Truist Financial Corporation (TFC) — Q1 2018 Earnings Call Transcript

Thank you 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 and provide some thoughts for next quarter and for the full year. We also have Chris Henson, our President and Chief Operating Officer, and Clarke Starnes, our Chief Risk Officer. We will be referencing a slide presentation during today’s comments. A copy of the presentation as well as our earnings release and supplemental financial information are available on the BB&T’s 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. Please refer to Page 2 and the appendix of the presentation for the appropriate reconciliations to GAAP. At this time, I will turn it over to Kelly.

Thanks, Alan. Good morning, everyone, and thank you for joining our call. We had a strong quarter, achieving record earnings and returns, excellent expense management, continued solid asset quality, and robust commercial loan growth when excluding mortgage warehouse lending. Net income available to common shareholders reached a record $745 million, reflecting a 97% increase from the first quarter, with adjusted net income at a record $767 million. Our diluted EPS was also a record at $0.94, a 104% rise compared to the first quarter, and when accounting for merger costs and debt extinguishment losses from the first quarter, it was $0.97, an increase of 31%. On a comparable basis, excluding mergers and debt extinguishments, we still see a 5% rise compared to the first quarter, which is impressive in a 2% environment. Our adjusted return on assets was 1.49, return on common equity was 11.75, and tangible common equity was 19.89, all reflecting very strong returns. Importantly, we achieved positive operating leverage on a debt basis compared to both the fourth and first quarters. Taxable equivalent revenues were $2.8 billion, up 0.6% from the first quarter. The net interest margin rose by 1 basis point to 3.44, and our core margin increased by 4 basis points, both exceeding our expectations. Our fee income ratio stood at 41.9, while our adjusted efficiency ratio was slightly up at 57.3 compared to 57.2. However, if adjusted for the system outage, the efficiency ratio would have shown improvement. Our adjusted non-interest expense was $1.68 billion, a decrease of 9.3% annualized versus the fourth quarter and a 1% decline versus the first quarter. We are focused on controlling expenses, even as we invest in future initiatives such as risk management, infrastructure transformation, digital product development, platform enhancements, and marketing. Chris will provide more details on these investments shortly. Our credit quality remained strong, with non-performing assets up slightly but still showing improvement compared to a year ago. We experienced seasonally higher charge-offs at 41 basis points compared to 36 in the fourth quarter, but on a year-over-year basis, it’s relatively stable. We recently announced the acquisition of Regions Insurance Group, which we are excited about as it enhances our cultural footprint and expands our market presence into Texas, Louisiana, and Indiana. Additionally, we increased our common dividend by 13.6%. On Page 4 of the presentation, you'll note we incurred $28 million in merger and restructuring charges pretax, translating to about $0.03 per share after tax. Daryl will provide insights regarding the outage and its impacts. Moving to Page 5, we aim to grow our sales as per our guidance; average loans were expected to increase by 1% to 3% but came in at 0.6%. Although it was slightly below expectations, when excluding mortgage warehouse lending, it adjusted to 1.8%, aligning with our guidance. Our credit quality metrics were stable at 41 basis points. The net interest margin improved under GAAP and core measures. Non-interest income slightly fell short of expectations, reporting at 0.8%, but if we exclude the estimated effects of the system outage, we would have seen an increase of 2%, aligning again with guidance. Expense management has been strong, showing a downward trend compared to the flat expenses we anticipated. On Page 6 regarding loan growth, we witnessed robust core commercial loan growth. Total loan growth was 0.6%, but excluding mortgage warehouse lending, it was 1.8%. Core commercial loan growth reached 5.2% after excluding the mortgage warehouse, with significant growth across various sectors. Commercial real estate increased by 7.7%, revolving credit by 5.7%, and commercial leasing by 4.6%. We are optimistic about the ongoing performance of these areas. We previously indicated an expected turnaround in mortgage activity, and we are seeing that now, along with a predicted mid-year turnaround in indirect lending. As for market sentiment, our interactions with business owners have revealed a positive outlook despite discussions coming from Washington. Our pipelines across all sectors are at record highs, leading us to anticipate improved loan growth moving forward as economic conditions appear favorable. While our non-interest-bearing deposits decreased by 6.7% due to seasonal adjustments, it was more than expected. Clients are showing increased cash usage, a trend we've highlighted, which is encouraging. We're observing positive developments with slight line drawdowns, indicating a growing confidence in investment. Our cost of funds is rising, and we expect further increases, but our betas remain manageable at 17%. Daryl will provide more specific details about this. I am confident that as loan growth accelerates, we will be able to handle any implications on betas effectively. Now, I'll hand it over to Daryl for further insights.

Thank you, Kelly, and good morning, everyone. Today, I’ll discuss credit quality, net interest margin, fee income, non-interest expense, capital, segment results, and provide guidance for the second quarter and the full year 2018. Turning to credit quality, it remained strong with net charge-offs totaling $145 million or 41 basis points, which is a slight increase but lower than last year. We have been below normal levels for some time, and this increase indicates some normalization. The percentage of loans and leases that are 90 days or more past due and still accruing decreased by 4 basis points from last quarter and last year. Loans 30 to 89 days past due decreased by 16 basis points from year-end, primarily due to seasonal improvements, though this was up slightly compared to last year. The NPA ratio increased by 2 basis points but decreased by six basis points from a year ago, with the minor increase largely attributed to our CRE and leasing portfolios along with a rise in foreclosed properties. On our allowance coverage ratios, they remained strong at 2.55 times for net charge-offs and 2.49 times for non-performing loans. The allowance to loans ratio was slightly up at 1.05%. We recorded a provision of $150 million compared to net charge-offs of $145 million. The reported net interest margin was 3.44%, an uptick of 1 basis point, while the core margin was 3.32%, up by 4 basis points. Excluding tax reform impacts, the reported margin would have risen by 3 basis points. The increase in both GAAP and core margins reflects asset sensitivity to the December rate hike and higher LIBOR rates. We successfully repriced our tax-exempt loans upward following tax reform. Deposit betas have continued to be lower than expected, with most of the rise in deposit costs related to indexed accounts. Since November 2015, cumulative deposit beta has been 17%, with this quarter seeing a higher beta at 24%. Asset sensitivity experienced a minor increase due to rising free funds and changes in our balance sheet mix. Regarding our fee income ratio, it was 41.9%, a slight decrease attributed mainly to seasonality. Non-interest income totaled $1.2 billion, with strong performance in investment banking and brokerage, up $22 million from last year. Insurance income rose by $18 million, largely driven by seasonality and employee benefits. However, service charges on deposits fell by $18 million mostly due to a system outage in February, during which we decided to refund several fees, incurring costs of about $15 million in lower deposit service charges and an additional $5 million in higher operating expenses. Other income declined by $40 million due to lower private equity investment performance and certain post-employment benefits. Excluding the system outage, we would have seen positive operating leverage on an adjusted basis for the linked quarter. As for adjusted non-interest expense, excluding restructuring charges, it amounted to $1.66 billion, down $39 million from the previous quarter's adjusted expense figure. Personnel costs decreased by $33 million due to the previous quarter’s bonuses related to tax reform, partly offset by a seasonal increase of $25 million in compensation-related expenses. Notably, we saw a reduction of 576 full-time employees compared to last quarter. Other expenses decreased by $127 million, mainly due to a $100 million charitable contribution in the fourth quarter. Additionally, changes by FASB now only allow service costs in personnel expenses, meaning that investment return benefits are recorded under other expenses, leading to a $15 million decrease compared to last quarter, with similar reductions expected for the rest of the year. Merger-related and restructuring charges rose by $6 million, primarily due to our facilities optimization. Our capital, liquidity, and payout ratios have remained solid; the common equity Tier 1 ratio stood at 10.2%, with a 39% dividend payout ratio and an overall total payout ratio of 82%. This included $320 million in share repurchases, maintaining the same authority for share buybacks in the next quarter. The LCR was 144%, and our liquid asset buffer was strong at 15.1%. Looking ahead to CCAR '18, we plan to increase the common dividend while keeping our capital ratios stable. We anticipate that our recent acquisition of Regions Insurance will influence the share buyback in the third quarter. Now, moving to segment results, community bank retail and consumer finance net income reached $324 million, an increase of $61 million. Net interest income decreased by $9 million to $886 million, largely due to fewer days, although wider spreads on deposits partially offset this decline. Non-interest income fell by $19 million primarily due to the system outage. For residential mortgage, the loan production mix consisted of 65% purchase and 35% refinance, similar to last year, with the gain on sale margin at 1.72% compared to 1.53% last quarter. Residential mortgage closings were down 16%, aligning with the forecasted 17% decline by MBA. Non-interest expense decreased by $22 million, mainly due to last quarter's one-time bonus. We closed two branches and plan to close 80 in the upcoming quarter, with around 150 closures anticipated this year. Moving on to community banking commercial, net income was $270 million, an increase of $36 million. Net interest income was down $12 million, primarily due to fewer days, but was partially offset by increased deposit costs. The commercial pipeline saw a positive increase compared to year-end. In terms of average loan balances, we had an increase of $642 million, with C&I and CRE seeing annualized growth of 6% and 4%, respectively. However, deposits decreased by $737 million due to a seasonal drop in non-interest-bearing deposits, while interest-bearing deposit costs increased by 9 basis points, translating to a deposit beta of around 45%. Financial services and commercial finance net income was $144 million, an $8 million increase. Non-interest income dropped by $14 million, mainly due to lower trading gains and seasonality in commercial mortgage banking. Nevertheless, compared to our corresponding quarter, non-interest income increased by $21 million, propelled by managed account fees from investment banking and brokerage. Average loans in this sector rose by $492 million with growth across all line items, although deposits saw a slight decline reflecting seasonal trends. Interest-bearing deposit costs went up by 13 basis points, equating to a deposit beta of about 65%. Finally, for insurance and premium finance, net income reached $62 million, an increase of $29 million, with non-interest income at $439 million, climbing $11 million driven mainly by seasonality. Organic growth was recorded at 3%, largely due to a 12% increase in new business, with Regions Insurance expected to contribute approximately $70 million in revenue in the second half of the year. Non-interest expense decreased by $18 million, mainly due to a one-time bonus paid in the fourth quarter. As for our outlook in the second quarter, we expect total loans to rise by 1% to 3% annualized linked quarter; net charge-offs to fall between 30 to 45 basis points; provision for loan losses to align with net charge-offs plus loan growth; stable GAAP margin with a slight rise in core margin; fee income to increase by 2% to 4% compared to the same quarter last year; expenses to decrease by 1% to 3% compared to the same quarter last year, excluding restructuring charges and one-time items; and an effective tax rate of 21%. For the full year of 2018, we anticipate loan growth in the 1% to 3% range, reflecting adjustments from first-quarter growth. Taxable equivalent revenues are expected to range from 2% to 4%, which includes the addition of Regions Insurance for the latter half of the year. Expenses are predicted to remain flat or decrease by 1%, excluding merger-related charges and one-time items. This optimistic outlook comes from enhanced expense control measures and reduced FDIs surcharges in the fourth quarter, as well as the expected contribution from Regions Insurance. An effective tax rate is forecasted to be between 20% to 21%. We expect to see our first-quarter revenue momentum continue and are confident that managing non-interest expenses will lead to positive adjusted operating leverage for the entirety of 2018. In summary, we achieved record quarterly earnings, showing positive operating leverage, strong credit quality, and superior expense control. Now, I'll hand it over to Chris to discuss the investments we are making to better serve our clients and grow revenue for the company.

Thank you, Daryl, and good morning. We are making significant investments, focusing on three main areas: risk management, backroom infrastructure to enhance efficiencies, and front room functionality to boost revenue. Starting with risk management, we have invested heavily, particularly in BSA/AML and cybersecurity, where we aim to be leaders, as well as in fraud prevention. Regarding backroom digital investments, I'll briefly highlight some of our current initiatives. First, we're continuously investing in our new retail platform, which includes features like credit and debit card controls, allowing clients to limit spending in specific geographic areas and enabling on/off controls. We are particularly enthusiastic about the upcoming Siri payment feature for Zelle, which will allow users to activate Zelle using fingerprints or facial recognition and is expected to launch in the next 30 to 45 days. Additionally, we are integrating a financial planning tool called EMPOWER for our private wealth clients, along with various debit card fraud alerts. Over the past year and a half, we have significantly increased our digital marketing campaigns by about 70%, with 86% of these initiatives incorporating a digital component. To illustrate, retail checking account openings online rose by 13.5% in the first quarter of 2018 compared to 2017, business checking increased by 43%, retail savings grew by 9.2%, and bank cards surged by 70%. These efforts have proven quite successful. In the fourth quarter, we began rolling out a platform called Voice of the Client, which connects with our business lines and will continue to be implemented this year and in 2019. This platform provides near real-time feedback on client concerns, enabling prompt resolution, and can be accessed via iPad. We launched Zelle on December 14th and have enrolled 164,000 clients, averaging 1,400 enrollments per day, with daily transaction volumes reaching approximately $1 million. In the second quarter, we will introduce TCH Faster Payments for incoming transactions, and by the third quarter, we expect to enable payment origination for our business clients. In February, we introduced a new mobile app for our auto business to improve client self-service, allowing payments and viewing reserves. Since its launch, we have seen 15,000 downloads and 11,000 payments made. We are also establishing a commercial portal to simplify access for commercial clients to our treasury systems with a single sign-on, which should be beneficial. From an agile development operations perspective, we started implementing agile teams in IT a couple of years ago, and we are now building our capability to adopt new technologies. Initially, we are focusing on three key projects: a small business onboarding project, retail online accounts, and a digital mortgage platform. As previously mentioned, we began integrating robotics in our organization about a year ago, and currently, we have around 25 bots and about 10 processors in operation, with an additional 75 under evaluation. Our enthusiasm also extends to front room functionality, with ongoing developments in retail, commercial, and insurance sectors. As Kelly mentioned, we anticipate an improvement in our auto business, primarily due to the rollout of our near-prime product, which has already created new revenue opportunities. We will also be launching a branch home equity loan product and expect to finalize that in a couple of months. In June, we plan to unveil a new credit card lineup featuring competitive market-based benefits, including travel options for all client segments. In mortgage, we are considering expanding into new markets such as St. Louis, Denver, and the Northwest for our corporate business. We are currently participating in syndicating credit through national auto dealerships, a program we commenced late last year, which could contribute additional balances this year. Regarding insurance, we are pleased with the acquisition of Regions Insurance, which we see as a strategic catalyst for restructuring our retail business. They operate in 10 states, including areas where we previously had limited market presence. We plan to approach these new markets strategically. Finally, we have made progress in implementing robotics within insurance and are optimistic about the associated revenue opportunities. We look forward to realizing the benefits of our investments in the future. Now, I’ll pass it back to you.

Thanks, Daryl and Chris. In summary, I would say we had a record quarter, record earnings and returns, strong core commercial loan growth, our optimizing portfolios are turning, that's a big deal. We have a strong disciplined expense focus. As you just heard, we have substantial future investments to increase our relationship with our clients. We have positive operating leverage expected going forward. We have excellent asset quality. We have strong market momentum. By the way, there was a recent study that came out that looked at the best markets in the country in terms of economic opportunity, and we’re in seven of the 10. We have three of our largest new markets that we've invested in being Florida, Texas, and Pennsylvania. All of which are turning and relatively making a big positive benefit as we go forward and have enormous opportunity. So all of that together helps me to still conclude that our best days are ahead. Alan?

Thank you, Kelly. At this time, I'll ask the operator to come back on the line and explain how our listeners can join and participate in the Q&A session. Euglena, if you would come back on and explain, please.

You're guiding for 2018 for 200 to 500 basis points of positive operating leverage, and you just spent about 10 minutes going through all the investments. Can you just tell us why you're confident about that positive operating leverage? Highlight maybe some of the segments, including insurance.

So, Mike, the way we can do that is because we’ve been talking for the last couple of years about our consistent focus, and it’s been building in effectiveness with regard to re-conceptualizing our business. If you look just from the start and say how could that be implicit to your question. How it can be is that we are restructuring and re-conceptualizing all aspects of our business front and backroom. What we're doing is we're harvesting expenses from the backroom and shifting into the front room. It’s like I’ll use an analogy with our board; it’s like you're living in a house and you’re building a new house for the future. You have to take care of the house you’re in and you have to invest for the future. You don’t have to spend the same money on the existing house that you’re in while you’re investing for the house of the future. It’s about re-conceptualization. That’s why robotics, AI, all of that is critical. Changes over the last 15 to 20 years, Mike, is this. We now have the tools through advanced automation to be able to do all the things we have to do better, more efficiently and reinvest that money for the future with regard to client satisfaction and revenue.

So my specific question on insurance: I was hoping you can give us more color on the pricing environment. You guys seemed a little bit more optimistic in the fourth quarter. Did you see improving prices in the first quarter? How do you see the improving pricing environment translating into a pickup in your revenue growth within your insurance business during the balance of 2018?

It's a great question, and we did see an increase in pricing during the first quarter. After previously reporting a decline in pricing in the 2% to 3% range during the fourth quarter, we actually observed pricing rise by about 2% following the hurricanes last fall. Our retention rates remain strong, with retail at 92% to 93% and wholesale around 75%. Additionally, we had a new business production rate of 11.8%, which is the highest I've seen in two or three years, reflecting new opportunities in the economic market. In comparison, the fourth quarter's new business production was only 3.7%. Our core organic growth rose from approximately 1.5% last year to 3% due to these factors—pricing, new business, and retention. We also have various operating opportunities, particularly with the acquisition of Regions. Over the past several years, we've conducted several strategic acquisitions, such as CRC wholesale in 2012, Crump in 2015, and Swett & Crawford. We're now focusing on replicating that success in retail, and the Regions Insurance acquisition allows us to do just that, as it represents about 15% of our retail business. This proximity enables us to achieve similar scale in retail as we have in wholesale. We are utilizing robotics and machine learning to improve workflow, which we believe will enhance our margins in the coming years. Looking ahead, we expect a normal seasonal increase in commissions of about 7% to 8% in the next quarter and anticipate continued economic expansion, which should further drive unit growth and new business production from both retail and wholesale. In this insurance cycle, the wholesale sector is performing stronger than retail, especially following large catastrophes where capital tends to favor wholesale. We are currently estimating $135 billion to $150 billion in losses, with new capital entering the market as well. Currently, property rates are increasing modestly, and while carriers are striving to raise casualty rates, professional lines remain mostly flat. Reinsurance markets have raised their rates in the low to mid-single digits, and we anticipate holding a 2% increase, which contrasts with the previous down market we experienced. The reinsurance rates will vary in the middle of the year, but we feel optimistic about pricing, our leading retention rates, and strong new business production. We also have several operational initiatives aimed at improving our bottom line, which leads us to feel positive about enhancing our operational performance over the next few years.

Kelly, you mentioned that you've been out in your markets over the past couple of months, and there is a lot of optimism. What do you think is going to be the catalyst to take that optimism to actually see an acceleration in commercial loan demand through your franchise?

Gerard, I've given a lot of thought to that, and I believe it relates to what I refer to as the boomer effect. The majority of businesses in this country are either owned or managed by baby boomers. During the 2008-2009 financial crisis, many of them came from stable financial situations and had built substantial value, only to see half of it wiped out. This caused them to become fearful, and it took time for them to regain their confidence and willingness to act. Currently, there is a resurgence of optimism; their confidence is returning, and they are actively considering various products. I hear them engaging in discussions. In the past, they might have taken longer to make decisions, but now they have spent about six months evaluating and have approached it with caution. I believe this is starting to unfold, and because these boomers are achievers and growth-oriented, they are not quick to act. However, I think we are on the verge of seeing this translate into real loan approvals, planned expansions, and equipment purchases that will support our growth and the economy. By the third quarter, I expect to see this reflected in loan growth for us and others, in tandem with economic growth.

As far as areas of focus for us, we're seeing some really nice opportunities as the economy is transforming more digitally in e-commerce with a focus on industrial and distribution markets, such as distribution centers. We are also doing some hospitality, select retail, things like single credit tenants, and local anchor grocery, with conservative opportunities there. We are still seeing some selected but multifamily opportunities. I think for us it's fairly widespread, so I wouldn’t say one market over another stands out. I think it's pretty broad-based. Now as far as underwriting considerations, we are being very careful. One thing that is a little unique right now is that it seems counterintuitive; some construction and development opportunities might be lower risk than some of the permanent ones because you can get really strong equity sponsorship in terms of being willing to take seasoning in a lease-up risk. If everything works out, then your ongoing cash flow coverages and debt yields look very strong. We're a little more cautious on the permanent side and we are letting a lot of that go to the secondary market. Overall, I think our underwriting standards are pretty consistent with a more through-the-cycle outlook.

It's mostly the non-banks: the insurance companies; any capital market executions; and particularly on the multifamily side, from where the GSEs are standing.

I really appreciate some of the specifics that you laid out in terms of your investments spend. You have kept your efficiency ratio stable at 57%, and your guidance for 2018 is pretty clear. As we look to 2019, the street has a 58% efficiency ratio which is ahead of where you’ve posted over the past two quarters. I’m wondering if you could take what you told us a step further and maybe talk about the impact on efficiency as the revenue opportunities, mentioned by Chris, become more mature in '19. What that means for the expense trajectory beyond this year?

I think what we are hearing is that we are making these investments. A, we are substantially paying for these investments by extracting expenses from the old business background. You are correct that as we head into '19, those investments will turn into revenue enhancements. I’d say the street is thinking a 58% efficiency ratio in '19 is reaching too hard. We see as we move through '19, those revenue streams combined with better economic conditions will enhance revenue growth in a time where we’ve got a tight control of expenses. I project a downward trend in efficiency versus an upward trend.

I just wanted to follow-up on two things. One, Kelly you mentioned that 2019 is a little further out, but you did say that it is possible to have flattish to downish expenses in '19. How should we think about that, including full-year operations of their regions and insurance acquisition of those operations?

No, that includes that.

We do not disclose the terms of the transaction. We don’t view it as a significant number, and we feel that all of our guidance incorporates the revenue and expense that we gave. It's going to impact some of our buyback in the third quarter.

Okay. So just to make sure I understand: the acquisition piece — the revenue, expenses; that's in the guidance for the full year 2018, because it's going to hit in the 3Q, right, is that correct?

Yes, we planned to close it early in the third quarter. Yes, there are 10 states. We overlap in six. We did not have Arkansas and Louisiana; we had a little bit in Indiana. The biggest are Arkansas and Louisiana. They bought the largest agencies in those markets. We’re going into new markets in a sizeable way; we’re really excited about that. We’re also implementing additional measures to enhance our client service.

Thank you, and thanks for everyone for joining us today. I hope you have a good day. This concludes our comments.