of that is impacted by the fact that recoveries do not reduce gross charge-offs because it's an acquired book, and therefore, the recoveries flow through the income line. That's one factor to consider. The other thing is we had securitization. We had a billion and a half move out of the denominator, and there are no delinquencies in that pool of loans. When you really make those adjustments, our originated book continues to be very steady. One to two basis points higher than last year.
Either if you're looking at quarter-over-quarter, it was one basis point. Year-over-year, two basis points. Again, very steady performance that we're very pleased with.
Got it. Thank you. Steve, I just would love to get your thoughts on the capital deployment here and how you're thinking about deployment going into 2017 CCAR. Do you see an opportunity to get more aggressive there in returns, and how would you prioritize buybacks versus dividends? Thanks.
Well, our capital priorities haven't changed from what we've had over the years. Organic growth, dividend, and then other actions. The balance sheet optimization activities of the fourth quarter were all successfully completed, and that was with the view of giving us the capacity to come into CCAR with a strong foundation. The board will make decisions later. We don't even have CCAR scenarios yet, it would be very premature for me to comment at this point.
Okay. Thank you.
Thank you. Our next question comes from the line of Bob Ramsey with FBR Capital Markets. Please proceed with your question.
Hey, good morning, guys. This is actually Kyle Peterson on for Bob today. Looks like your tax rate has been a little bit lower here. It looks like even when backing out the merger charges, it's running kind of more in that 24%-25% range. I just want to see if you guys could give any color moving forward on where we should expect that to run.
Yeah. That's pretty consistent with where we've been, the guidance that we provide is in that same range. I think 24%-27% is what we said in the press release. That excludes significant items. When you tax effect the significant items of 35%, it does make that rate look lower on a GAAP basis. If you adjust for the significant items, you get to the 25%. If you actually FTE adjusted that, it would actually be higher. That's a range we're very comfortable with going forward.
Okay. Great. I guess just a little bit on margin. I know you guys mentioned your guidance includes a rate hike in the middle of the year. I guess where do you guys see the core margin going in the event of no additional rate hikes throughout the year?
Higher. We're going to see the core margin continue to expand. Again, it's not going to be hugely significant, but we've talked about probably one to two rate hikes requiring to take place in order for us to start to see margin expansion. We actually think we're going to get that with the one rate hike now. Again, the margin will be a bit volatile this year because of what's happening with purchase accounting and accelerated accretion, but we'll be sure to keep you informed in terms of what we see there and update it as it rolls through.
Okay, great. Thank you.
Thank you.
Thank you. Our next question comes from the line of Scott Siefers with Sandler O'Neill & Partners. Please proceed with your question.
Morning, guys.
Hey, Scott.
Mac, I was hoping you could expand on your comments on just sort of the nuance of the purchase accounting pull forward. Just curious specifically on slide six, if you can sort of walk through the changes and sort of what drove those relative to when you guys had given that slide out at the Goldman Sachs conference last month. Just kind of curious, is that just initial behavior of the acquired portfolio, or sort of what changed in that time period?
Yeah, Scott. The best way to think about it is if the loan pays off and renews early, then we accelerate the purchase accounting adjustment, and that comes into the margin. That happened in the fourth quarter to the tune of about $10 million.
Okay.
Now what you have to also realize the flip side of that, as an acquired loan moves from the acquired portfolio to the originated portfolio, we have to establish a reserve for that. In the fourth quarter, roughly half of the increase or the reserve build is due to acquired loans from FirstMerit moving into the originated portfolio.
Yeah.
We're going to continue to see accelerated accretion in the margin, and we're going to continue to see some higher provision expense as we reserve for those loans that come into the originated book.
Okay.
That's where it gets a little complex, and we can't actually predict what is going to renew on a forward basis. We'll give you this chart every quarter updated for what's happened and let you know what the inflows and outflows are.
Okay, perfect. I appreciate that.
Scott, if I could just add, normally, you would expect to see renewal activity first and second quarter on these commercial loans. We are trying to share with you an expectation that there will be, in addition to scheduled maturities, there will be, we think, just more economic activity associated with the outlook, the improved outlook. Expansions of working capital lines, maybe more CapEx, things like that. We could be in a period that is more active than what we have had recently as we go through the first half of 2017.
Yeah. Okay. No, that all makes sense. Thank you. I was just curious as well. I think when you originally gave the guidance for 2017 on that 20%+ revenue growth, that was assuming no rate increases, either the one we got in December or anything this year. Would the 20% still hold true even if we get nothing else? Just out of curiosity, you guys have always been so conservative on the rate outlook with basically always assuming none. Just curious why you decided to add even just the one into the outlook.
Yeah, Scott, I think the guidance still holds true. We just felt that it feels more certain this time.
Yeah.
That it just made more sense from a reality perspective in how we built out the budget and how we thought about 2017. We did put the one additional increase in mid-year, and that is rolling through our budget for 2017.
Okay.
Scott, like prior years, we have contingent expense reduction should we find the environment to be different than we anticipate.
Yeah. Okay, good. All right, perfect. Thank you guys very much.
Thanks, Scott.
Thanks, Scott.
Thank you. Our next question comes from the line of Erika Najarian with Bank of America. Please proceed with your question.
Hi, good morning.
Good morning, Erika.
Good morning.
I just wanted to ask a question on how given that rate hikes could potentially be more certain in 2017 and especially beyond, I'm wondering if you could help us think about how your asset sensitivity could have changed with the FirstMerit acquisition now fully in your books for the next rate hike. In 1Q of 2016, your margin went up two basis points, and I'm wondering, given the comments on a potentially structurally higher NIM anyway, core NIM in 2017 plus a 25 basis point rate hike, plus the fact that your deposit costs haven't moved, whether the expansion quarter-over-quarter in core NIM is likely going to be greater than the two basis points in 1Q 2016.
Erika, the FirstMerit balance sheet actually didn't change our asset sensitivity or interest rate risk significantly. If anything, FirstMerit might have been a little bit more asset sensitive. We don't really think that this has had a huge impact on how we're positioned, either before or after the FirstMerit acquisition. Clearly, it's all going to depend on what happens in the marketplace and what happens with the competition. We're in a new environment for liquidity based on new regulations and requirements. Certainly, when the first rate hikes come through on an increasing cycle, you typically don't see as much up-pricing on the deposit side as quickly. We might be conservative with a 40%-50% beta in what we're assuming.
We feel comfortable with those assumptions, and we're going to continue to monitor what's happening in the environment just to make sure that we're competitive from a liquidity perspective.
Got it. Thank you.
Thanks.
Thank you. Our next question comes from the line of David Long with Raymond James. Please proceed with your question.
Thank you. Good morning, everyone.
Morning, David.
I just wanted to see if you guys can talk a little bit about your strategy on the retail banking side in your newly acquired Chicago market here after the FirstMerit deal. In the Chicago market, you guys may not have the critical mass like several of the competitor larger banks here. Just want to see how you plan to compete, then also how you look to invest in that market in the future.
David, we've outlined, and I'll try and cover this again. Mac may want to add to it. We've outlined that we'll continue with the strategy that FirstMerit had, which was a niche approach for emphasizing commercial or business lending. We have made a commitment to SBA lending in Chicago, and the team largely is in place now. The same with home lending and with our mortgage capabilities. We've added significantly. We're continuing to add, at this point, into our Chicago team on the mortgage front. We like our distribution in terms of the spread. It's not concentrated given the size of that market. It's obviously grossly under scale, that will cause us to focus on these niches and growing these niches, and perhaps growing in some other areas over time.
The emphasis will be to maintain the discipline that FirstMerit had in terms of growing commercial lending activities in Chicago principally.
Got it. Thanks for the color.
Thank you, David.
Thank you. Our next question comes from the line of Terry McEvoy with Stephens Inc. Please proceed with your question.
Hi. Thanks. Good morning.
Good morning.
I just wanted to circle back to Ken's question on that 4Q expense target of $609. If I remember that presentation last quarter, it did not include some personnel expenses, the FDIC insurance premiums. I'm wondering if you could help us with a GAAP number and also just the amortization as well to just better understand what 4Q could look like, again, from a GAAP standpoint.
Yes, Terry. The 609 does not include intangible amortization. That's a number excluding that figure. Certainly, the 609 is a quantitative measurement looking at the 255 growing at 3%. We are making investments in revenue-producing capabilities, personnel, technology, basically for FirstMerit markets where we have additional opportunities. We've talked about SBA, we've talked about home lending. We will be adding some expense relative to those investments without a doubt, but we'll also be adding revenue associated with those investments, too. Certainly, the 609, as we get closer to that, we'll reconcile in terms of what those investments look like. Feel very comfortable that we're going to get the cost takeouts that we've signed up for, and we're going to make additional investments into revenue opportunities that we think are available to us.
Earlier you said, for the most part, you'd get the full cost saves by the end of 2Q with a little bit moving into Q3. Could you be a little more specific in terms of what you expect to realize by the middle point of 2017?
It's going to depend a bit on how we move through the conversion and integration process. There are still some expenses that we're working to get out that might be more longer term in nature around real estate and those types of things. To the extent anything bleeds into the third quarter, I don't expect it to be material. There will be some third quarter impact.
Great. Thanks for taking my questions. Appreciate it.
Okay. Thanks, Terry.
Thank you. Ladies and gentlemen, as a reminder, if you'd like to ask a question, please press star one on your telephone keypad. Our next question comes from the line of Kevin Barker with Piper Jaffray. Please proceed with your question.
Good morning.
Yeah, hi Kevin.
Just wanted to follow up in regards to some of the questions around capital. Your CET1 ratio obviously appears to have very healthy and plenty of excess capital to be deployed over time. It seems like your TCE ratio is relatively low compared to the peer group. Are you comfortable bringing down the TCE ratio below 7% as long as you have the CET1 ratio well above an 8% ratio?
Hey, Kevin, it's Mac. We are focused on CET1. We do have an operating range of 9% to 10% for CET1. As you see, the 950, which is where we are today, kind of calibrates, translates to a 7.2 TCE. We do monitor the tangible common ratio. It is something that we pay close attention to. I'm not sure I see it going below 7%, it certainly is calibrated to CET1, and that's the ratio that we're really focused on.
Okay, that's helpful. When you're obviously building the provision, given the purchase accounting accretion that's coming off of FirstMerit, and you'll probably see that continue to grow. At what point do you feel like you would be at a more, I guess, a normalized level on a reserve to loan ratio? How long do you think it will take to get to that point following the FirstMerit acquisition?
Kevin, I'd probably refer you to slide six in terms of what the kind of the accretion around purchase accounting. I mean, basically, as the acquired portfolio moves into an originated portfolio, as those loans renew, we'll see the purchase accounting adjustments decline, and you'll see us over that period of time replenishing the reserve, building a reserve on those loans as they move from acquired to organic. Clearly, what you see on slide six would be an elongated view, because we are going to see this pulled forward as loans renew early. I would just ask you to kind of think about slide six and calibrate around the numbers on that page, understanding that it's going to be accelerated.
Okay. When you think about the risk profile pro forma of the FirstMerit acquisition, do you feel that your reserve to loan ratio should run higher than it was in the past, or do you feel like it could run a little bit lower than what it was in previous quarters prior to the acquisition?
Well, I think as we move towards normalization, you're probably going to be a little bit higher than previously. That's how I would say because just our base charge-offs level, we still remain below the long-term target, but we are definitely moving towards more normalization as recoveries decrease.
Thank you for taking my questions.
Thanks, Kevin.
Thank you. Our next question comes from the line of Peter Winter with Wedbush Securities. Please proceed with your question.
My questions have been answered. Thank you.
Thanks, Peter.
Thank you. Our next question comes from the line of Brian Klock with KBW. Please proceed with your question.
Good morning, thanks for taking my question. I want to follow up just really quickly, Mac, on an earlier question about the deposit beta assumptions. I think you said 40%-50%. Is that what you're expecting from the December hike that just happened in 2016, or is that what your asset sensitivity assumptions are, or is that yes to both?
That would be yes to both.
Okay.
The 40%-50% is average across the entire deposit portfolio.
Okay.
We've been pretty consistent in talking about a 50% beta over time. As we think about the December hike, we've modeled something in that range.
Okay. I guess a follow-up question. Steve, you mentioned some of the improved commercial sentiment post-election. Actually, you guys, in the fourth quarter, your C&I loan growth was pretty solid relative to some others that we've seen some softness in middle market. Maybe you can talk about what kind of trends you're seeing in the C&I book, and is there that potential for some enhanced and increased CapEx that may actually finally happen in the Midwest?
I think the early read from many of our customers is one of more optimism and what they're telling us and what more broadly our various line management and RMs are telling us is much more activity compared to prior periods in terms of potential investments. We are, I think, better positioned than we've been for maybe a decade in terms of CapEx and expansion in the different businesses here in the Midwest.
Great. If I could throw one more in. I don't know, Mac, do you have the growth that you did get in loans this quarter from FirstMerit versus HBAN?
I don't have that.
Okay. Okay, thanks for your time, guys.
Thank you.
Thanks, Brian.
Thank you. Ladies and gentlemen, once again, it is star one to ask a question. We will pause just a moment to allow for any other questions. Ladies and gentlemen, we have reached the end of our question and answer session. I would like to turn the call back over to Steve Steinour for closing remarks.
Thank you all again. 2016 was highlighted by the acquisition of FirstMerit and our continued strong core financial performance. We're encouraged by the focused activities of our colleagues and the sentiment of our customers. With sound fundamentals in place at the start of the year, we're positioned for solid performance in the coming quarters. Clearly, our strategies are working, and our execution of goals continues to drive good results. We expect to continue to gain market share and grow share of wallet. The addition of FirstMerit's solid balance sheet, strong credit performance, valuable customer base, and new markets provide opportunities for us to further accelerate achievement of our long-term financial goals. We're already realizing revenue synergies in several areas. Finally, I want to close by reiterating that our board and this management team are all long-term shareholders. Our top priority is integrating FirstMerit and growing our core business.
At the same time, we'll continue to manage risks and volatility and do so with the intent of driving solid, consistent long-term performance. Thank you for your interest in Huntington. We appreciate you joining us today. Have a great day.
Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.