Truist Financial Corporation (TFC) — Q1 2017 Earnings Call Transcript

Thank you, Debbie 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 first quarter of '17 and provide some thoughts for next quarter. We also have other members of our executive management team who are with us to participate in the Q&A session: Chris Henson, our President and Chief Operating Officer; and Clarke Starnes, our Chief Risk Officer. We will be referencing a slide presentation during our comments. A copy of the presentation as well as our earnings release and supplemental financial information are available on the BB&T website. Let me remind you that BB&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&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 today's presentation includes certain non-GAAP disclosures. Please refer to Page 3 and the appendix of the presentation for the appropriate reconciliations to GAAP. And now, I will turn it over to Kelly.

Thanks, Alan. Good morning, everybody. Thank you very much for joining our call. As always, I really appreciate your interest in our company. So it's a very good start to 2017. We had record quarterly revenues, good expense control and strong returns. Our net income available to common shareholders was 348 million, down 28%, but remember that included several major items I'll discuss in just a moment. So adjusted net income was 611 million which is up by a significant 15.1% versus first quarter of '16. Adjusted EPS totaled $0.74, up 10.4% versus the first quarter of '16 and our returns were really good. Our adjusted ROA was 1.21%, adjusted return on common equity was 9.18% and return on tangible common equity was 15.56% and our risk-related adjusted assets return was 1.5%. We had record taxable equivalent revenues totaling 2.8 billion, up 9.1% versus the first quarter of '16 and up 7.6% annualized versus the fourth quarter, so good revenue momentum, driven more by net interest margin, which increased 14 basis points to 3.46% versus the fourth quarter. Our fee income ratio declined slightly to 42.1% versus 42.6%, but let me just make a point of emphasis here. Remember that it's down from where we typically had around 44%. The reason is because our fee income ratio, every time we do a merger gets diluted because the smaller institutions just don't have all of the fee services that we have. That's one of the reasons we acquire these companies and while it's down, there's really an indication of an alternative because over two or three years we'll bear all that fee income pack ended for those companies, so that's not a negative; it's just an implicit opportunity. If you're following me still on slide 3, our GAAP efficiency ratio was 75%, again factoring in the unusual items, so the adjusted efficiency ratio was 58%, which was down from 59.5% in the fourth quarter. Credit had an outstanding quarter; credit improved across the boards, so NPAs, performing TDRs, delinquencies, and net charge-offs all declined versus last quarter, and we have great credit quality. If you're looking at our deck on slide 4, I'll mention a couple of selected items. The first is the loss on early extinguishment of debt where we announced in early January that we terminated 2.9 billion on FHLB advances and a pre-tax charge of 392 million, which reduced earnings per share, but remember, this increases our run rate and margin going forward. We did have merger-related restructuring charges of about 36 million pre-tax and that was a $0.02 negative impact on diluted EPS. And we had excess tax benefit on equity-based awards which you've been hearing about in further conference as well. This will be a recurring item temporarily in the first quarter, but remember, it could be up or down. So we're trying to take it out, but we just don't consider it a normal type of recurring item. If you look at page 5, we just want to give you a quick report guide on how we did relative to our guidance for the quarter. So if we divide the loans, we were a little bit short of guidance, but as we anticipated that may improve with rates being back down, but that's a little volatile and substantially out of our control. Credit quality was very consistent with our expectations. Net interest margin was a little better than our expectations given in our guidance. Noninterest income was as expected, expenses were a little better, and operating leverage at 10.5% was a little better. Overall, we got most of the checks, with a few exceptions; we felt that was a favorable outcome. If you go to page 6, let's take a look at loans. This is a really strong quarter for us. Our underlying loan growth was very good relative to the market; I'll explain what I mean by that. If you look at our actual GAAP loan growth annualized, it was down 0.9%, but if you look at average loans underneath that, we had really good growth in a number of areas. Equipment finance was up 21%, Grandbridge was up 16%, commercial credit capital was up 10%, and sales finance increased by 297 million or 11%, but I'll point out that was primarily due to a portfolio purchase late in the fourth quarter. We did not plan any additional portfolio purchases in our foreseeable future survey for '17. The good news is that our C&I growth, excluding mortgage warehouse, was 4.5%, which was very strong. That was growing substantially because of our community bank production which was up a lot compared to the first quarter of '16. In fact, the first quarter of production growth was our best in history, and I say that because of the improvement in our mainframe which I'll talk about in a moment. Our expectation for GAAP growth for the first quarter is 1% to 3%. If you look at page 7, this gives you a little bit more color regarding what I call underlying loan growth. We're really focused on optimizing our use of capital for lending. We think the marketplace today is not like it's been for the last couple of decades. You can't just grow loans in and out of '17. I think that's a good thing. It's really important to look at the kind of loans, the kind of credit implications, and in particular the kind of returns you get relative to capital allocation, because as you know, capital allocation in our business today is a significant deal since we are required to keep much more capital than we historically have. So, we are analyzing our loans today in three categories: our core categories, which is basically C&I, Community Bank, etc.; our seasonal portfolios, which include mortgage warehouse lending and all lending subsidiaries, which go up and down based on seasonal factors; and then what we're calling an optimizing portfolio, which are portfolios that we have decided for various reasons to allow to run off over a period of time. It doesn't mean we are automatically out of the business; it just means right now we don't want to grow those kinds of loans. If you think about our growth strategies within those three areas, obviously we're trying to grow the more profitable loans with better risk profiles. We are reducing exposure to prime auto given its low profitability and uncertain market outlook, and it's not that we're concerned about our quality; it’s just because we're very conservative on underwriting. We don’t take long-term positions, etc. The pricing you get under these loans today is simply not attractive relative to the capital we have to allocate. So we’re not exiting the business, we're just being more strategic about pricing and turning more conservative and prioritizing profitability. We continue our strategy to reduce exposure to residential mortgage, which is due simply to low profitability and the expectation of rising rates. In terms of our core and seasonal portfolios, we expect them to grow in the range of 5% to 7% for the second quarter. If you take those 5% to 7% minus the optimizing portfolios, that gets you down to the 1% to 3% growth I mentioned earlier. But it's important to look at the underlying areas that we are focused on growing. They are performing nicely at 5% to 7% considering current margins. This core growth was primarily driven by our corporate strategies, but largely by our Community Bank. I want to emphasize, regarding Community Bank, this is a bit specific, but over the last eight years, Main Street has really struggled, and we are primarily a Main Street lender. As you know, most of the growth in the market over the last several years has been by large companies who have engaged in extensive restructurings and established a dominantly strong international market, which we don’t participate in. Relative to many of our competitors, we had a tougher time due to our focus on Main Street. Now, we believe Main Street is changing, which I’ll elaborate on in a moment, and improving. If it does improve, you should expect to see BB&T's loan potential perform better than many of our competitors who have been depending on long-term growth from large firms and their international exposure. We think BB&T's time has come. If you look at page eight on deposits, there is not a lot to elaborate on. Our non-interest bearing deposits were down, but it remains relatively stable; I think everybody is aware of that. We believe our net interest margins are likely to stay low, around the 10% to 15% range after the last rate increase, and frankly, we think they are going to remain low. Now, I want to take a minute before I turn it over to Daryl to provide some insight into what we are actively pursuing from an executive leadership perspective moving forward. First, regarding the marketplace, there is considerable volatility and politically charged atmosphere today. Congress seems to be moving forward one day and then backtracking the next; there's not much we can do about that. However, we believe that there is a decent chance that most likely, over the next several months, maybe by the end of the year, we will see our revised healthcare program, a combined tax bill with infrastructure, and improvements in regulation. Of course, there are no guarantees here and there are countless opinions about that, but that’s our belief. So, we think the market is getting better, but we're not waiting for the market to improve. We feel that if it comes, that's fantastic. We're taking initiative on what we can control. Thus, there are six focus areas that we are really energized about today, all of which have a significant positive impact on our company. One of these is accelerating our growth in the Community Bank. As I mentioned, as Main Street improves, so will we. Despite skepticism about the current environment, I’ve recently visited many of our regions and have interacted with our lenders and clients. I can tell you that the optimism is palpable; people are excited. They aren’t paying as much attention to the rhetoric coming out of Congress. While opinions might change, what’s evident today is the enthusiasm around loan requests, new equipment, new buildings, and the hiring of more associates. It's happening! I can't guarantee what changes will transpire, but it’s happening today. We are going to increase our corporate banking loan growth. That segment has been a standout for us over the years, and we have a unique opportunity to continue to grow that even faster. We are being very conservative in terms of our home positions and lower corporate exposures, but we can elevate those while still being prudent. Expect to see our corporate loan growth remain robust. We are also intensifying our efforts on our business, which has been in development for several years. We’re going to emphasize strategy and that’s been working extraordinarily well concerning assets under management and lending. Additionally, we’re optimizing our consumer portfolios by deemphasizing prime automotive, focusing on risk. We maintain a high-quality portfolio related to that specific segment. You should know, over the last two years, we have tightened our risk controls relevant to that area, and our performance is commendably good compared to the industry. Some concern exists in this industry, yet our facts exhibit positive performance relatively speaking because we have proactively managed our distributions accordingly and adjusted pricing to ensure better returns. This optimization strategy also entails investing heavily in digital transformation. We are focusing on three specific areas. One area is improving our U platform. Remember, we introduced our U mobile interaction platform about a year and a half ago, positioning it as top-tier in the industry. We continue to allocate resources towards that effort daily, and we plan to expand our investments in advertising and social media significantly. Critically, we’re enhancing processing costs, which yield substantial opportunities across all banks, utilizing AI and robotics to drive efficiencies in our operations. We are aggressively pursuing this path, recognizing the vast potential to optimize back-office expenses, and I’m genuinely excited about it. It’s still early to declare total success, but the concept is solid. Lastly, we have a strategic mortgage, residential mortgage profit improvement plan in place, which Chris is driving, aimed at increasing efficiencies and capacity. We anticipate considerable performance improvements in that area over time. That captures our key focus areas. We believe in the opportunity for value creation and ongoing improvement as we execute our strategy consistently. Now, let me turn it over to Daryl for more insights.

Thank you, Kelly, and good morning everyone. Today I'm going to talk about credit quality and interest margin, fee income, non-interest expense, capital results, segment performances, and lastly provide some guidance for the second quarter. Turning to Slide 9, we had a really strong quarter with regard to credit quality, improving in all categories. Net charge-offs totaled $148 million, down slightly. Loans that were 90 days or more past due and still accruing decreased by 14.8%, and loans that were 30 to 89 days past due decreased by 25.3% due to seasonal improvements in our consumer-related portfolios. NPAs were down 1.5% from last quarter. Looking at the second quarter, we expect net charge-offs to remain in the range of 35 to 45 basis points, assuming no unexpected deterioration in the economy, and we expect NPAs to remain relative. Turning to Slide 10, our allowance coverage ratios remain strong at 2.49 times for net charge-offs and 2.05 times for NPLs. The allowance-to-loans ratio was unchanged at 1.04%. Excluding acquired portfolios, the allowance-to-loans ratio remained stable at 1.13%. Our effective allowance coverage remains robust. Provisions for credit losses matched net charge-offs at $148 million. Going forward, we expect loan loss provisions to match charge-offs plus loan growth. Turning to Slide 11, net interest margin was 3.46%, up 14 basis points from last quarter. Core margin was 3.28%, up 10 basis points versus last quarter. The increase in GAAP margin resulted mostly from higher earning asset yields, securities through misc. adjustments from the prior quarter, and the impact of the Federal Home Loan Bank termination, offset by slightly higher deposit betas due to the recent rate increase. As a reminder, we restructured $2.9 billion of Federal Home Loan Bank advances at the beginning of the first quarter and recorded a pre-tax loss of $392 million. Asset sensitivity improved driven by shrinking fixed-rate loans such as auto and mortgage, alongside continued growth in core deposits. Looking at the second quarter, core margin will increase by 2 to 4 basis points due to the March rate increase. Looking at our GAAP margin, we will remain relatively flat on a linked quarter basis due to the decline in purchase accounting benefits. Continuing on Slide 12, our noninterest income ratio stood at 42.1%, down slightly, primarily due to the increase in net interest income. Noninterest income totaled $1.2 billion, up 3.1% from last quarter. Our fee income changes included an increase of $39 million in insurance income, mostly driven by seasonality and employee benefit commissions. This was offset by investment banking and brokerage commissions resulting from several large deals that closed last quarter. Looking ahead to the second quarter, we expect fee income to increase by 6% to 8% compared to the second quarter of last year. Moving to Slide 13, noninterest expenses totaled $2.1 billion, excluding the $392 million Federal Home Loan Bank restructuring charge, merger-related charges, and the mortgage reserve adjustment from the prior quarter; core noninterest expenses were slightly below $1.7 billion, down 2.9% from last quarter. Personnel expense saw a slight uptick driven by a $34 million increase in payroll taxes and equity-based compensation, with approximately $25 million of that increase attributed to seasonal FICA expense and 401(k) matching. This increase was mitigated by FTE reductions and a $28 million decrease in salaries and incentives. Additionally, loan-related expense increased by $36 million, largely driven by the prior quarter’s release of $31 million in mortgage repurchase reserves. Going forward, we expect expenses to remain flat to up 2% compared to the second quarter of last year, excluding merger-related and restructuring charges. It's also worth noting that the effective tax rate is expected to return to the 30% range in the next quarter. Turning to Slide 14, our capital and liquidity remain strong. Common equity tier 1 was 10.1% fully phased-in. LCR stood at 124%, and our liquid asset buffer is very strong at 12.7%. Our dividend payout ratio was 64% on a GAAP basis due to the Federal Home Loan Bank restructuring, with our total payout at 106%. We are currently targeting a total payout in excess of 100% with our recently submitted CCAR '17 capital plan. Now, let’s look at segment results beginning on Slide 15. Community Bank net income totaled $334 million, essentially flat. However, our commercial loan production is a strong indicator of how Main Street is performing right now. This was the best quarter we've ever seen. We continue to strive for efficiency; our operating margin improved to 40.6% in the first quarter. We believe we can further improve efficiency in the Community Bank as we explore opportunities to realign the branch network. Turning to Slide 16, residential Mortgage Banking net income was $48 million, down from last quarter. Net interest income decreased by $12 million primarily due to lower average balances. Noninterest expense increased by $36 million due to higher loan processing expenses driven by a $31 million release of mortgage repurchase reserves. Production mix was 52% purchase and 48% refinance, and again, our sale margins were 1.01, up from 0.86 last quarter. Looking to Slide 17, Dealer Financial Services recorded income of $29 million, down from last quarter. This was due to a slight decrease in net interest income, principally stemming from credit spread declines on loans resulting from a competitive marketplace. The provision for credit losses increased by $9 million, mostly driven by higher charge-offs in regional acceptance and increased loss severity trends. Charge-offs in regional acceptance escalated to 8.9% this quarter; however, the risk-adjusted yield remains strong at 8.7%. We continue to target lower LTVs. Next quarter's charge-off rate should drop significantly lower than 8%. Charge-offs for the prime portfolio remained excellent at 16 basis points. On Slide 18, Specialized Lending net income totaled $50 million, up $4 million from last quarter. We experienced strong year-over-year loan growth and production growth in Premium Finance, Sheffield, Equipment Finance, and Government Finance. We anticipate strong seasonal growth in Specialized Lending in the second quarter, expecting it to approach mid-teens annualized versus the first quarter of this year. Moving on to Slide 19, Insurance Holdings net income totaled $47 million, up $13 million from last quarter. Noninterest expense totaled $389 million, up $15 million from last quarter, primarily driven by higher incentive expenses, payroll, and defined contribution expense, partially offset by a decrease in salary expenses. The increased noninterest income seen from last quarter primarily reflects seasonal employee benefit commissions. Adjusting for the timing of profit commissions, organic growth was up approximately 1%. Turning to Slide 20, Financial Services produced $91 million in net income, down from last quarter, primarily due to lower investment banking, client derivative, and private equity investment income. Corporate banking reported strong loan growth of 8%, alongside strong loan and deposit growth of 11% and 36% from last quarter. On Slide 21, I’d like to summarize our outlook for the second quarter. We expect loan growth in the range of 1% to 3% annualized compared to the first quarter. We anticipate growth in commercial, specialized, direct retail, and revolving credit. In terms of credit quality, we foresee net charge-offs and NPAs to remain steady in comparison to the first quarter. We expect linked quarter GAAP margin to remain stable and linked quarter core margin to increase by approximately 2 to 4 basis points, driven by the March rate increase. We predict net interest income to rise by 2% to 4% annualized versus last quarter. We expect noninterest income to grow by 6% to 8% compared to the second quarter of last year. Excluding merger-related and restructuring expenses, expenses will remain flat to increase by 2% versus the second quarter of last year. In summary, we exhibited strong earnings performance, excellent credit quality, increasing core and GAAP margins, and effective expense control for the quarter. Now, let me turn it back over to Kelly for closing remarks and the Q&A session.

Thanks, Daryl. To reiterate, we believe it was a great start with solid operating earnings and good expense control, as Daryl described. We have future opportunities to continue to rationalize our expense structure through mergers and in our branches, including potential closures. When you consider all these elements with our focus on our six strategic areas, we are optimistic about our ability to continue improving. The key is consistency in execution, which we are diligently committed to. Now, I will turn it to Alan.

Thank you, Kelly. At this time we'll start the Q&A session. Debbie, could you please explain how our listeners may participate in the session?

Hi, good morning, guys.

Good morning.

The fee income looked good this quarter and the guide for growth for the second quarter, 6% to 8% year-over-year; wondering what you see as some of the drivers of the fee income improvement year-over-year. And then also on the insurance, you had a good quarter. Could you just speak to the economics of that business and whether you are seeing any improvement in pricing and some of the trends there?

Hey, John, this is Chris. Fee income is certainly one of the drivers, and next quarter will be insurance. I'll return to that in a moment. We're expecting investment banking to perform much better. As Daryl mentioned, we had a pullback recently due to several deals that closed last quarter, but we see our pipeline rebuilding. We think that growth could be in the 10% to 12% range, or possibly a bit more. We think the mortgage pipeline is beginning to rebuild with rates down; while that won't be a significant quarter, we anticipate some improvement there. Additionally, trust investment could also see slight growth. Regarding insurance, as Daryl noted, the first quarter is usually seasonally strong due to the employee benefits pickup—we typically see our best performance there in the second quarter. All in all, we see a possibility for increases around 5% or 6% growth in the second quarter, and our underlying trends are very positive. While pricing is still down in the 3% to 4% category, our core organic growth is up 1%. We're outpacing pricing through underlying new business growth, and our core business, internet services across our banking footprint, grew about 11% this quarter. Our California business has also performed well with approximately 15% growth, and wholesale remained relatively flat. All in all, we've had a strong quarter in insurance and are clearly taking market share.

Thanks, Chris, and Daryl, just a follow-up. When you couple that fee income outlook with the expense guide, what are you thinking for the progression of the efficiency ratio as you look at your adjusting number from the first quarter moving into the second quarter and the rest of the year?

John, we consistently aim for positive operating leverage every quarter. For the second quarter, we do expect an uptick in expenses due to seasonality but continue to prioritize technology investments. So, it’s difficult to make exact predictions right now; however, we feel very confident that we will see positive operating leverage and improved efficiency year-over-year, particularly in the latter half of the year.

Good morning, Kelly, and good morning, Daryl.

Good morning, Gerard.

Kelly, I want to follow up on your comment about artificial intelligence and robotics. Where do you think you are in that process? Are we in the first inning or hasn't even started yet? What do you envision over the next two or three years regarding what this could do to your operating expenses by making you more efficient?

So, Gerard, I would say we’re sort of in the first inning. We’ve been testing some areas to ensure we’re comfortable with the whole AI and robotics concept. To give you an example, Daryl conducted a test in his financial reconciliation area where a human took two hours to complete a task. With AI and robotics, we reduced that to just 15 minutes. We’re currently engaging experts in the field to assist us in optimizing our approach over time. I see this as a major development, allowing us to invest in other areas while maintaining control over back-end expenses. That’s why we’re optimistic about our long-term operating leverage; we’ll keep investing in new technologies while simultaneously reducing costs in traditional processes. I'm excited about it. It's a little early to claim victory, but the concept has significant promise.

In light of this, what's your total technology budget? Not just for AI, but overall, when looking at tech spending this year, what numbers are you looking at?

Gerard, this is Chris. Of our $11 billion in revenue, our CapEx is probably around the 4% to 5% range, so roughly four to $500 million. The grand majority of it would likely go toward technology spending, including compliance costs; however, we are attempting to pivot more towards discretionary digital and client service efforts. It will inevitably require some time to make this shift, with a significant fraction of that investment directed at digital initiatives.

Great. As a second question, Daryl, on the LCR, I think you said you’re around 124%. If regulations change and you’re not held to the same LCR ratio as other banks, what's a more comfortable number that you would target if mandated?

I think we have some flexibility to bring it down about 20% to 25%, give or take. It definitely adds value, but it lowers profitability returns. It’s not the most efficient use of the balance sheet. So, we can bring it down while continuing to optimize our portfolio.

Great, thank you, guys.

Hi. I was wondering if you could elaborate on the expense side. The expenses were lower than we anticipated this quarter. Your statements around expense management seem quite positive. However, the outlook for the second quarter appears a bit higher than anticipated. Can you help square those expenses with what you did for this quarter, especially regarding the guidance for sub-$1.7 billion on average for the year?

Matt, obviously, there are many moving parts. In the second quarter, we will see seasonal rate increases, along with salary increases. We are still investing substantially to rectify our BSA AML issues and improve our platform, which has made significant progress but will take time to complete. Consequently, expenses are likely to rise through the second quarter, before plateauing and starting to decline. By year-end, we should see expenditures lower, with a noticeable increase in the second quarter due to seasonal factors, ongoing technology investments, and BSA-related costs which will trend upward relative to the first quarter.

Once we navigate through the peak expenses Kelly mentioned over the next quarter or so, we will get closer to $1.7 billion or perhaps a bit lower.

Thank you. Regarding your comments on regional acceptance corporations, you noted an 8.9% net charge-off for this quarter and your revised underwriting standards. Have you seen a considerable improvement in credit losses and charge-offs since these changes? Or is credit stress still prevalent in lower FICO scores?

Hi Kevin, this is Clarke. We have seen improvements, particularly in our 30 to 60 and 60 to 90 day metrics, which encourages us regarding the stabilization of losses. While our actual losses this quarter were 8.6% compared to 7.33% last year, we believe there’s a high probability of maintaining similar levels for 2017. In the larger industry we see increased severity trends; many subprime lenders are financing smaller car models. While overall vehicle demand has remained stable, the small car segment is facing significant pressure. Given that, during the third quarter of 2015, we implemented underwriting changes that has proven beneficial in mitigating some of these challenges, and I believe we’re doing better than a lot of competitors.

In your view, are we going to notice an improvement in residual values this year or may that take place next year given the stresses we have seen in used car prices?

Great question. There's still a risk of further deterioration. Yet, we observed some firming in the small car segment as we approached March even as the overall index remained flat. Overall, we are optimistic that we might have seen the worst in the recent downturn; our underwriting modifications should help counteract any minor drops in the future.

Good morning. Thanks for taking my question. Kelly and Daryl, could you drill down a bit into your comments regarding increasing efficiency within the Community Bank? You had a nice improvement this quarter, but what specific measures are you implementing to lower the efficiency ratio going forward?

Let me give a general response, Matt, and I will let Chris provide more detailed information. We have been working for several years on rationalizing our cost structure within the Community Bank. The most notable example is reducing the number of tellers and platform staff, as our transaction volumes have been decreasing by about 4% annually for some time. We are closely monitoring those declines in transaction activity and adjusting our workforce correspondingly. We are also accelerating our focus on consolidating and closing branches; we closed approximately 40 branches last year and plan to close around 100 this year. We don't anticipate branches will vanish entirely, but we adapt to changing transaction dynamics with expanded digital capabilities for clients. I will allow Chris to elaborate further.

Yes, Kelly is absolutely correct. We’ve minimized teller staff and merged roles into what we refer to as branch bankers. This has created efficiencies within branches. Additionally, we have recently seen strong momentum in commercial and retail loan production—our best quarters ever regarding revenue production, with commercial loan production up 22% year-over-year and retail up 25%. We are observing the recovery of Main Street, reflecting the health of our core client base as they experience substantial financial activity. Our operating margin for the Community Bank and related efficiency initiatives are expected to yield further improvements. Our goal for branch optimization is to reduce our footprint, enabling further focus on our growing digital platforms. Out of our retail clients, around 60% engage actively with digital services, while 50% of our business clients utilize digital technology. We’re excited to capitalize on these trends; currently, about 30% of our transactions occur through digital channels, solidifying our branch optimization efforts.

For my follow-up, could you provide additional context on your comments about accelerating corporate banking loan growth? You mentioned tweaking exposure sizes—are there specific industries that you plan to target within the corporate banking platform?

Sure, Matt. We have built out several industry verticals over the last several years, equipped with experienced corporate bankers, which will be our focal areas for growth. We're diversifying across industries but remain steadfast in our commitment to ensuring we have expertise within specific sectors. Compared to our peers, we’re including more granular syndications while keeping our average commitments marginally lower overall. This will allow us to strategically grow our exposures while enhancing our relationship management capability.

In addition to increasing corporate exposures, we'll solidify our overall growth strategy moving forward.

Good morning.

Good morning.

I wanted to ask you about the capital payout ratio. You mentioned it would be above 100% as you look into next year. I think the ratio was 100%, 106% this quarter; would that be in conjunction with merger-related costs and adjustments moving forward?

Yes Marty, we don’t foresee many more merger-related costs impacting our future efforts. There may be minor restructuring costs related to potential branch closures; however, it won’t be a meaningful number going forward. Achieving a total payout ratio exceeding 100% will be based on our GAAP net income, but we don’t expect significant fluctuations in that regard.

Understood. Given your liquidity coverage ratio of 124%, even if unchanged, you have capacity to deploy that liquidity. Considering your optimizing portfolio’s sizeable influence on the overall portfolio, is it beneficial to keep a tight lens on funding for growth within mortgage, even as rates may rise?

You are correct in emphasizing our liquidity positions. However, our objective is not solely to maintain optimized portfolios in residential mortgages that have low returns. It is more beneficial to channel our focus toward core portfolios while allowing optimization portions to run down gradually. Moreover, as our core portfolios grow, we gain effective leverage that balances liquidity management.

As we continue to enhance company profitability, our balance sheet growth may not be as significant, allowing us to focus on reallocating to higher yielding assets moving forward.

Hi everyone, this is Amanda Larsen on for Ken.

Good morning.

Are you at the point where you’d consider expanding security balances, or do you anticipate remaining cash-heavy with hopes for better loan growth in 2H?

Amanda, we are comfortable with our current security balances, which are approximately 20% of our total balance sheet. Regarding LCR changes, should regulators adjust our requirements, we may consider realigning. As for increasing security holdings, those typically yield lower returns, which isn't ideal long-term, although we need enough liquidity on the books.

Overall, the current market conditions may not be ideal for security purchases right now.

Your deposit trends have been quite low; can you speak about how industry deposit pricing measures against your expectations and your willingness to become more competitive given opportunities observed on the asset side?

We've found that the industry, ourselves included, has underestimated deposit data, as it has risen much slower than anticipated. With our last two increases, we projected deposit data to grow between 40% and 60%. However, we believe the data remains muted on the retail side. We're being competitive, particularly with corporate clients; the retail segment, however, is progressing more slow compared to our forecasts.

Great, thank you very much.

Hi, thanks for taking my question, good morning. First question is broader in scope, Kelly. You've been consistent in expressing optimism about policy reforms and improving economic outlook with your clients—concerning loan growth or broader economic growth. However, until now, there's been a disconnect between positive sentiment indicators and core data—whether it’s around loan growth or concerning weak economic data overall. Is there a risk we could see optimism start to fade if tangible policy changes don’t occur and political dysfunction arises? At what point do you start worrying about your clients' optimism turning into skepticism?

Indeed, that’s a pivotal question for us all right now. In terms of why there's not yet been a correspondence between optimism and solid data—timing plays a factor. It often requires 90 days or so to see investments, projects, and consumer behavior adapt to the increasing sentiment. Nonetheless, we are beginning to witness tangible growth with clients expressing intention about expansions and loan requests reaching levels we haven’t seen in eight years. As for policy changes, if we don't see significant progress in Washington, that optimism may turn negative, which could impact consumer spending and yield slower economic growth. That said, the resiliency observed in the market indicates there is a real need for businesses to invest in improvements—companies using dated technology and equipment inevitably leads to replacement demand beyond their frugality. After a prolonged period of cautious spending, the desire to invest and grow is revitalized. While I don't foresee immediate risks affecting optimism, significant inaction in Washington this year could dampen sentiments by year-end.

That's helpful. Have you observed any increases in utilization rates thus far?

Not fundamentally. However, we’ve seen the growth in our loan pipelines, which offers us hope regarding increased activity; so our production metrics are strong and contributing to an anticipated loan growth of about 4% to 5% in our core portfolio during the second quarter. This suggests that we are on track to convert this optimism into tangible value.

Good morning.

Good morning John.

Given the size of the optimization portfolios, can you elaborate on your expectations for loan growth trends in 2018? If we do see favorable macro conditions and positive policy changes, would there still be an optimization portfolio at that point, or would you expect overall loan growth to rise to high single digits instead of mid-single digits?

I believe we can expect the portfolios to contribute positively if the economic conditions and operational environments remain stable. As the demand from our optimization portfolios diminishes, the expansion of core portfolios will occur naturally, leading to sustained growth, and consequently all of this points to enhanced revenue abilities through innovation if market factors are favorable. That would allow 2018 to bring stronger growth rates as we progressively shift from an optimizing focus to one where we can concentrate on core operations and elevate growth towards higher digits.

For certain, we can try to achieve growth percentages anywhere from 5% to 6%, and with the right outlook of 6% to 8% as the market recovers down the line.

Thank you. Can you elaborate on the bank's overall exposure to the retail industry? I believe I missed any comments regarding our exposure in the CRE book and your C&I portfolio.

Sure, John. We consider our CRE exposure to be about $4.1 billion, with nearly 70% of that related to neighborhood grocery-anchored centers, ensuring we face reduced risk. Approximately $600 million outstanding is through REITs, where 80% of that is comprised of investment-grade holdings. Additionally, we have roughly $1.3 billion in direct retail exposure, with around 30% to 40% classified as investment-grade. While we’re aware of industry pressures and evolving ecommerce attributes affecting retail, we currently find performance manageable and maintaining strong asset quality.

Great, thank you.

Good morning, everyone; thank you for taking my questions. Kelly, you discussed optimism regarding the economy. However, North Carolina has faced its own unique challenges over recent years. Have you noticed any disruptions in business activities there given these circumstances, and have those issues impacted your overall performance?

There has been significant discussion about it, but the actual optimism within North Carolina remains very strong across the business community. We continue to observe strength in the economy and expect positive developments going forward. While past concerns did pose some effects, the positive momentum from businesses far outweighs those issues, and we are optimistic about future growth.

As a follow-up, regarding the segmentation of your loan portfolio into these categories: was this a new classification, or has this been a process you've been pursuing, and has the optimizing portfolio designation been around for some time?

We have just named those categories, Nancy. In reality, it’s been a strategy in place for some time, and we thought a clearer classification process would help drive understanding of our objectives while supporting broader strategies for loan production and improving bottom-line performance.

Thank you.

Thanks, Nancy.

Thank you, good morning. I wanted to get more clarity around the anticipated resolution of your BSA/AML concerns, along with your views on potential M&A activity and whether those restrictions might be lifted.

Regarding BSA/AML, we have been making excellent progress. Although it has only recently gained public attention, we've been addressing these matters for about a year and a half. We're close to achieving first-class BSA/AML standards, and while we still need to satisfy regulators, we expect to streamline through this process relatively quickly. We don't see substantial threats within the solvency space, which have been disproportionate issues related to operational processes. With a seasoned BSA officer on our team, we're confident we can exit these constraints in the near future. On the M&A front, while traditional commercial bank acquisitions might be limited for now, we’re exploring opportunities across technology and insurance sectors in addition to maintaining our existing growth focus. I anticipate that as market conditions improve, there will be consolidation trends in the industry as we scale and strengthen our capabilities.

Thanks a lot.

Okay, thank you, Debbie, and thanks to everyone for joining us today. We still have a few questions in the queue, which we'll follow up on later this morning. Please feel free to reach out to our Investor Relations team as needed. This concludes our call, and we wish you a great day.