Truist Financial Corporation (TFC) — Q2 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 second quarter 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 our presentation includes certain non-GAAP disclosures. You may refer to Page 2 and the appendix of the presentation for the appropriate reconciliations to GAAP results. And now, I will turn it over to Kelly.

Thanks, Alan, and good morning, everybody. Thanks for joining our call. We appreciate it. So we had a strong second quarter: record earnings, record revenues, good expense control, and the best returns in almost three years. So looking at some of the highlights, our record net income is $631 million, up 16.6% versus the second quarter of 2016. Diluted EPS was $0.77, but when you adjust for certain charges, it’s $0.78, up 9.9% versus the coming quarter. Our returns were strong: ROA, ROA common equity, and return on tangible common were 1.22%, 9.30%, and 15.6% respectively. Record taxable equivalent revenues totaled $2.9 million, up 3.9% versus the second quarter and also up 10.7% annualized versus the first quarter. Our net interest margin on GAAP increased 1 basis point to 3.47% versus the first quarter. Our core net interest margin increased 3 basis points to 3.31% versus the first quarter. We had a nice increase in our fee income ratio, increasing from 42.1% to 42.7%, as a function of continuing to leverage our fee income businesses into the new acquisitions in Pennsylvania and other new markets. Our GAAP efficiency ratio was 61%, but when adjusted, as we normally do, our efficiency ratio was 58.6% versus 58%, up a tick. I would point out that we’ve been talking about for the last two or three years about these major projects we’ve been working on. These major projects are wrapping up, and we expect expenses will not only peak but slowly decline. I’ll point out specifically that most of the BSA/AML work has been completed. We’re in the 98-plus percentile with that, and there will be some time needed to mature, especially regarding exiting from the consent order. But you can expect our BSA expense levels to begin to decline as we head into the third and fourth quarter. Credit quality is fantastic and shows significant improvement across the board. NPAs, performing TDRs, and net charge-offs all declined versus last quarter. We are clearly at pristine credit quality at the company. Importantly, in terms of our CCAR application, as you saw, it was approved. That includes a 10% increase in the quarterly dividend to $0.33, which we expect the board to approve next week. We also approved up to $1.88 billion in share repurchases and indicated we would repurchase $920 million in the third quarter. Even so, our common equity Tier 1 ratio remains strong at 10.3%. I will point out on Page 4 the one special item, a $10 million, $0.01 impact pertaining to merger and restructuring charges. Looking at Page 5 in your slide deck, we believe we did a good job meeting or exceeding guidance. Specifically on loans, we were on the high side of our total loan range at 1% to 3%, and our core guidance was 5% to 7%. We beat that at 7.5%. Credit quality remained low, and NPAs declined. Our net interest income was above the stated range of 3% to 4%, landing at 6.3%. We’ve had relatively aggressive guidance, and we clearly met or exceeded those benchmarks. Turning to Page 6, I’ll provide insight on the loan area. This is an excellent execution of complex profit-improving loan strategies. Total loan performance was up 3%, which is solid in today’s industry. However, core non-seasonal loans, such as C&I, were up 6.1%, while combined CRE and construction development showed a robust 7% growth. We had strong performance overall, particularly in specialized lending areas. Our Community Bank experienced the best quarterly commercial production in its history. Main Street is optimistic, which I will elaborate on shortly. There are several key portfolios within our loan growth strategy. In our longer-term strategy, we focus on growing more profitable loans with a better risk profile without rushing growth. We are optimizing the portfolios to stabilize them at levels reflecting current profit projections. We aim to ensure solid growth in core loans, and we anticipate growth to be within 5% to 7% during the third quarter. Observations show that Main Street is rebounding and optimism is improving, driven by increased activity and confidence among small- and medium-sized businesses. This rebound is translating into better production and closings within our Community Bank. Our confidence is high. Over the past few months, I have visited 23 out of our 26 regions, and each region has reported increased confidence and activity among their local businesses, resulting in an upward trend in loan growth. We observe that larger businesses were previously thriving, while smaller businesses struggled but are now turning around. Positive movement in tax reform will further support GDP improvements, and overall sentiment indicates stability and continued progress for our company and for the industry as a whole.

Yes, thank you, Kelly, and good morning, everyone. Today, I’m going to discuss credit quality, net interest margin, fee income, noninterest expenses, capital, segment results, and guidance for the third quarter. Starting with Slide 9, we had a strong quarter in credit quality, showing improvement overall. Net charge-offs totaled $132 million or 37 basis points, which is a decrease from 42 basis points last quarter. Loans 90 days or more past due and still accruing decreased by 9%. Loans 30 to 89 days past due increased by $69 million or 8.6%, primarily due to expected seasonality in our consumer-related portfolios. NPAs were down 13.9% from last quarter, primarily due to a decline in nonperforming C&I and the residential mortgage loan sale. For the third quarter, we expect charge-offs to remain in a range of 35 to 45 basis points, assuming no unexpected deterioration in the economy. Given that NPAs are close to historical lows, we expect them to remain stable. Moving to Slide 10, our allowance coverage ratios remain solid at 2.8 times for net charge-offs and 2.43 times for NPLs. The allowance-to-loan ratio was at 1.03%, down slightly from last quarter. Excluding acquired portfolios, the allowance-to-loan ratio was 1.12%. Our effective allowance coverage remains strong. We received a provision of $135 million compared to net charge-offs of $132 million. Moving on to Slide 11, compared to last quarter, our net interest margin was at 3.47%, which is a 1 basis point increase. The core margin was at 3.31%, up 3 basis points from the last quarter. Both GAAP margin and core margin benefited from short-term rate increases, partially offset by funding rate increases. Given that we do not expect further rate increases this year, GAAP margin is anticipated to decline by 1 to 3 basis points next quarter, while core margin is expected to remain stable. In regard to Slide 12, our fee income improved to 42.7%, which we attribute to positive results from the acquisitions we made and our team's success in implementing BB&T's sales culture. Noninterest income totaled $1.2 billion, which is up by $49 million compared to last quarter. Our growth in fee income included an increase of $23 million in insurance income, largely driven by seasonality in P&C commissions. Looking ahead to the third quarter, we expect fee income to increase by 1% to 3% compared to the same period last year, keeping in mind that our insurance will seasonally be lower in the third quarter. On slide 13, our adjusted efficiency came in at 58.6%, which is down 1% from the same period last year. We are committed to improving our top-tier efficiency while also making prudent investments to generate additional revenue. Adjusted noninterest expenses totaled $1.7 billion, up by $58 million from last quarter’s adjusted expense number. Personnel expenses increased by $31 million, primarily due to performance-based incentives and merit increases. Merger-related and restructuring charges decreased by $26 million, largely due to prior quarter's write-off of software and write-down of real estate. Professional services expenses increased by $16 million, offset by a $10 million decrease in outside IT expenses, both related to BSA/AML efforts. Other expenses increased by $16 million, mainly due to operating charge-offs, charitable donations, and employee travel. Our FDIC costs are up minimally from last year due to improved performance, which is offset by an increase in the FDIC surcharge. Moving forward, expenses are expected to remain stable or increase by 2% compared to the third quarter of last year, excluding merger-related and restructuring charges. We believe expenses will remain well below $1.7 billion. We expect the effective tax rate for the third quarter to be approximately 31%. On Slide 14, our capital and liquidity remain strong. We are pleased to have received non-objection to our capital plan. Next week, we will seek board approval to increase our quarterly dividend to $0.33 per share. We have received approval to repurchase $1.88 billion over the next four quarters, and our capital plan calls for repurchasing $920 million in the third quarter. Our common equity Tier 1 stands at 10.2%, and our liquidity coverage ratio is 122%, with a robust liquid asset buffer at 13%. Now let’s take a look at segment results on Slide 15. Community Bank net income totaled $345 million, an increase of $5 million from last quarter and up $43 million from the second quarter of last year. Net interest income increased by $32 million from the first quarter and $99 million from the second quarter of 2016. This was the best quarter for commercial production we’ve seen, growing 25% year-over-year. This signifies the increased activity we’re witnessing on Main Street and highlights our excellent bankers’ effort in building strong relationships. Moving to Slide 16, Residential Mortgage net income was $46 million, down from last quarter. Noninterest expenses increased by $4 million, driven by elevated regional production costs. The production mix was composed of 68% purchase and 32% refinance, with a gain on sale margin of 1.61%, up from 1.01% last quarter. Discussing Slide 17, Dealer Financial Services net income totaled $38 million, a $9 million increase from last quarter, mostly attributed to a decrease in the provision for credit losses due to lower net charge-offs in prime auto and Regional Acceptance. As anticipated, net charge-offs in Regional Acceptance fell to 6.5% this quarter. Our risk-adjusted yield remains strong at 10%, while Regional Acceptance 30 to 89 days past due stood at 6.6%, up from last quarter, largely due to seasonality. Moving to Slide 18, Specialized Lending net income amounted to $54 million, increasing by $3 million from the previous quarter, driven primarily by a lower provision for losses. We experienced strong year-over-year production growth in premium finance and government finance. Looking at Slide 19, Insurance Holdings net income was $55 million, an increase of $9 million from the previous quarter. Noninterest income from the second quarter of last year reflects the timing of wholesale commission payments. Adjusting for the timing of these commissions, organic growth was approximately 1%. Noninterest expenses totaled $396 million, an increase of $7 million from last quarter, largely influenced by elevated personnel costs. Looking ahead to the third quarter, we anticipate insurance income will generally yield the lowest revenue quarter of the year. Finishing with Slide 20, Financial Services generated $115 million in net income, up $23 million from the previous quarter. This improvement primarily derives from higher investment banking and brokerage fees, improved funding spreads on deposits, and a surge in loan volume. Corporate Banking achieved strong loan growth of 9.1%, while Wealth recorded impressive growth of 18.2% from last quarter. Finally, on Slide 21, I want to summarize our outlook for the third quarter. We expect loan growth to be in the 1% to 3% annualized range compared to the second quarter. We anticipate faster core loan growth at 5% to 7% annualized. Our credit quality guidance is in line with last quarter expectations. We forecast net charge-offs to be in the 35 to 45 basis point range and NPAs to remain relatively stable compared to the second quarter. We predict GAAP margin to decline by 1 to 3 basis points while the linked quarter core margin remains flat compared to the last quarter. Net interest income should also remain stable, similar to last quarter. Noninterest income is expected to rise by 1% to 3% versus the third quarter of last year. Excluding merger and restructuring charges, expenses will be stable to slightly higher, but below $1.7 billion compared to the third quarter of last year. Restructuring charges will include those related to real estate as we optimize our branch network. In summary, we had stronger earnings performance, good revenue growth, excellent credit quality, increasing core and GAAP margins, and appropriate expense control for the quarter.

Thanks, Daryl. To summarize my thoughts, I believe we had a solid quarter characterized by record earning and revenues, good expense control, and significantly improved returns. We are executing excellently on our key revenue strategies. Our loan portfolios show marked improvement, notably in Specialized Lending performance, and our insurance business is thriving. We are energized about implementing new systems and processes utilizing AI and robotics. We are laser-focused on managing expenses. Main Street is revitalized, and we believe that our best days lie ahead.

Okay. Thank you, Kelly. Operator, at this time, if you could come back on the line and explain how our listeners may participate in the Q&A session.

I was hoping to follow up on the outlook for the stable NIM on a GAAP basis. Specifically, why aren’t we expecting or why shouldn’t we expect some increase in the NIM, given the Fed hike in June and some of the optimization that you’re doing both on the loan portfolio and deposit side?

Currently, Matt, we’re forecasting our beta and deposits to be in the 20s from the June rate increase, and there’s an opportunity that we might perform better than that. We have some contractual deposits and borrowings that will be priced higher, which is negating some of the core and GAAP margin at this time. In terms of purchase accounting, it’s somewhat predictable; it could be down 2 to 4 basis points. We’re just aiming to provide an estimate that we can confidently deliver.

Okay. And just a quick clarification on the expenses. What’s the expense base that you’re using from 3Q 2016 when you’re saying flat to up 2%?

If you look at the third quarter of 2016, excluding merger-related costs, it stands at $1,668,000,000, which I have as core expenses for the third quarter of 2016. We believe, as Kelly indicated, our focus on expenses will keep us well below $1.7 billion for this year's third quarter.

Okay. Thank you. That’s helpful.

Yes.

Hey, good morning.

Good morning.

Just to continue the conversation, could you provide some context regarding the core run rate you’re targeting for the quarter you just completed? When you say well below $1.7 billion, is that primarily driven by the AML/BSA costs that you referenced in your remarks earlier, Kelly?

I think it’s related to the peaks and finalizations of the BSA/AML processes, but also includes ongoing projects. Clip is a significant commercial loan project we have been focused on for the last two years, which was converted in early July. Its completion will reduce overall expenses. In addition, we’ll be more aggressive regarding branch closings. We’ll be at over 130 branch closings this year as we've identified several branches that are overlapping or closely situated to others that we can reasonably close without losing material business or sacrificing service quality.

Additionally, Betsy, you should expect decreases in personnel, occupancy, IT, and professional costs to be our focus over the next couple of quarters.

Okay. And so based on the outlook you have for 3Q, you triangulated to achieve positive operating leverage for us on a year-over-year basis. Is that likely to hold true on a quarter-over-quarter basis as well, or do you think it will seem more flattish?

I believe we have a hopeful chance of achieving that quarter-over-quarter, but definitely on a year-over-year basis. We didn’t quite make it this past quarter, but we gave it our best effort. I think we are well positioned for the upcoming quarter.

Okay. Great, thank you.

Hey guys, thanks for taking my questions. I have a question regarding the portfolio optimization initiatives, specifically what’s driving that? Are there concerns regarding any form of credit issues moving forward? Are there other areas you might look to optimize in the upcoming quarters?

Michael, let me provide some insight first, and then I’ll have Clarke elaborate. This is a significant focus for us; there are absolutely no credit issues. Our current portfolio is in excellent condition. However, we have these two portfolios, approximately $30 billion in mortgages and about $10 billion in auto, that aren't producing optimal performance. In this rising interest rate environment, it’s not wise to continue rapid growth in the mortgage fixed-rate portfolio, which many understand. Additionally, we’re altering the nature of our revenue-sharing arrangements with dealerships in our auto portfolio to be more consumer-friendly. This transition has caused some reduction in loan growth, but we are re-pricing these assets to acceptable levels. As we continue these adjustments, profitability will stabilize, resulting in a better balance on growth and returns. Therefore, while we are temporarily slowing down in these areas, we expect improvements moving forward.

Absolutely. Michael, we will also be keeping a close eye on regulatory conditions and how they impact both sectors we discussed.

Thank you both, that's helpful. Moving on to a different topic, could you provide some general commentary on the insurance business, particularly the life sector, and what expectations you have for it moving forward?

Certainly, Michael. In prior discussions, we've mentioned that pricing rates had decreased about 4%. Currently, we're witnessing stabilization with a potential for growth. Instead of seeing a 4% decline, we expect to be down around 2.5% to 3%. This shift enables us to gradually elevate our core growth closer to more desirable levels. Our current year-to-date growth in new business stands at 2.2%, with a significant uptick of 8% during the latest quarter. This reflects positive momentum, which will help offset the pricing decline. We’re also implementing various optimizing efforts, including restructured initiatives in our employee benefits segment, with robust synergies from the Swett & Crawford conversion completed in February. Therefore, we expect improved margin growth from 2016 to 2018, aiming for a 2% to 3% increase. We anticipate being in the mid-23% range by the end of 2018. Overall, our core businesses, including BB&T Insurance Services, McGriff on retail, and CRC on wholesale, are performing as expected or showing slight improvements. There is generally positive momentum compared to two quarters ago.

I appreciate the detailed insight. Thanks for handling my questions.

Hi, good morning. I'm interested in your thoughts on capital optimization concerning payout sustainability. Your recent CCAR outcomes have allowed for a robust increase in shareholder payouts. With your CET1 ratio above 10%, given your size and risk profile, it seems relatively high. What levels do you envisage in the long term?

Currently, with actions taken in the third quarter, our CET1 ratio could decline by about 30 basis points, leaving us around a 10% CET1. As we proceed with share repurchases, we might dip below 10% but not significantly, possibly to 9.5%. The outlook will depend on regulatory conditions; if they allow for a decrease in ratios, we would adjust accordingly. However, as it stands, we believe maintaining at least a 10% CET1 ratio supports our return on equity over our cost of capital.

Understood, Daryl. One final question about the bank card fees and the recent jump. You noted a reduction in accrual for rewards; is this something that will consistently affect your run rate for that revenue line going forward?

That was likely a one-off effect, probably around $5 million to $6 million. Some of our commercial card clients did not utilize all of their rewards, resulting in an adjustment.

Got it. Thank you. Lastly, could you elaborate on credit quality conditions in the auto sector, and what you’re observing in the prime versus sub-prime markets?

Certainly, John. Currently, our total retail auto portfolio stands at about $13 billion. Approximately $3.9 billion is allocated to sub-prime lending in Regional Acceptance, while the remaining $9 billion constitutes prime loans. The quality and performance of the prime portfolio is exceptional, with very minimal year-over-year losses, indicating no deterioration. Our conservative lending practices have protected it. As for Regional Acceptance, we've seen recent improvements, and we anticipate charge-offs around 8% for the year, which is not considerably higher than last year. We believe improvements in underwriting processes implemented over the last couple of years will continue to have a positive impact.

Thank you both for the insights.

Hi, good morning.

Good morning.

I wanted to clarify your comments regarding expenses peaking. As we look beyond this year into 2018, are you referring to specific areas linked to compliance and BSA, or are you saying expenses are peaking for the broader organization?

I'm indicating that expenses are peaking for the organization as a whole, driven by two factors. The projects Daryl mentioned are moving toward completion status, including our general ledger, commercial loan system, data center, and implementation of BSA. The second part involves rationalizing our branch network’s cost structure amid improving regulatory conditions, allowing us to review operations and eliminate unnecessary expenditures. Overall, we're looking to run the bank more efficiently than we've done in recent years.

Thank you for that clarification. Another question revolves around the potential impact of the Fed's balance sheet reduction on your deposit growth and betas. Given your focus on Main Street, might it be expected that your wholesale or non-retail deposits could be less sensitive in this scenario?

Absolutely. The Fed's balance sheet restructuring does not affect Main Street banking operations or BB&T directly.

Good morning.

Good morning.

Regarding loan growth, your previous comments highlight improved trends and demand. While you've indicated a range of 1% to 3%, why not guide higher given the positive outlook?

We’re generally conservative with our guidance to avoid overshooting expectations. Recent insights suggest that our guidance may be on the conservative side; we’re likely to achieve closer to 3%. Yet, we opt to maintain cautious estimates to avoid scrutiny if targets are not met.

Thanks, Kelly. Before I go, regarding expenses tied to the BSA/AML, could you help us quantify the current run rate and provide any estimates on when you might mitigate the consent order?

To provide some perspective, we’ve spent around $80 million this year on developing our BSA/AML program, and we’re nearing completion. I estimate that about $50 million to $60 million of this expenditure will persist for ongoing operations, while the rest will decline as we finalize compliance projects. I foresee expense reductions becoming evident over the next 4 to 5 quarters, paving the way for a new standard.

Thanks for the insights.

Thanks. I have a couple of questions about deposits and the recent decline. You've mentioned retail and commercial deposits are growing, yet public funds seem to be the driver behind the overall decline. Is this connected to liquidity requirements affecting how those deposits are managed?

When analyzing public deposits, we’re rationalizing our funding dynamically, as we’re focusing on clients that make sense for our funding model. It’s essential to recognize that while we may lose some public funds, our core retail and commercial clients are stable and growing well. The reduction is simply a strategic decision rather than a concern over losing significant business.

Marty, think of public funds largely as substitutes for short-term non-core funding. We manage these resources dynamically, allowing for healthier core funding overall, which is a positive story, not a negative one.

When looking at your planned share repurchases, do you envision stock price continually rising throughout the year, or is there specific reasoning driving this accelerated approach?

The decision is based on our current excess capital. We see no immediate need for it, and thus, returning it to shareholders swiftly is beneficial. Although I don’t have the foresight to predict stock price movements, I’m comfortable with moving capital back to shareholders in a timely manner.

Regarding your AML/BSA expenditures, with such significant investment made, is there an opportunity for better productivity beyond mere compliance to gain value?

Marty, we are adhering strictly to regulatory requirements, but yes, we will derive benefits – for instance, we’ve created comprehensive screening processes in commercial lending through this investment which provides added value.

Certainly. The systems established provide improved measures for identifying fraudulent transactions, increasing value derived from our compliance work.

Thank you. Good morning, guys.

Good morning.

Regarding the Treasury's proposals on regulatory changes released a month ago, can you highlight the aspects that would most positively impact BB&T?

The proposals laid out by Secretary Mnuchin form a well-thought-out plan that I believe will be beneficial. The main emphasis is on allowing banks to operate without micromanagement from regulators, which proves advantageous not just for us but the entire banking system. With less pressure from regulations, banks can operate more efficiently, enhancing overall lending to stimulate economic growth. Additionally, he recognized the convoluted mortgage lending process that has complicated housing growth, which also requires rectification. By simplifying this pathway, we can promote healthier lending practices essential for recuperating the economy.

Kelly, could you compare the current credit quality to previous cycles such as the late 70s or the 1990s banking issues? Where do you stand today?

I would categorize the present loan portfolio and overall banking system as very stable. It does not resemble cycles characterized by commercial real estate booms or the mortgage crisis of 2007 and 2008. There are minor concerns that are being addressed in relevant sectors, but overall, this cycle presents a healthier financial environment. The banking system is well-positioned, unlike the previous downturns we experienced.

Thank you for your insights, Kelly.

Kelly, with the passing of time and gaining clarity on your cost management strategies, how does this influence your M&A perspective? Do you see opportunities for greater cost efficiencies?

With regards to M&A, the ability to operate more efficiently certainly makes acquisitions more appealing, especially if we can bring less efficient firms onto a stronger platform. This will enhance the economic viability of the deal. However, scale is also defining in M&A dynamics. We see banks engaging in mergers largely to gain scale. We’re currently in a pause phase regarding M&A, not ready to release yet, but I can say we’ll be looking for opportunities, focusing on mergers within current markets, while out-of-market opportunities will need a more careful consideration for perhaps differing reasons than before.

Thank you for the informative background.

Okay. Thank you, Debbie, and thanks to everyone for joining us today. If you have further questions, please don’t hesitate to contact Investor Relations. This concludes our call. We hope you have a good day.