Greetings, ladies and gentlemen, and welcome to the BB and T Corporation Earnings Conference Call. Currently, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. As a reminder, this event is being recorded. It is now my pleasure to introduce your host, Alan Grier of Investor Relations from BB and T Corporation.
Thank you, Gail, and good morning, everyone. Thanks to all of our listeners for joining us today. On today's call, we have Kelly King, our Chairman and Chief Executive Officer and Daryl Bible, our Chief Financial Officer, who will review the results for the Q2 and provide some thoughts for the Q3 and the remainder of this year. We also have Chris Henson, our President and Chief Operating Officer and Clark Starnes, our Chief Risk Officer to participate in the Q and A session. We will reference a slide presentation during our call today.
A copy of the presentation as well as our earnings release and supplemental financial information are available on the BB and P website. Let me remind you that BB and T does not provide public earnings predictions or forecasts. However, there may be statements made during the course of this call that express management's intentions, beliefs or expectations. BB and T's actual results may differ materially from those contemplated by these forward looking statements. Please refer to the cautionary statements regarding forward looking information in our presentation and our SEC filings.
Please also note that the presentation contains certain non GAAP disclosures. Please refer to Page 2 in the appendix of our presentation for the appropriate reconciliations to GAAP. And now, I'll turn it over to Kelly.
Thank you, Alan. Good morning, everybody. Thanks for joining our call. We always appreciate your time and attention. So I'd say the Q2 was overall very strong, particularly when you look through all the parts.
We had record earnings, record returns, strong revenues, very good expense control, great asset quality and improved loan growth. Net income was a record $775,000,000 or up 22% versus the second of 2017. Excluding mergers, it was a record 792,000,000 dollars Diluted EPS was $0.99 up 28%. Adjusted diluted EPS was a record $1.01 which was up 29% versus the 2nd quarter. I would point out that if you look at the pretax ex Merx earnings, they are up 6% versus Q2 2017, which is simply showing that independent of the tax reductions, our business is meaningfully improving.
Our ROA, RO, common equity and return on tangible were $149,000,000 $11.74 $19.78 respectively. And I think importantly, if you look at adjusted ROA, ROACE and ROTCE, it was 152, twelve oh one and a first round of 242 on our return on tangible. Importantly, we did achieve positive operating leverage in the second. And also, quarterly revenue totaled $2,900,000,000 which was up 9 point 2% annualized compared to the first, was insurance seasonality and that was still a very, very strong revenue quarter. Loans held for investment did perform very, very well, up 3.5%.
So we're seeing the turn that we have been expecting over the last 2 or 3 quarters. Net interest margin increased 1 basis point to 3.45%, and our core was up 2 basis points to 3.35%, at a strong fee income ratio of 42.5%, which is up from 41.9% in the Q1. Adjusted efficiency ratio was 57.4% versus 57.3%, so about flat. Adjusted non interest expenses totaled $1,600,000,000 which was a decrease of 2.1% versus 2017. I'm very pleased with our expense discipline.
I would say to you that our flat guidance for the year remember includes regions, so it is net down, which is, I think, very good when you hear in a minute and I talk about a lot of the things we are doing. Credit quality was just great. NPA ratio was 0.28%, decreased 2 basis points. Charge offs were 30 basis points versus 41% in the first and 37% in 2nd last year, so great credit quality. If you're following along, I'm on Page 3.
In terms of strategic highlights, I would point out we did close the Regions Insurance sale, which is a really attractive deal. We closed it on July 2, great addition from both our cultural and market perspective, strengthened our presence in many Southeastern markets and importantly, expanded into new markets in Texas, Arkansas, Louisiana and Indiana. In our capital plan, we do not have, as you know, a further objection. We have an 8% increase in quarterly dividend planned on top of the 13.6% increase that we did in the Q1 and up to $1,700,000,000 in share repurchases, some of that we use in the region's acquisition. But if you look at the combination of the first and the projected third quarterly dividend increase, it's up 22.7% from the Q4 of 2017.
So maintaining a strong and growing dividend for our shareholders is very important, and we are executing on that. On Page 4, we just had fairly straightforward selected items, mostly related to real estate losses in closing branches and back run facilities, and that was about $0.02 a share. On Page 5, let's talk a little bit about loan growth. The birth fees that we've seen to turn that we've been expecting, so we had 3.5% growth in loans, very strong in C and I, which was up 6.3%. Strong performance in a number of areas, corporate banking, mortgage warehouse, lending.
Sheffield was up 32% annualized and that's seasonal, but still strong. Commercial equipment capital was up 16% annualized, dealer floor plan, premium finance. I point out Community Bank was up 3.5%. That's a big deal because you recall over the last several quarters, I've been talking to you about how for the last number of years, Main Street has been kind of dead in the water, and we've been expecting it to recover. Well, it is recovering.
Optimism is strong, equipment purchases, other types of acquisitions and purchases are happening. So we're really pleased to see Community Bank. That's an engine for our company. CRE is up 2.8 percent annualized, and that's very first farm. I would also point out that our end of period loans are up $3,000,000,000 greater than end of period loans for the Q1, which is 9% annualized.
Our auto portfolio made the turn in the quarter as we expected. Our mortgage loans grew on average as we expected. So really both optimizing portfolios have now turned and that will be a positive push in terms of more total loan growth as we go forward. So when we think about loan growth, I'll talk about the guidance in a little bit, but I personally think that loan growth should be in plus or minus 4% as we go into the 3rd bar and any major changes in the economy. If you look at Page 6, in terms of deposits, it was a healthy quarter for us.
I'm very pleased. Our non interest bearing deposits with DDA growth, we grew 4.3%. That's very strong compared to the industry and reflects a lot of our integrated strategies that are really paying dividends now. Our non interest bearing deposits grew very strongly, increased $567,000,000 Percentage of non interest bearing deposits increased to 34.2 I do want to make a comment about betas. So cost of interest bearing deposits was 57 0.57, up 11 basis points or a 41% implied beta.
I would just comment to you that, that was a bit outside maybe than what you expected, but we have frankly a few markets that we were getting some outsized competition We made a conscious strategic decision to react in those markets. That's not a kind of normalized beta increase. That was more of a marketing strategic change. So I would expect the beta to lower from that level. Daryl will give you a little commentary on that, but I would expect to see that lower.
So I know that looked a little outside of the table, that's why that is. I want to make just a comment before I turn it to Daryl in terms of the economy in general, what we're seeing out there. It's really very positive and very strong. I've just completed 23 of our 24 regional visits. As you know, I go out and spend the whole day in the region.
I did 2 of them last week.
When I
talk to business CEOs, they are very optimistic. They are spending and planning to spend on CapEx. Interestingly, competition is heating up. They are facing intense wage pressure and difficulty in finding the people that they need. 1 construction CEO told me that in certain cases, he was having to raise prices 25% to get the kind of people that he needed.
So my takeaway from that from an economic perspective is we can expect higher inflation and higher rates. There's no incongruent information out there contrary to that. So I think that's most likely as we look forward, which is good news for the economy and good news for banks. I'm going to comment a little bit later on some of our key strategies that I think are very important in your view of how things are going at BB and T. But for right now, let me let Daryl give you some more color in terms of more of the numbers.
Thank you, Kelly, and good morning, everyone. Today, I'm excited to talk about our excellent credit quality, improving margins and loan growth, strong expense control and our guidance for Q3 and full year 2018. Turning to Slide 7. Credit quality remains very strong. Net charge offs totaled $109,000,000 down 11 basis points.
We had improvement across most loan categories, but indirect loan charge offs drove most of the decline. Loans 90 days or more past due and still accruing as a percent of loans and leases decreased 4 basis points from both linked and linked quarters. Loans 30 to 89 days past due increased 5 basis points due to seasonality and 1 basis point from a year ago. The NPA ratio was 28 basis points and matched the lowest level since 2006. We saw declines in non performing assets in most categories.
Continuing on Slide 8. Our allowance coverage ratios remained strong at 3.49x for net charge offs and 2.74x for NPLs. The allowance to loans ratio was 1.05%, flat from last quarter. We recorded a provision of $135,000,000 compared to net charge offs of $109,000,000 The provision was $26,000,000 higher than net charge offs, contributing to a flat allowance to loans ratio with period end loans up more than $3,000,000,000 from March 31. Turning to Slide 9.
The reported net interest margin was 3.4145 percent, up 1 basis point. Core margin was 3.34%, up 2 basis points. Both increases reflect asset sensitivity and higher short term rates. The deposit beta for this quarter was 41%, slightly less than our modeled about 50% beta. In addition to the index accounts repricing this quarter, deposit costs were impacted by many rate specials in many of our markets.
We expect this to abate in the next quarter. Since 2015, our cumulative deposit beta has been 24%. Asset sensitivity decreased due to changes in our loan mix and deposit mix offset by the decline in the investment portfolio. Continuing on Slide 10. Our fee income ratio was 42.5%, up slightly mostly due to seasonality.
Non interest income totaled $1,200,000 Insurance income was up $45,000,000 mostly due to the seasonal increase in P and C permissions. We don't expect prior year storms and other events to significantly impact profit based commissions for the rest of this year. For July 2, Insurance Group acquisition will benefit insurance income starting in the Q3. Keep in mind that insurance income is seasonally lower in the Q3. Service charges on deposits returned to normal levels following last quarter's system outage.
Mortgage banking income declined $5,000,000 primarily due to gain on sale margins declined 30 basis points, mostly due to retail originations. Investment banking and brokerage income declined $4,000,000 mostly due to deal timing. Turning to Slide 11. The adjusted expense came in just under $1,700,000,000 or $38,000,000 Personnel costs increased $35,000,000 due to annual merit increases and the increase in performance based incentives. FTEs declined 126.
The initiative to reduce the amount of space continues to have a positive impact on occupancy and equipment expense down 7,000,000 dollars About 740,000
square feet of
BB and T occupied space has been vacated since January. Other expenses were up $12,000,000 mostly due to the increase in the Visa indemnification reserve, which was not expected. Merger related and restructuring charges were down $4,000,000 Nearly all these costs were related to real estate losses due to our branch closing strategy. Expenses will include the impact of Regent's insurance acquisition starting in the Q3. Well controlled expenses contributed positive operating leverage versus Q2 of 2017.
Continuing to Slide 12. Our capital, liquidity and payout ratios remain strong. The approved capital plan includes a dividend increase and share repurchases. Our $2,900,000,000 capital plan is similar to what we did last year weighted more heavily towards dividend payout. The 7.5% dividend increase represents a cumulative 22.7% increase since the Q4 of 2017.
The region's insurance acquisition will impact 3rd quarter share buyback. Now let's look at our segment results beginning on Slide 13. Community Bank Retail and Consumer Finance net income was $377,000,000 The $53,000,000 improvement was driven by balance sheet growth, improving deposit spreads, seasonal increase in card based fees and deposit service income offsetting the negative impact from the February system outage. Residential mortgage originations were up 17%. Our production base mix was 77% purchased and 23% refi and the gain on sale margin was 1.40% versus 1.72% last quarter.
We closed 80 branches and plan to close about 85 more later this year. This strategy continues to help us control expenses and provide more funds to invest in our businesses. Continuing on Slide 14. Average wells increased $721,000,000 driven by residential mortgage and a seasonal pickup in the mortgage warehouse funding. As expected, the auto portfolio stabilized and we expect it to grow going forward.
Deposit balances increased $983,000,000 when growth in both EDA and CDs. The deposit beta was 19%. Turning to Slide 15. Community Bank Commercial net income was $277,000,000 A $7,000,000 increase was mainly due to improving deposit spreads. The commercial pipeline was up compared to both linked and like quarter.
Continuing on Slide 16. Average loan balances were up $268,000,000 Growth in C and I construction loans were partially offset by the decline in income producing property loans. End of period loans grew 4.4% annualized. Competitive pressures on loan pricing remained as we saw a decline in loan spreads. Deposits were down $203,000,000 due to a decline in public fund deposits, which was partially offset by increases in commercial deposits.
The deposit beta was about 67%. Turning to Slide 17. Financial Services and Commercial Finance net income was 145,000,000 dollars driven by loan growth and improving deposit spreads. This was offset by slower fee income due to the timing of investment banking deals and an increase in incentive based compensation. Continuing on Slide 18.
Average loans were up $292,000,000 and deposits were flat. Corporate Banking, Wealth and Granbridge all showed good loan growth. Interest bearing deposits were up 20 basis points and a beta of 74%. Turning to Slide 19. Insurance, Holdings and Premium Finance net income totaled 73,000,000 dollars The $11,000,000 improvement was driven by seasonality and P and C commissions, partially offset by the related increase in incentive based compensation.
Light quarter organic growth was up 5.2%, mostly due to a 15% increase in new business. The Regent Insurance acquisition will add about $70,000,000 in revenue for the second half of this year. And its EBITDA margin for the second half of 2018 will be about 20%. Turning to Slide 20, you will see our outlook. For the Q2, we met all of our guidance except for non interest income, which we talked about publicly last quarter.
This is mostly due to mortgage. Investment banking was also a little soft this quarter due to the timing of some of the deals closing. Looking to
the Q3, we expect loans to
be up 2% to 4% annualized linked. Our guidance has improved in light of the quarter's performance and strong momentum such that the high end of the range plus or minus 4% looks promising. Net charge offs to be in a range of 35 to 45 basis points. The loan loss provision to match net charge offs plus loan growth. The build this quarter is the result of strong end of period loan growth, which positions us well for future quarters.
The GAAP and core margin to be up slightly. Fee income to be up 3% to 5% versus like quarter. Seeing deals closed already in Investment Banking this quarter gives us more confidence that we'll be at the higher end of this range. Expenses to be up 1% to 3% versus white quarter and an effective tax rate of about 20%. For the full year 2018, we expect loans to grow in the 1% to 3% range.
Taxable equivalent revenues are expected to be up 1% to 3%. The decline from previous annual guidance reflects slower mortgage banking income growth. Expenses are expected to be flat. This is a bit higher due to the FDI surcharge, which was added back into the 4th quarter and an effective tax rate for the year of 20% to 21%. We continue to feel confident that revenue growth along with flat non interest expenses will result in positive operating leverage for the full year 2018.
In summer, we had record quarterly earnings, positive operating leverage, very strong credit quality and excellent expense control. Now let me turn it back over to Kelly for additional comments.
Thanks, Daryl. So as you just heard Daryl summarize very well, the overall integrated very positive results for the quarter. But I want to talk to you a minute or 2 about what's really more important. I mean, focusing on what's going on every quarter and the detail of every quarter is interesting. So much more importantly, its key is what are we doing as we look forward for the future of this company for our shareholders and our other constituencies.
So we are working very, very hard on what I've been calling for several quarters our disrupt or die strategy. You can see that in a graph on Page 21. We laid it out in terms of disrupt or die to simply to get our own people's attention because the world is really changing. It's changing really, really fast. It's going to continue to change at a more rapid pace.
Think AI, machine learning, digital, all of the various components we all know about are real. And so we are very, very seriously focusing on the front room and the back room of our businesses, focusing on reconceptualization and figuring out how to operate our businesses more efficiently and more effectively. For example, right now, and this has been in place for a number of weeks, we've already got major projects going on in terms of reconceptualizing operations in our whole IT area, think agile DevOps and all of the things that go with that. Our insurance business is going through a top to bottom, reconceptualization process, incorporating the Regions Insurance acquisition and we expect substantial improvement in our insurance business as a result of that. We have major projects going on in reconceptualizing our commercial and retail banking in the community bank.
That's just to give you a couple of anecdotes. So for example, we have a project going on right now that will reduce the turnaround time in making a small business loan from 28 days to 3 days. That's really, really important stuff in terms of making it more convenient and easy for our clients. In terms of our branches, auto loan business. By the end of this year, we will have our loan approval time down from 1.5 days to 4 minutes.
This is big stuff. This will change the business. As Daryl pointed out, we'll be closing like 160 branches this year to be able to reinvest in other aspects of our branch system and other aspects of the bank. In our commercial area, we are working on a project that will evaluate and improve performance from end to end. That's for the beginning of the request all the way through the final booking of the loan.
We're considering and are very likely soon going to start a major project on general expenses, including things like layers of management. So as you can see, we're looking top to bottom every aspect of the company because we simply have to reinvest in the future of the business. It's basically an online banking business that we and everybody else has. We have to protect that, but at the same time, we have to streamline it and harvest expenses out of that old bank and reinvest it in the new bank. And it needs to be focused primarily on client interaction and relationship management.
So what are we doing? We're developing right now an entirely new ATM strategy. We have substantially improved retail product line. For example, we just introduced in the last couple of weeks 5 new credit cards. Feedback from the field is fantastic.
We're encouraging and really kind of pushing our market leaders, our branch managers to be out making calls in the market 3 times per day, which is a dramatic improvement. We have in the retail and the commercial side a new program we call Financial Insights. This is a big deal. So historically, we and other banks have gone out and called on clients and to ask about their loans and deposits and fee income. We don't do that anymore.
We go out and talk to our clients about their dreams, their goals, their hopes in life, what are their financial plans. And we particularly focus on talking to them about their leadership, because we believe everything starts and stops around leadership. And so if we can help our clients and prospects improve their leadership, we know they will do better. That's a good thing.
And then
in return, we will do better. We focus on helping them grow their business. Inherently, we get more loans, deposits and fee income. We have a number of things on the marketing support side that are really big deal. We have a new program called Voice of the Client.
Historically, we would basically only be able to give our people in the branches and other parts of the bank feedback about once a year. This force of decline is essentially real time feedback. So if a person comes in a branch in Dallas, Texas today, within a day or so, the lady sometimes the same day that banker and that banker's supervisor and all the way up to me, we know exactly whether it was good or bad interaction. If it was good, we've got them on the back. If it was bad, we coach them in terms of how to improve.
We set up a new program called Client First Solutions, where we are looking diligently, continuously on how we can improve our business to make it easier, simpler, faster and more secure for our clients. Just year to date, that group has uncovered 32 client enhancements. We just instituted a couple of months ago a virtual banking center, so that when our clients are less likely to come into the branch, we will be much more active in terms of touching them on a regular basis in the manner that they want to be touched from a digital perspective. We are enhancing our marketing and digital sales. Frankly, we're getting fantastic 4 to 5 to 1 paybacks on the investments in those areas, and we're very excited about it.
In the Retail Community Bank, we have an agile revenue team that once a month, actually it's multiple teams. Their challenge is to continuously look for ways to improve what we do, product lineup, the way we deliver any aspect of the business and get it into effect with a fast kind of agile kind of approach is very, very exciting. And we back all of that up by a much more enhanced focus on client insights and analytics. So the concept is to disrupt the old bank, cut calls, reallocate, innovate and reconceptualize the business and it's working very, very well. Keep in mind that we are investing a substantial portion of those cost reductions back into the new bank, but at the same time, we're holding expenses flat for 2018 and expect to in 2019.
That's a pretty big deal and it's what we need to do. So our people are working really, really hard to work on all that. But most importantly, beyond all that, I would just remind you, BB and T, we're a little different than some companies. We are intensely focused on why we are here. We believe that when we focus on the fundamental purpose for our organization, we are more effective and more successful.
Now we make loans, we get deposits and we get fees and all that, but that's not why we're here. We are here to make the world a better place to live. We're very serious about that, and that's why we focus on things like financial insights. When we make the world a better place to live by making loans and deposits such, of course, our bank does well and our shareholder does well. But when you get up in the morning and focusing on other people, other companies and doing what's best for them, good things in life happen.
You get up in the morning, you're focusing on yourself, how many loans you're going to make and in deposit you will get, what your personal raise will be, what your personal bonuses will be, life doesn't work out so well. So we are making sure that our culture is consistent across our organization that everybody in our company has to be on the same page in terms of why we live. But that's a big deal. We're going to talk to you more about that when we have our Investor Day. So I just wanted to mention to you, if you look at Page 22 on our deck, we are having our Investor Day on November 13th 14th in Greensboro.
We're having it at our new BB and T Leadership Institute. We're very excited about it. It's almost a $40,000,000 new project. It's set back in a nice tranquil wooded setting, walking trails. It has 48 attached rooms.
I've been to a lot of these leisure programs in places around the country. This is the best in class. So I'm excited about showing it to you. I hope you will come on the evening of 13th. We'll have a special presentation and show you around the institute.
I think you'd be really impressed with it. I will mention that we do have 48 rooms attached to the institute. So the first 48 investors that sign up, you'll get to stay in these brand new really nice rooms there at the institute. And of course, there's a nearby really nice hotel for the rest. So we're looking forward to seeing you in Greensboro on November 13th and spending the next day with you.
So with that, we'll turn it back to Alan and we'll go to questions.
Okay. Thank you, Kelly.
Dale, at this time, if you will come back on the line
and explain how our listeners can participate in
the Q and A session.
Our first question is coming from John Pancari from Evercore. Please go ahead. Your line is
open. Good morning.
Good morning. Good morning. I want to just ask on the expense side.
I know you just indicated that you do expect expenses for the year to be flat. I believe that you had indicated previously flat to down modestly for the year. Did anything change that is impacting that outlook? And if so, can you give us some more color on it? Thanks.
Yes, John, this is Darryl. I said in my beginning remarks that we used to have in the Q4 the FDIC surcharge coming out. We put that back in. When you look at the DIF, the DIF numbers from the last two quarters are flat basically. So while there's still a chance it may come out in the Q4, we weren't sure about that.
So we wanted to be conservative to make sure that we were given proper guidance. So if it does come out in the Q1, that would be an upside for us.
But John, keep in mind that, that is flat, including regions. So our core expenses are still down, including the FDIC impacts a little bit.
Okay. All right. I got it. And then for loan growth, I know you're you just indicated, Kelly, that you feel better that it could reach 4% plus or minus. What is that timeframe for when you think you can get to that level?
Is that more of a longer term thing? And I believe previously you had indicated maybe a longer term range of 4% to 6%. So I just want to get your thoughts.
Yes. So plus or minus 4, John, is for the 3rd. I know we technically show it in our deck, 2 to 4, but I'm just saying based on what I see. And as I said, I've been to 23 regions. I've been 2 regions last week.
And based on everything I've seen and talked to our people, I think we've got a very good chance. I can't guarantee, of course, I think we've got a very good chance of being in the plusminus 4 for the 3rd. And then the guidance we give them a 4 still stands as we go beyond that.
John, the specific categories for the next quarter we're seeing besides C and I and mortgage, which really helped us this quarter, we're seeing really good traction in our indirect businesses and auto and Sheffield and also credit card. So all those should get us to that level.
Okay. Got it. Got it. And then one last thing, if
I could. On the insurance side, your insurance revenue was flat year over year. We had looked for
a few percent growth. Can you give us
a little bit more color on what's impacting that?
Yes, sure, John. Keep in mind, a year ago, we had $12,000,000 in performance based commissions that we did not receive because of the storms in the fall. So if you exclude that, really we were up 5.2% core organic growth in the quarter and so far 4.2% year to date. And we're seeing actually acceleration in our new business production. 1st quarter was up 11.8%.
We were up 15% in the 2nd quarter, and I haven't seen those kind of numbers really in years. So the economic expansion is really helping drive that. And pricing is up in 2%, 2.5%. We see that sort of stabilizing as opposed to sort of down to like it was in the year 2017.
So I just leave
it with as a result, we've been kind of guiding up 2.5% to 3% in organic growth and really for the year 2018, what we're really seeing is up now about we think we're going to be up in 3.5% to 4%. So we're kind of moving it up 1% if you would.
Got it. All right. Thank you.
Our next question is coming from Jennifer Demba from SunTrust. Please go ahead.
Thank you. Good morning. Good morning.
I have two questions. First, Kelly, could you just talk about your capacity and interest for bank M and A now? And secondly, the slide, the disruptor dies side on number 21, very helpful. Which strategies on that slide do you think present the most opportunity for BBT over the next couple of years?
Yes. So on the M and A front, keep in mind that we've been in this pause in terms of M and A. I haven't officially lifted that pause, but I will be candid with you. I think we're basically ready to get back in M and A. In terms of our internal capacity, we took this pause because we needed to make sure we got all these major projects worked and that they're all in really good shape.
We're still in the process of working through the final step with regard to the consent order you saw. We have been released from the consent order with the FDIC in the state, not yet been released with regard to the Fed, and we're working with them on that. I expect that to be released in the not too distant future, but I can't control that. And so but in any event, at some point, that's going to be released. And there's some possibility even forward to release, we can still do M and A.
So I'm not overly worried about that. The bigger issue is the availability of mergers and the economics. I will tell you that there is a meaningful increase in activity in really just the last couple of months. We've been approached by a number of institutions in the last 60 days that would like to consider a partnership with us and we're very humbled by that and we very much appreciate that. And of course, we will look at them.
But it's all about economics. And I've said repeatedly that the economics of M and A has changed because when we talk about this change in terms of digital banking and the change in demand for convenience from our clients, that's real stuff. And so we're seeing declines in the 5 plus percent range in terms of branches. Other banks are seeing the same thing. And so when you particularly close on our market deal, unlike in the past where you would forecast an increasing cash flow and discount it back to figure out what it price is, now you're forecasting a declining cash flow and standing back.
So and then the market is really not yet quite caught up with that. They'll figure it out, but they haven't quite figured it out yet. So I think odds of us doing out of market deals are pretty slim. I think the odds of us being able to do in market deals are pretty good. But I know every time I say that sometimes people say they want to go sell our stock.
I'll tell you that's not a smart move because if we do deals, it's going to be good for our shareholders. We're just not going to do stupid deals. We're not going to do deals that have long term dilutive economics that makes no sense to our shareholders. So we're going to look at deals and we'll do it if it makes economic sense. So we do a deal, you'll be happy with this deal.
With regard to the disruptive Dow, I appreciate your question on that. I think that's the most important thing because it sets up all of the investments and sets up improved EPS and improved stock price to do M and A, so it all integrates together. I would say the most immediate substantial impact is the reconceptualizations in the Community Bank. It's our guys, David Weaver and Brent Sandrich, are doing substantial changes in terms of the cost structure and reallocation of resources and the penetration of the market. It's a big deal.
I'd say that's followed closely by our IT reconceptualization, which is a complete change top to bottom in terms of how we do that. And then I would say, follow closer to insurance. And so and then a number of others, but that's kind of the top 3, I would say. But all of it together is what's allowing us to have flat expenses and making these major investments in the future of the bank. And that I can't overemphasize how important that is for investors to look at banks.
Banks that are out there just cutting expenses willy nilly and not investing for the future you may not have a very bright future. And so we're going to have a very bright future and we think doing what we're doing is appropriate. So thanks for the question and where you see
it. Thank you.
Our next question is coming from Betsy Graseck from Morgan Stanley. Please go ahead. Your line is open.
Hi, good morning.
Good morning, Betsy.
Hey. So a couple of follow ups. One on the reinvesting in the business, very passionate presentation you gave on Page 21, Kelly. The question I have is, as you look out over time and we're talking 2 to 3, 4 years, do you think that this has an impact on the organization? Or does everything that you're doing keep pace with the expense ratio today?
Betsy, as you know, we're in a new world and it's hard to those of us that have been around a long time, we can think we can speak more clearly about historically because we know what the facts are. When you're in a whole new world and you're trying to develop new understandings of what the various costs are, it makes it a little harder. So given that, I think we will be able to make the kinds of recapitalizations, invest in the business and still see a slowdown with pressure on our efficiency ratio. Now insurance business is growing really fast and that's pushing upward pressure. You know how that works.
But when you put all of that together, I still see in the short run, my target is 55. And I think longer term as revenue kicks up, you can even push a little lower than that. But over the next few years, I would be thinking in terms of doing all we're doing and still seeing positive operating leverage and downward pressure on the efficiency of Russia. Got it.
Betsy, you're breaking up a little. We can't hear you, Betsy.
Betsy, we can't hear you. Maybe if you can dial back in, we'll let somebody else in and we'll let come right back in behind them if you can dial back in.
We will now move to the next question waiting for Ms. Krausek to dial back in. We have now a question coming from Ken Usdin from Jefferies. Please go ahead.
Hi, this is Amanda Larson on for Ken.
Hey, Amanda.
How are you doing? Good. Can you talk about the balance sheet and liquidity management strategy here given the expectation that loans will continue to grow? What's your outlook for deposit growth and mix and what betas are you assuming over the next few quarters?
Yes, Amanda. So we are starting to get traction on our loan growth. We saw that this quarter, and we're guiding to stronger loan growth next quarter and hopefully continuing on from there. So we want to have bell thores in the water, so we will and as we're starting to see deposits also start to grow, I think we're still fortunate that our DDA is growing. That is growing not as fast as it was, but it's still positive.
But we are getting growth in our checking as well as NMDA products. Last couple of quarters, we've got growth in CDs. We will toggle our deposit growth to match our loan growth the best that we can. As far as deposit betas go, we did see a big spike up in our deposit beta from last quarter from 24 to 41. If you look at it, we had increases both in the REIT consumer, commercial and in the wealth and large corporate.
Our guess is that, that will moderate this next quarter. We believe that it will go probably from the low 40s back into the 30s as we continue to have more traction and growth in deposits. That's what we see in the pipeline right now, feel that we're going to have a good deposit growth quarter this next quarter with sites that we see now and that should match very well with the loan growth. But we will continue to monitor that. But I think on a next quarter or 2 basis, I think deposit pressures will abate a little bit.
Okay, great. And then can you talk about your expectation for purchase accounting accretion in 2H and your expectations for the extent of 2019? Thank you.
Yes. So purchase accounting, probably by the end of 2019, you probably won't even be asking the question anymore as it continues to fall off. Right now, the difference between our reported margin and core margin is 11 basis points. We see that contracting probably by the end of 2019 going down to maybe only 4 or 5 basis points difference. I think each quarter that goes by, it's 1 or 2 basis points gap change between the 2 of them.
So it is coming in over that time period over the next 4 to 6 quarters. Does that help?
Absolutely. Thank you. Our next question is coming from John McDonnell from Bernstein. Please go ahead. Your line is open.
Hey, guys. Good morning.
Daryl, I wanted to ask on the fee revenue. It looks like the guidance came down a bit. It looked like it was 2% to 4% previously and now 1% to 3% for the year. Is
that more of a year
to date performance or do you expect lower growth in the second half? Maybe you could talk about the drivers there on the fee revenue side?
Since half of the year is in there, it's really driven by what we've seen in mortgage to date. And quite honestly, while mortgage volumes are very strong, spreads continue to be very tight. Chris mentioned insurance rebounding, so we should have some nice growth, organic growth on the insurance side to help offset part of that. And then the investment banking, we believe that is timing. This past quarter, we missed our forecast on investment banking.
But with the deals that we've seen close already this quarter, we feel very confident Investment Banking and brokerage will have a strong second half of the year. I think we're going to have with Investment Banking, service charges and insurance a decent relatively strong fee income for second half of twenty eighteen just with mortgage being a little bit softer.
So the timing aside, just to the extent the full year is a little lighter than you might have thought coming in, it's really mortgage as the driver there for the full year?
Yes. We've been through these cycles many times when refi volume goes down, there's less volume and people just bid up very competitively, very lower pricing, and you see that dramatically in the retail businesses. Our spreads are just down a lot, and I think you're seeing that across the whole industry. But we're positioned very well. Our purchase activity is strong.
Our producers, originators out there are gaining share. So I think we're equal to or gaining share in the marketplace. It's just that spreads are tighter.
Okay. And then a follow-up on expenses. You mentioned the FDIC charge is the driver of the change in expense guidance for the full year. If you're assuming the FDIC surcharge remains, how much is that can you just remind us how much that FDIC charge is? And then how are you feeling about the ability to generate positive operating leverage in the second half of the year and for 2018?
So the surcharge is worth $21,000,000 a quarter. I would say if you look at linked quarter between 2nd and third, that's a tough comp for us just because you have seasonality and some of the fee businesses insurance and we have regions coming in. From the regions insurance, we will not get any synergies really in that business until we get through the system conversion. System conversion is scheduled for November of this year. After that, Chris can comment on it, but we think margins will go from about 20% up to about 30% over the next year through 2019.
So we think margins will rise there. So I would say linked quarter, 3rd quarter, challenging delivering a very good run, but it's going to be close. So it could go either way. But for the half a year, 4th quarter definitely, year over year, very, very good that, that should also have operating leverage there. So I think we really have a lot of good momentum going on.
I basically see revenue growing 2% to 3% and expenses being flat. That's kind of the story that we have right now.
Exorbing expense base of regions.
Got you. Got you. One last thing, guys. When you look at CECL coming on, what kind of progress are you guys having with the preparations for CECL?
So if you looked at it, there was a good white paper that came out this past week by the Bank Policy Institute. They did a research white paper. And we've been talking about CECL now for a couple of years and it really confirmed what we've been saying is that it's very procyclical and is a major threat to the economic stability and a financial crisis. Greg Baer, their CEO, testified in Congress this past week on that. But if you really look at it, what came out in the study, which is amazing, is that CECL expects that you have perfect knowledge of what's going to happen.
If you look at the economic forecast in 2007, nobody was foreseeing a big recession coming. So if you model in what expectations were and they did this in those white paper, and actually doubled the contraction of the recession if you had CECL in place back 11 or 12 years ago. So I think that's a huge risk to the country, to the economy that people really need to think about. When you look at CECL, while the economics of lending hasn't changed, accounting has departed from the economics. When you front load all your expenses, it impacts earnings and capital.
Since we are an industry where capital is part of an accounting number and it's part of how we manage the company, You have to pay attention to the accounting piece. So I would say, you have 1 foot in economics, 1 foot in accounting and the regulators and hopefully FASB will make some modifications before they put a lot of risk into the economy. It's not good for the term assets that you see in the consumer portfolios. It's not good for portfolios that have higher risk in subprime. So there are a lot of negatives out there.
Ironically, the way that CECL is actually set up, we're actually seeing less reserves on the commercial side because you're actually reserving to the maturity and not really to the expected life of the assets. So the whole economics of CECL versus accounting has been totally disconnected.
Got it. Thanks guys.
The next question is coming from George Cassidy from RBC. Please go ahead.
Good morning, Kelly. Good morning, Daryl.
Good morning. Hey, Daryl. How are you doing?
Good. Kelly, I took with some interest your comments about visiting your different regions of the franchise and talking to your customers, particularly the one you highlighted, the construction owner and what they have to do for raising about maybe interest rates will go higher than what we're currently forecast by the Fed. So my question is when you guys underwrite your variable rate loans, what kind of interest rate assumptions or interest rate increase assumptions are you using in that underwriting? And second, will you change them where they'll go up even higher if you start to see higher inflation?
Gerard, this is Clark. That's a great question. I think that's we think is something differentiates our approach to CRE lending from others for many years. We don't underwrite specifically on current cap rates. We always look at stress exit underwriting.
So we always look at at least a couple of 100 basis points over the current accrual rate with the floor and our floor has been in roughly the 6.5% range, but because of the issue you and Kelly just raised, we're evaluating whether that floor needs to go up or not. So we always try to get ahead and make sure we stress these projects for the potential rate shocks and don't fool ourselves about how we size the loan. But we certainly see less of that focus by others in the markets, which creates a lot of we believe oversized new credits in many cases.
Does it, Clark, does it make it harder for you guys to compete then because you're doing it more conservatively than some of your peers?
Absolutely, in certain aspects. For example, I would tell you right now, it's very difficult to compete on a fully stabilized IPP project for what I just said. They tend to have very high sizing based upon trended rents and extrapolation of expenses and low vacancy and so non recourse. So we're just not playing there. We think that that's too much leverage.
So we're doing more C and D where we have very strong initial equity guarantees, stress underwriting. So we're well protected for we believe the risks we're taking.
So we're
having to pick our positions to play based upon that. But we still think we can compete effectively, even that said.
But Gerard, as you well know, we run the business from a long term through the cycle perspective. And when we get into this period of the cycle, we always see it. Many competitors scrambling for asset growth, very short term focused, and they're willing to price and structure whatever it takes to get growth. That feels good today, but it doesn't feel so good when the creation comes. So we run through the cycle, so it will feel good on both sides.
So yes, it does make it harder for us today. We work harder at it. We don't give up, But we're not going to go out there and make loans at the prices some of these people are making and structures some people are making just to get loan growth. It's a fool's game.
And then as a follow-up question, Kelly, going back to Slide 21, I took with interest how you're going to increase the national lending business and I recognize that in equipment finance mortgage and Sheffield, you're basically already there. But I'm more interested in the corporate and commercial real estate. When you don't really have a national customer base, and I know you have some customers, but it's not in your footprint. How do you avoid adverse selection if you're going at the national level?
Well, you have really good people and you hire local knowledge people. So we have a great team headed by Rupert Sheik and Cory Boart. And when we ask them to expand as we have, we give them the resources to go into the markets and have local knowledge people, because we've learned and you've seen it over the years, if somebody can leave one market and send some people on the plane and fly out to the West Coast to make a few loans, it doesn't work out so well. So our strategy is to domicile people in the marketplace that have local knowledge. And so we're not at a competitive disadvantage in terms of appropriate knowledge.
So we will be able to expand and it's really just a matter of resource allocation and we're allocating more resources there because our people have performed extremely well.
Yes. Gerard, this is Chris. I would just add, we have our Grandbridge business, which really is a national business and has been for years, and we have people throughout the country today. And so it's really about Rufus working with Grandbridge and sort of duplicating what he did on the corporate side and bringing in bank balance sheet lenders to kind of sit alongside the Grandbridge folks, which are really kind of secondary marketing kind of lenders. And we think that will work really well to be able to put more on the balance sheet and to be able to do construction type financing that we might not have done in the past as well.
Great. Thank you. Look forward to seeing you in November.
See you then. Thank you. Next
question is coming from Mike Mayo from Wells Fargo Securities. Please go ahead.
Hi. Can you hear me?
Yes. Yes, I am.
Okay. Can you elaborate more on your efficiency guidance? I mean record EPS, lower guidance for efficiency. So it's a little bit of a disconnect. I know you've addressed that, but you're lowering the range from 100 to 400 basis points of positive operating leverage to 100 to 300 basis points of positive operating leverage.
And I think what you said is the FDIC benefit you pushed out and so a little bit of mortgage softness, maybe there's some investing in there. That's still a pretty wide range for just 2 quarters left. I don't know if you can be more specific to the 100 to 300 basis points annual positive operating leverage. And I think the reason for the sensitivity to this is you guys didn't miss your efficiency targets a few years ago. Your efficiency did become the worst it's been for BB and T in a decade.
And look, it's still good progress, it's still good efficiency, but it hasn't been the best efficiency like it once was. So what's your commitment to that 55% short term? I guess, can you define short term? Is that maybe in 2020? Could it be next year?
What's your commitment and conviction to improving that efficiency since you're pulling back a little bit your guidance here?
So Mike, I'll give you the conceptual and Daryl can give you some detail. Our commitment and conviction is absolute. But you just need to remember, Mike, what happened to us during the frankly, during the 1990s 2000s, we were growing really fast for mergers. We kind of had to, and we did that well. But in that period of time, we didn't invest as much as investors take maybe we should have in the back room.
So as we headed into the last 10 years, we simply had to substantially ramp up our investment in updating a number of our systems like our new accounting system, our new commercial loan system, our new data center and a long list of other systems. So we've had an accelerated, I'd say, 3 or 4 year period of substantial ramp ups. I told our people at the time, I told the market at the time that it would drive our efficiency ratio up, but it would start subsiding. That is exactly what happened. It popped up to 59.5 desired haul on an adjusted basis.
It's now down to about 57.3 percent and it's moving in a trajectory as we projected in that 55% kind of range. Obviously, the denominator matters and we've talked about that in the past. But denominator side, if it's somewhat neutralized, yes, I feel good about being able to make all the investments we're making and moving towards that 55 ish kind of target because we are really figuring out some neat ways to do our business better. I mean, this isn't just about trying to work harder and do what you did, just working a little harder. This is about working smarter.
In this business today, that's required. And the good news is there are substantial new tools, think AI machine learning, robotics, etcetera, that we've never had before. And so, yes, we're confident and excited about it.
Okay. So a little detail, Mike. You want to focus on the things that we can control. So on the expense side, we've been doing a great job this year on controlling expenses. If you look at our FTEs year over year, we're down 1600 FTEs and we haven't missed a beat in how we're operating our company.
As that goes forward, I would expect our FTEs also to continue to be right sized going into the future. As Kelly mentioned, in the branches, we're rationalizing the branch system. We also have a big program within our back office facilities. We're just starting some testing and learning on the front office facilities. So when we started this venture, we have about had about 21,000,000 square feet in the company.
Right now, we're about 18.5 percent and that's continued to come down. We'll probably over the next 2 to 3 years, everything else being equal, be close to 16,000,000 square feet, maybe a little bit better than that. We're going to use those costs, as Kelly said, redeploy them in robotics and digital, help drive revenue, help continue to drive costs, all that comes together. So if we can continue to keep costs flat and continue to make the investments, we feel that based on the economy, revenue could be 1% or 2% or could be 3%, 4%, 5%. We will get what we can within our risk appetite, but we will definitely generate positive operating leverage.
And then one follow-up, since mergers have impacted the efficiency. And Kelly, I agree with you. Since Southern
So if you look
at your stock price versus peers or the S and P, absolutely. But the deals most recently in Pennsylvania, I'm not so sure they helped. And I think you talked about fishing I think I was triggered when Daryl said his oars are in the water because your fishing analogy, if the fish aren't butting on one side of the boat, well, maybe you catch the fish on the other side. So I think in market deals are better received than out of market deals. So what additional confidence can you give us that if BB and T were to pursue acquisitions, it'd be more like the 25 year record than say the stock price performance after the Pennsylvania deals?
And also, if you can define you said a meaningful increase in activity, if you could define activity, it's not like we've actually seen a lot of deals. So what does that mean?
Yes. I think I would generally agree, Mike, with your assessment of the last 25 years with one caveat. When you peg it to the Southern National thing, that's a lofty peg. As you know, that was the most effective MOE in the entire country. We were 10%, they were 9%.
We were all over each other. I think we've got cost 50%. I mean, it was a sweetheart deal. Comparing that to Pennsylvania is apples and oranges, it might even be apples and turtles. And so you can't really make that comparison.
But yes, but Pennsylvania was not as attractive as Southern Nashville, but it was very attractive. Now has it gone a little slower than I expected? Yes. But I'll tell you, Mike, it's they have really turned. I mean, I was up there 2 times last week in fact.
It has really turned. It's a stable kind of market. It's not a go go market like Atlanta or Dallas, stable kind of market, particularly where we are, most around Lancaster and Allentown in that area. So it takes you a little longer. And remember, those were done right at the beginning of the substantial change in terms of economics around digital, etcetera.
So as we go forward, the kind of stock price impact, EPS impact, etcetera, that we've had historically on deals, I think is what you would expect going forward. And so you do fish on the side of the boat where the fish are, but sometimes the fish on the side of the boat that are biting aren't the kind of fish you want. And so that's what I've been trying to say about out of market. There are a lot of fish out there for us on that side of the boat today. Out of the market is just the price isn't going to work.
But in terms of the activity, we've had 4 pretty attractive cannabis approach us in the last 60 days. We haven't even gone back down and started looking yet, because I think we're preferred acquirer. So we're going to have I'm sorry, go
ahead. Last short follow-up. So what size? Are these tadpoles? Are these sharks or I'm not a big fisherman, but what size do you want
to do for you here?
Well, there are a couple of I wouldn't call them tadpoles, I'd call them little brown. There are a couple of little browns, but so we wouldn't be particularly interested in them. But we but there are some that are good sized catfish. I'm not a fish in the middle of mine. But let me be more specific.
I'm thinking kind of our minimum target area today is 20,000,000,000 and we really kind of like 30,000,000 more than 20,000,000. So today is you know all those deals we used to do, I remember they were $200,000,000 $500,000,000 all those days ago. So it's more like $20,000,000,000 to $30,000,000,000 as today, as to say
$50,000,000 All
right. Thank you.
Yes.
We'll now take a final question from Saul Martinez from UBS. Please go ahead. Your line is open.
Good morning. Hello? Hello? Hello? Hello.
Can you hear me? Yes.
Sorry about that. I didn't hear that I was called. Hey, I just wanted to come full circle on the discussion on deposit betas and make sure I understand the logic. So obviously, you're expecting it to tick down from the 41% this quarter into the 30 plus percent range. Having said that, the cumulative beta has been about 24%.
I think you mentioned that you're modeling about 50%. And frankly, 41% doesn't seem that high given where we are in the cycle, in the tightening cycle right now. So how do we think about the progression, just say, beyond the next couple of quarters? Do we see a bit of a downtick? But as we progress in the interest rate cycle and get closer to whatever the terminal Fed funds rate is, where do you see the incremental deposit beta tracking to?
And how do we think about sort of the cumulative deposit beta in this cycle?
So I think what we were trying to convey is that we had a spike up in the second. That was part of the market itself, but a substantial part of our own strategic decisioning to respond to some market conditions. That part will subside as we head into the 3rd and the 4th. Now if we continue to see substantial increases in rates And if corporations continue to use their available cash, which they're doing today, and there's more demand for lending, lending pace goes up, there'll be more demand for I mean more demand relative to swap for funding and that will drive better. So my own personal view is it will for us it will supply some in the next 3 or 4 couple of quarters.
And then depending on what happens with rates, it will more slowly, more naturally tick up. Because you're right, I mean, 41 in and of itself not inherently bad. It's just that it popped up real fast and we want to try to explain why it popped up real fast. You would expect it to have gotten to that level more over a several core period. Yes.
If you look historically, in the past cycles, it's been between 40% 60% deposit beta. Right now, our cumulative number is 24%. I don't see it getting over 50% cumulatively. It's going to be at the low end of that range. But as Kelly said, once we abate in the next quarter or 2, we'll probably gradually grow up, but we'll probably stay in the lower end of that range going forward.
Okay. No, that's helpful. Got it. And then just a quick follow-up on Regent. Have you disclosed or given a sense of what
the magnitude is of
how much the
Best take right now, we'll probably buy back about $200,000,000 of shares this quarter. And then as depending on the size of the balance sheet, we communicated to the marketplace last quarter that we want our capital ratios to have a CET1 that's over 10%. The reason we're doing that is that if we cross over $250,000,000,000 over the next couple of years, we have the AOCI risk that goes through our numbers. And right now with higher interest rates, the capital hit with our portfolio and pension that we have out there is about 100 basis points. So our CET1 would fall when you cross over 250 from, call it, 10% to 9% on day 1 once you cross over.
So that will probably long answer to we won't probably spend all the $1,700,000,000 that we asked for. Some of it was used up with the Regions Insurance acquisition and some of it, we won't be able to spend just because we want to keep it over 10%. But it really depends on how much our balance sheet grows and how fast. We'll update every quarter what we're looking to buy repurchase in the earnings call. But right now for this quarter, I'd say about $200,000,000
Okay. No, that's helpful. Thanks a lot.
That will conclude today's conference call.