Truist Financial Corporation (TFC) — Q2 2018 Earnings Call Transcript

Thank you, Gail, and good morning, everyone. Thanks to all of our listeners for joining us today. On today’s call, we have Kelly King, our Chairman and Chief Executive Officer; and Daryl Bible, our Chief Financial Officer, who will review the results for the second quarter and provide some thoughts for the third quarter and the remainder of this year. We also have Chris Henson, our President and Chief Operating Officer; and Clarke Starnes, our Chief Risk Officer, to participate in the Q&A session. We will reference a slide presentation during our call today. A copy of the presentation as well as our earnings release and supplemental financial information are available on the BB&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 the presentation contains certain non-GAAP disclosures. Please refer to Page 2 and the appendix of our presentation for the appropriate reconciliations to GAAP. And now, I’ll turn it over to Kelly.

Thank you, Alan. Good morning, everybody. Thanks for joining our call. We always appreciate your time and attention. So I’d say the second quarter was overall very strong, particularly when you look through all the parts. We had record earnings, record returns, strong revenue, very good expense control, great asset quality and improved loan growth. Net income was a record $775 million, or up 22% versus second quarter 2017. Excluding mergers, it was a record $792 million. Diluted EPS was $0.99, up 28%. Adjusted diluted EPS was a record $1.01, which was up 29% versus the second quarter. I would point out that if you look at the pre-tax ex-merger earnings, they are up 6% versus second quarter 2017, which is simply showing that independent of the tax reductions, our business is meaningfully improving. ROA, RO Common Equity and Return on Tangible were 1.49%, 11.74% and 19.78% respectively. And I think importantly, if you look at adjusted ROA, ROCE and ROTCE, it was 1.52%, 12.01%, and a very strong 20.2% on Return on Tangible. Importantly, we did achieve positive operating leverage in the second quarter. Quarterly revenue totaled $2.9 billion, which was up 9.2% annualized compared to the first. That was insurance seasonality, but it’s still a very strong revenue quarter. Loans held for investment did perform very well, up 3.5%. So we’re seeing the turn that we have been expecting over the last two or three quarters. Net interest margin increased 1 basis point to 3.45%. And our core was up 2 basis points to 3.34%, and a strong fee income ratio of 42.5%, which was up from 41.9% in the first quarter. Adjusted efficiency ratio was 57.4% versus 57.3%, so about flat. Adjusted noninterest expenses totaled $1.6 billion, which was a decrease of 2.1% versus 2017. I’m very pleased with our expense discipline. I would say to you that our flat guidance for the year, remember, includes Regions, so it is net down, which is very good. When you hear in a minute, I’ll talk about the many different things we are doing. Credit quality was just great. The NPA ratio was 0.28%, a decrease of 2 basis points. Charge-offs were 30 basis points versus 41 basis points in the first quarter, and 37 basis points in the second quarter last year. So great credit quality. If you’re following along, I’m on Page 3. In terms of strategic highlights, I would point out that we did close the Regions Insurance deal, which is a really attractive addition we closed out on July 2, strengthening our presence in many Southeastern markets, and importantly, expanding into new markets in Texas, Arkansas, Louisiana and Indiana. In our capital plan, we did not have a Fed objection. We have an 8% increase in quarterly dividend planned on top of the 13.6% increase that we did in the first quarter. And up to $1.7 billion in share repurchases. Some of that was used in the Regions acquisition. But if you look at the combination of the first and the projected third quarterly dividend increase, it’s up 22.7% from the fourth quarter 2017. We’re maintaining a strong and growing dividend, which is very important for our shareholders and we are executing on that. On Page 4, we just had straightforward selected items, mostly related to real estate losses, closing branches, and back-room facilities. That was about $0.02 a share. On Page 5, I’ll talk a little bit about loan growth. We’re very pleased that we’re seeing the turn that we’ve been expecting. So we had 3.5% growth in loans, driven mainly by C&I which was up 6.3%. Strong performance in several areas, including corporate banking and mortgage warehouse lending. Sheffield was up 32% annualized, and that’s seasonal, but still strong. Commercial Equipment Capital was up 16% annualized; Dealer floor plan and the Premium Finance areas also saw growth. I’d point out that Community Bank was up 3.5%. That’s significant because if you recall over the last several quarters, I’ve been discussing how for the last number of years Main Street has been stagnant, and we’ve been expecting it to recover. Well, it is recovering. Optimism is strong. Equipment purchases and other acquisitions are happening. So we’re really pleased to see Community Bank perform well. That’s an engine for our company. CRE is up 2.8% annualized. I would also point out that our end-of-period loans are up $3 billion, greater than the end-of-period loans for the first quarter, which is 9% annualized. Our auto portfolio made the turn in the quarter as we expected. Our mortgage loans grew on average as we expected. This will be a positive push in terms of total loan growth moving forward. When we think about loan growth, I’ll get Daryl to talk about the guidance in a bit. But I believe that loan growth should be in the range of plus or minus 4% as we enter the third quarter, barring any major changes in the economy. If you look at Page 6, in terms of deposits, it was a healthy quarter for us. I’m very pleased that our noninterest-bearing deposits or DDA grew by 4.3%. That’s very strong compared to the industry and reflects a lot of our growth strategies that are really paying dividends now. Our noninterest-bearing deposits increased significantly, by $567 million. The percentage of noninterest-bearing deposits increased to 34.2%. I want to make a comment about betas. The cost of interest-bearing deposits was 0.57%, up 11 basis points, or a 41% implied beta. I would just comment that this beta is outside maybe what you expected, but we have some markets where we are facing outsized competition, and we made a conscious decision to react in those markets. This is not a normalized beta increase; it was more of a marketing strategic change. I would expect betas to lower from this level; Daryl will give you more commentary on that. I want to highlight that the economy in general, from what we’re seeing is very positive and strong. I just completed 23 of our 24 regional visits. As you know, I spend a whole day in each region. I did two of them last week. When I talk to business CEOs, they are very optimistic; they are spending and planning to spend on CapEx. Interestingly, competition is heating up; beta is facing intense wage pressure and difficulty finding the right people. One construction CEO told me that in certain cases, he had to raise prices by 25% to secure the workers he needed. So, the takeaway from an economic perspective is that we can expect higher inflation and higher rates. There is no incongruity in the information out there concerning this. So I think that’s what we should expect moving forward, which is good news for the economy and good news for banks. I’m going to comment later on some of our key strategies, which are very important in your view of how BB&T will perform. But for now, let me let Daryl provide more details on the numbers.

Thank you, Kelly, and good morning, everyone. Today, I am excited to talk about our excellent credit quality, improving margins and loan growth, strong expense control, and our guidance for the third quarter and full year 2018. Turning to Slide 7, credit quality remains very strong, with net charge-offs totaling $109 million, down 11 basis points. We saw improvement across most loan categories, but indirect loan charge-offs drove most of the decline. Loans 90 days or more past due and still accruing as a percent of loans and leases decreased 4 basis points from both the linked and year-ago quarters. The NPA ratio was 28 basis points and matched the lowest level since 2006. We experienced declines in nonperforming assets across most categories. Continuing on Slide 8, our allowance coverage ratios remained strong at 3.49 times for net charge-offs and 2.74 times for nonperforming loans. The allowance to loans ratio was 1.05%, flat from last quarter. We recorded a provision of $135 million compared to net charge-offs of $109 million, making the provision $26 million higher. The net charge-offs contributed to a flat allowance to loans ratio with period-end loans up more than $3 billion from March 31. Turning to Slide 9, the reported net interest margin was 3.45%, up 1 basis point. Core margin was 3.34%, up 2 basis points. Both increases reflect asset-sensitivity and higher short-term rates. The deposit beta for this quarter was 41%, slightly less than our modeled 50% beta. In addition to the index accounts repricing this quarter, deposit costs were impacted by several rate specials in many of our markets, and we expect this to abate in the next quarter. Since 2015, our cumulative deposit beta has been 24%. Asset-sensitivity decreased due to changes in our loan mix and deposit mix offset by changes in the investment portfolio. Continuing on Slide 10, our fee income ratio was 42.5%, up slightly, primarily due to seasonality. Noninterest income totaled $1.2 million, with insurance income up $45 million, mostly due to the seasonal increase in property and casualty commissions. We don’t expect prior year storms and other events to significantly impact profit-based commissions for the remainder of this year. The Insurance Group acquisition effective July 2 will benefit insurance income starting the third quarter. Keep in mind that insurance income is seasonally lower in the third quarter. Service charges on deposits have returned to normal levels following last quarter’s system outage. Mortgage banking income declined by $5 million primarily due to a 30 basis points decline in gain-on-sale margins, mostly due to retail originations. Investment banking and brokerage income declined by $4 million mostly due to deal timing. Turning to Slide 11, adjusted expenses came in just under $1.7 billion, which is up $38 million. Personnel costs increased by $35 million due to annual merit increases and the increase in performance-based incentives. FTEs declined by 126. The initiative to reduce the amount of office space continues to positively impact occupancy and equipment expenses, which were down $7 million. About 740,000 square feet of BB&T occupied space has been vacated since January. Other expenses were up $12 million, primarily due to an unexpected increase in the Visa indemnification reserve. Merger-related and restructuring charges were down $4 million, with nearly all these costs related to real estate losses due to our branch closure strategy. Expenses will include the impact of Regions' Insurance acquisition starting in the third quarter. Well-controlled expenses contributed to positive operating leverage versus the second quarter of 2017. Continuing to Slide 12, our capital, liquidity, and payout ratios remain strong. The approved capital plan includes a dividend increase and share repurchases. Our $2.9 billion capital plan is similar to what we did last year, focused more heavily toward dividend payout. The 7.5% dividend increase represents a cumulative 22.7% increase since the fourth quarter of 2017. The Regions Insurance acquisition will impact third quarter share buybacks. Now let’s look at our segment results beginning on Slide 13. Community Banking Retail and Consumer Finance net income was $377 million, with a $53 million improvement driven by balance sheet growth, improving deposit spreads, and a seasonal increase in card-based fees and deposit service income, offsetting the negative impact from the February system outage. Residential mortgage originations were up 17%. The production-based mix was 77% purchases and 23% refinances, and the gain-on-sale margin was 1.40% versus 1.72% last quarter. We closed 80 branches and plan to close about 85 more later this year. This strategy continues to help us control expenses and provide more funds to invest in our businesses. Continuing on Slide 14, average loans increased by $721 million, driven by residential mortgage and seasonal pickup in mortgage warehouse funding. As expected, the auto portfolio stabilized and we expect it to grow going forward. Deposit balances increased by $983 million with growth in both DDA and CDs. The deposit beta was 19%. Turning to Slide 15, Community Banking commercial net income was $277 million. A $7 million increase was mainly due to improving deposit spreads. The commercial pipeline was up compared to both the linked and year-ago quarters. Continuing on Slide 16, average loan balances were up $268 million, with growth in C&I construction loans partially offset by declines in income-producing property loans. End of period loans grew by 4.4% annualized. Competitive pressures on loan repricing remain as we saw a decline in loan spreads. Deposits were down by $203 million due to declines in public fund deposits, partially offset by increases in commercial deposits. The deposit beta was approximately 67%. Turning to Slide 17, Financial Services and Commercial Finance net income was $145 million, driven by loan growth and improving deposit spreads. This was offset by slower fee income due to the timing of investment banking deals and an increase in incentive-based compensation. Continuing on Slide 18, average loans increased by $292 million, while deposits remained flat. Corporate Banking, Wealth, and Grandbridge all showed good loan growth. Interest-bearing deposits were up by 20 basis points, resulting in a beta of 74%. Turning to Slide 19, Insurance Holdings and Premium Finance net income totaled $73 million. The $11 million improvement was driven by seasonality in P&C commissions, partially offset by the related increase in incentive-based compensation. For the quarter, organic growth was up 5.2%, primarily due to a 15% increase in new business. The Regions Insurance acquisition will add about $70 million in revenue for the second half of this year. The EBITDA margin for the second half of 2018 will be about 20%. Turning to Slide 20, you will see our outlook. For the second quarter, we met all of our guidance except for noninterest income, which we discussed publicly last quarter, mainly due to the mortgage sector. Investment banking was also a little softer this quarter due to the timing of some closing deals. Looking to the third quarter, we expect loans to be up 2% to 4% annualized. Our guidance has improved based on the quarter’s performance and strong momentum, indicating that the higher end of the range, plus or minus 4%, looks promising. We expect net charge-offs to be in the range of 35 to 45 basis points, with the loan-loss provision to match net charge-offs plus loan growth. The build this quarter is the result of strong end-of-period loan growth, which positions us well for future quarters. We anticipate GAAP and core margins to increase slightly, and fee income to grow by 3% to 5% compared to the same quarter last year. We have already seen several deals close in investment banking this quarter, giving us more confidence we’ll be at the higher end of this range. Expenses are expected to be up 1% to 3% compared to the same quarter last year, with an effective tax rate of about 20%. For the full year 2018, we expect loans to grow in the range of 1% to 3%, with taxable-equivalent revenues expected to grow by 1% to 3%. The decline from previous annual guidance reflects slower mortgage banking income growth. We expect expenses to remain flat, which is a bit higher due to the FDIC surcharge that was added back in the fourth quarter, with an effective tax rate for the year of 20% to 21%. We continue to feel confident that revenue growth, along with flat noninterest expenses, will result in positive operating leverage for the full year 2018. In summary, we had quarterly earnings, positive operating leverage, very strong credit quality, and excellent expense control. Now, let me turn it back over to Kelly for additional comments.

Thanks, Al. As you just heard, Daryl summarized the overall very positive results for the quarter effectively. But I want to take a minute to emphasize something really important. While focusing on the quarterly details is interesting, what’s far more important is what we’re working on and what lies ahead for the future of this company, for our shareholders and other constituencies. We are diligently pursuing what I’ve referred to as our Disrupt-or-Die strategy, which you can see laid out in the graph on Page 21. We framed this in terms of disrupt or die to capture our people’s attention because the world is changing rapidly. Change will accelerate even more going forward. I think AI, machine learning, digital advancements, and various consumer expectations are very real. Therefore, we’re focusing seriously on both the front and back rooms of our businesses, aiming for enhanced operational efficiency and effectiveness. Presently, we have significant projects underway to reimagine our IT operations with an emphasis on Agile and DevOps methodologies, which can make all the difference. Our insurance business is undergoing a top-to-bottom reimagining process, especially with the Regions Insurance acquisition, and we expect substantial improvements in that area as a result. In Commercial and Retail banking, we are working on projects to drastically reduce turnaround times; for instance, we aim to cut the time for small business loan approvals from 28 days to just 3 days. This is critically important for client convenience. By the end of this year, our auto loan approval time will go from 1.5 days to just 4 minutes. This is transformative and will change the business significantly. Daryl mentioned earlier that we will be closing approximately 160 branches this year so that we can reinvest in other areas of our branch system and other aspects of the bank. In our commercial sector, we’re undertaking an initiative to evaluate and enhance our performance from start to finish. We are examining all aspects of the company, seeking cost reductions and reallocations to reinvest in our future. Protecting our online banking business, which most organizations currently have, is vital, but we also need to streamline it and utilize cost savings to reinvest in new banking models. Our new product lineup is significantly improved. For example, we launched five new credit cards in the last few weeks, and we’re receiving fantastic feedback from the market. We’re pushing our market leaders and branch managers to be out in the field making calls three times a day, a noteworthy improvement for our business. Additionally, we have a new initiative called Financial Insights that emphasizes understanding our clients' dreams and goals, focusing more on their leadership because we know that successful businesses are led effectively. This approach encourages loan growth, deposits, and fee income generated by helping our clients achieve their objectives. We have been gathering valuable feedback from our clients in near real-time through a new program called Voice of the Client, which greatly enhances our service quality. Our operations are utilizing 32 clients discovered through back office efforts, leading to the establishment of a virtual banking center. Given the shift in customer preferences towards digital engagement, we are proactively connecting with clients regularly through digital channels. Our marketing and digital sales strategies are proving to be highly effective generating wonderful returns on our investments. Within the Retail Community Bank, we have an agile revenue team that meets monthly; they look for continuous improvement in product delivery and operational efficiency, and they implement changes rapidly. We back all these efforts with a stronger emphasis on client insights and analytics. The concept is to disrupt the old banking model, cut costs, reallocate resources, and redefine our business strategy. We believe this approach is already proving effective. Keep in mind, however, we are investing a substantial portion of those cost reductions back into our new operating model while maintaining flat expenses for 2018 and aiming to do the same in 2019. Our people are laboring diligently to bring these strategies to life. Most importantly, I want to reiterate BB&T’s commitment to a purpose-driven organization. We believe that focusing on our core mission enhances our effectiveness and success. We’re here to improve the world we live in through our work, which ultimately leads to the growth of our bank and success for our shareholders. Our Investment Day is scheduled for November 13-14 in Greensboro, and we’re excited about it. We’ve invested $40 million into our new BB&T Leadership Institute, which features 48 attached rooms for attendees, and I encourage the first 48 investors to sign up to stay at the institute. I look forward to seeing everyone there and hope you’ll enjoy our new facility. Now, let’s turn it back over to Alan for Q&A.

Thank you, Kelly. Gail, at this time, could you please explain how our listeners can participate in the Q&A session?

Good morning.

Good morning.

Good morning.

I want to just ask on the expense side. I know you just indicated that you do expect expenses for the year to be flat. I believe that you had indicated previously flat to down modestly and for the year. Did anything change that is impacting that outlook? And if so, can you give some more color on it? Thanks.

Yeah, John. This is Daryl. I noted in my opening remarks that we put the FDIC surcharge back into the fourth quarter. When you look at the differential numbers from the last two quarters, they’re essentially flat. While there is still a chance this may come out in the fourth quarter, we’re not sure about that. So, we wanted to be conservative to provide proper guidance. So if it does come out in the fourth quarter, that would be an upside for us.

But, John, keep in mind, that that is flat including Regions. So, our core expenses are still down, even including the FDIC surcharge.

Okay. All right, I got it. And then, for the loan growth, I know you are – you just indicated, Kelly, that you feel better that it could reach 4% plus or minus. What is that timeframe for when you think you can get to that level? Is that more of a longer-term thing? And, I believe previously you had indicated maybe a longer-term range of 4% to 6%, so I just want to get your thoughts.

Yeah, so a plus or minus 4%, John, is for the third quarter. I know we technically showed in our deck 3% to 4%. But I’m just saying based on what I see, and as I said, I’ve been to 23 regions, I’ve been to two regions last week. Based on everything I see and having talked to our people, I think we have a very good chance of hitting that target. I can’t guarantee it, of course, but I believe we have a strong likelihood it could be plus or minus 4% for the third quarter. The guidance we’ve provided before still holds as we move beyond that.

John, for specific categories in the next quarter, we’re seeing in addition to C&I and mortgage, which were big help this quarter, we’re also seeing really good traction in our indirect businesses, in auto and Sheffield, along with credit card growth. All these factors should help us achieve those targets.

Okay. Got it, got it. And then one last thing if I could, on the insurance side, your insurance revenue was flat year-over-year. We had looked for a few percent growth. Can you provide more color on what’s impacting that?

Yeah, sure, John. Keep in mind, a year ago, we had $12 million in performance-based commissions that we did not receive due to the storms in the fall. So if you exclude that, we actually saw a 5.2% core organic growth in the quarter, and so far, 4.2% year-to-date. We are witnessing significant acceleration in our new business production. First quarter was 11.8%, we observed a 15% increase in the second quarter. I haven’t seen these kinds of numbers in years, which shows that the economic expansion is helping drive that growth. The pricing is also up by 2% to 2.5%. We see that stabilizing compared to prior year dips in 2017. Therefore, we’re currently guiding for approximately 2.5% to 3% in organic growth. We now believe that we will be up about 3.5% to 4%. So, we’re looking at an increase of around 1% if you will.

Got it. All right, thank you.

Thank you. Good morning.

Good morning.

I have two questions. First, Kelly, could you just talk about your capacity and interest for bank M&A now? And secondly, the slide – the Disrupt-or-Die slide on number 21 is very helpful – which strategies on that slide do you think present the most opportunity for BB&T over the next couple of years?

Yeah, so on the M&A front, keep in mind that we’ve paused M&A activity. I haven’t officially lifted that pause. But I’ll be candid with you. I think we’re essentially ready to reengage in M&A, in terms of our internal capacities. We took this pause to ensure we got all these major projects worked on and stabilized. We’re still working through the final steps regarding the consent order. You saw we have been released from the consent order with the FDIC and the state; however, we’re not yet released by the Fed, and we’re in discussions with them on that. I anticipate that to occur in the not-too-distant future, but I can’t control that timeline. In any event, that will be released and sometime in the fourth quarter, we can still engage in M&A. I’m not overly worried about that. The more pressing issue is the availability of attractive merger opportunities and the economics behind them. I will say there’s been a notable increase in activity in just the last couple of months; we’ve been approached by several institutions in the last 60 days that would like to discuss potential partnerships with us. We greatly appreciate these approaches, of course, we'll consider them. Ultimately, it boils down to economics. I've mentioned repeatedly that the M&A economics have changed due to the shift in digital banking demands and expectations from clients. We’re witnessing declines in the 5%-plus range in banks' branches. Banks are realizing the same trend. Thus, as you price out-of-market deals, unlike in the past where you’d forecast increasing cash flow, one now has to consider declining cash flow forecasts. The market hasn’t fully adjusted to this yet but eventually will. So, the odds of us pursuing out-of-market deals are likely slim. However, looking at in-market deals appears quite positive. I realize that each time I mention this, some people feel the urge to sell our stock, but I assure you, that would not be a wise decision. Should we engage in deals, it would significantly benefit our shareholders. We are merely not going to engage in opportunistic deals that yield long-term dilutive effects to our shareholders.

Thank you.

Hi, good morning.

Good morning, Betsy.

A couple of follow-ups. One on the reinvestment in the business, very passionate presentation you gave on Page 21, Kelly. The question I have is, if you look out over time, perhaps two to four years down the road, do you think that this will impact the organization’s efficiency ratio, or will everything that you’re doing keep pace with the expense ratio?

Betsy, we’re in a new world. For those who have been around a long time, we might think more clearly about the historical benchmarks. But, now that we’re in a whole new world, it complicates matters and makes defining expectations challenging. As a result, my belief is that we can implement significant improvements and continue to invest in the business while still experiencing downward pressure on our efficiency ratio. The insurance businesses are going to be streamlined and that pushes pricing naturally. You know how that typically plays out. But when you aggregate all of that, I think we can still target about 55. In the longer term, as revenues increase, we may even move below that figure based on the operating leverage.

Got it.

Betsy, I’m sorry, we can’t hear your last question.

We can’t hear you, Betsy.

Betsy, we can’t hear you. Perhaps if you could log back in, we’ll let someone else take the floor, and you can return afterwards.

Hi, this is Amanda Larsen on for Ken.

Hey, Amanda.

How are you doing?

Good.

Can you talk about the balance sheet and liquidity management strategy given the expectations that loans will continue to grow? What’s your outlook for deposit growth in terms of mix, and what deposit betas are you assuming over the next few quarters?

Yeah, Amanda, so we're starting to gain traction on our loan growth, as evidenced by this quarter, and we're guiding for stronger loan growth next quarter and hopefully continuing from there. We’d like to keep both oars moving, so we need to see deposits grow as loans grow. Fortunately, our DDA continues to grow; it’s not at the same rapid pace it once was but it remains positive. We’re also seeing growth in checking and MMDA products. Over the last few quarters, we’ve seen some growth in CDs, and we’ll align our deposit growth to match our loan growth as best we can. As for deposit betas, we observed a significant spike this quarter, jumping from 24% to 41%. The increases were substantial across REIT, consumer, commercial sectors and large corporate accounts. We estimate this will moderate next quarter. We feel that we will have a good deposit growth quarter this upcoming period, matching loan growth. However, we must continuously monitor this, but our expectations are that deposit pressures will ease a bit.

Okay, great. And then, can you talk about your expectation for purchase accounting accretion in the second half, and your expectations for the extent of decline in 2019, and how that interplays into your NIM expectations for both the second half and 2019? Thank you.

Yeah, so by the end of 2019, you likely won’t need to ask this question. Right now, the difference between reported margin and core margin is 11 basis points. We anticipate this spread will narrow by the end of 2019 to about 4 or 5 basis points. Each quarter going forward, there’ll likely be 1 or 2 basis points' difference between them. So that gap is closing over the next four to six quarters. Did that help?

Absolutely. Thank you.

Hey, guys. Good morning. Daryl, I wanted to ask about fee revenue. It looks like the guidance came down a bit; it went from 2 to 4 previously down to 1 to 3 for the year. Is that driven more from year-to-date performance or do you expect lower growth in the second half? Can you talk about the drivers there on the fee revenue side?

Since half the year is accounted for, it’s driven mainly by our observations in the mortgage sector to date. Honestly, the mortgage volumes are very strong, but spreads are getting tighter. Insurance income is rebounding, so we should see solid organic growth from that side of the business to help offset some of the mortgage weakness. The investment banking side experienced timing issues this past quarter, but we believe we've placed well for the second half of the year. We think investment banking and brokerage will show strong performance as the quarter progresses. So, overall, we’re confident in having decent fee income for the second half of 2018, despite mortgage experiencing some softness.

So, the timing aside, it’s fair to say the full-year forecast is a bit lighter than you might have expected, driven primarily by the mortgage line?

Yeah, we’ve gone through these cycles many times. When refinance volume decreases, there’s less activity, and pricing gets very competitive, leading to lower pricing in retail sectors. Our strategy is adapted significantly, and I think we position ourselves well to regain market share. Overall, net-net, we are poised to regain share in the marketplace, but spreads will remain tighter.

Okay. And then I’ll follow-up on expenses. You mentioned the FDIC charges as a driver of the change in expense guidance for the year. If you're assuming the FDIC surcharge remains, how much is that? Can you remind us how much that FDIC charge is and how you're feeling about the ability to generate positive operating leverage in the second half and for 2018?

So the surcharge costs $21 million a quarter. If you look at the linked quarter between second and third, it’s a tough comp for us because we have seasonal variations in several fee businesses, including insurance and Regions-related adjustments. After the Regions Insurance system conversion in November, we should start to see synergy benefits. The margins are expected to rise from approximately 20% to 30% over the next couple of years through 2019. So I would assert that linked quarters will be challenging, but year-over-year for the fourth quarter should be very positive, providing operating leverage, as I foresee our revenue growing 2% to 3% while expenses remain flat.

Got it.

Keeping in mind the expense base absorption of Regions.

Got you. One last thing, guys, when we look at the CECL, what kind of progress you have been making on your preparations for CECL?

If you look at it, there was a white paper this past week from the Bank Policy Institute. We’ve been discussing CECL for a couple of years now, and it confirms our observations that CECL is very pro-cyclical and poses major threats to economic stability. The research indicated that CECL would require you to have perfect knowledge of future economic conditions. If we saw the forecasting that existed back in 2007, no one was anticipating a major recession then; therefore, if you modeled expectations in that context, you would see that it could double the contraction of that recession if CECL had been implemented back then. This is a significant risk to the economy that requires attention. In following CECL’s model, it presents less reserves for commercial loans due to reserving only for the expected life of assets, creating disconnection between accounting and economics, which is detrimental to earnings management. This accounting approach has significant implications for our capital structure.

Got it. Thanks, guys.

Yeah.

Good morning, Kelly, Good morning, Daryl.

Good morning.

Hey, Daryl. How are you doing?

Good. Kelly, I found your comments about visiting your different regions and talking to your customers particularly interesting. And I took note of your statements regarding the construction owner, plus your thoughts on interest rates possibly rising more than currently forecasted by the Fed. So my question is, when you guys underwrite your variable rate loans, what assumptions do you typically incorporate regarding interest rate increases? And second, will you adjust those assumptions if you start to see higher inflation?

Gerard, that's a great question. We believe that stress exit underwriting is what differentiates our CRE lending approach. We don’t specifically underwrite based on current cap rates; instead, we always account for several hundred basis points over the current accrual rate with a floor, which is roughly in the 6.5% range. We are currently assessing whether that floor needs to be raised in light of the discussions you and Kelly raised. It’s essential that we stress test our underwriting in situations of rate shocks to ensure we remain conservative. This method contrasts with the approach many others may take.

Does that make it harder for your company to compete since you're maintaining a more conservative foothold than your peers?

Absolutely in certain aspects. It’s particularly challenging for us to compete on fully stabilized income-producing properties based on our conservative sizing calculations, which lead us to determine a more appropriate structuring of our offers. Thus, we’re focused more on C&D loans where we can ensure good initial equity and guarantees. We're mindful of the risks we're undertaking, ensuring we protect our positions. We are selective in our approach but overall believe we can compete effectively in this climate.

Gerard, as you understand, we operate the business from a long-term, through-the-cycle perspective. In times like these, we often see competitors scrambling for asset growth focused on short-term gains and willing to undercut on pricing and structuring just to achieve volume. It may feel rewarding in the moment, but it usually doesn’t end well when pricing goes down. We approach this business with a focus that’s consistent with our values, so while it’s proving more difficult today, we refuse to yield to those adverse strategies. Our team pushes through and persists.

And as a follow-up question, Kelly, regarding your slide on Page 21, your plans to enhance national lending business are intriguing, especially in equipment finance, mortgage, and Sheffield. I notice that you don’t have a national customer base in your CRE and corporate lending segments. How do you avoid adverse selection as you expand at a national level?

Well, it’s imperative that we employ experienced people who have local market knowledge. We have an incredible leadership team headed by Rufus Yates and Cory Boyte. When tasked to expand, we ensure they have the requisite resources to hire local market talent. We’ve learned that you cannot just take someone from one market and send them on a plane to another market expecting success. Our strategy emphasizes the necessity of having appropriate local expertise at the marketplace so we aren't at a disadvantage concerning knowledge.

Gerard, this is Chris. I would also like to add that we have a Grandbridge business that provides national coverage, and it has performed well over the years. Our team is located throughout the country. We plan to replicate the successful model currently in place at Grandbridge on the corporate lending side, allowing our bank balance sheet lenders to collaborate with our Grandbridge team, which specializes in secondary market lending. We believe this strategy will work exceptionally well, enhancing our ability to engage in construction financing that we may not have previously tackled.

Great. Thank you. I look forward to seeing you in November.

You bet. See you then.

Thank you, Gerard.

Hi. Can you hear me?

Yes, go ahead.

You’re fine.

Could you elaborate more on your efficiency guidance? You’ve reported record EPS but lower guidance for efficiency. I understand you pointed out the FDIC benefit being pushed out and the mortgage softness. However, that's still a considerable variability in your guidance range for two quarters left. Would you please provide more detail regarding your commitment to that short-term efficiency target? Is this target still in 2020 or could it be the following year? What’s your assurance of the potential for improvement in efficiency considering you're slightly adjusting your guidance?

Certainly, Mike. I assure you that our commitment to improving efficiency and our conviction is unwavering. You need to remember that during the ‘90s and 2000s, we grew quickly through mergers, and while we executed that well, we didn’t invest sufficiently in back-end systems. Over the last 10 years, we were required to ramp up investments in significant areas such as a new accounting system, commercial loan system, and data center among others. This led to elevated efficiency ratios, but we promised this would progress favorably over time, which is exactly what has occurred. The efficiency ratio is currently around 57.3%, and it continues to slide toward our original goal of 55% as expected. The denominator matters, and we’ve discussed that in the past. While we focus on improving our efficiency indicators, I maintain confidence that investments will enhance our operations. Significant advancements, including technology and methodologies such as AI and machine learning, grant us new capabilities we’ve not experienced previously. We feel optimistic regarding improvements in this area.

Okay. Let me add some detail, Mike; we want to focus on measurable outcomes. We’ve done an impressive job controlling expenses thus far this year. Year-over-year, we’ve reduced our FTE count by approximately 1,600 with no impact on how we operate the company. As we look ahead, we remain committed to right-sizing our workforce further. The strategy to rationalize our branch network is ongoing, and we also have excellent programs within our back-office operations that have just started. When we began this initiative, the company had approximately 21 million square feet of workspace. We are now down to about 18.5 million and plan to approach 16 million over the next couple of years. We will leverage these savings to explore innovative technologies such as robotics and digital solutions, while driving revenue without incurring additional operational costs. If we can maintain flat expenses and generate revenue growth of around 2% to 3%, it sets us up nicely for positive operating leverage.

And one final follow-up. While M&A activity has historically benefited BB&T's performance, I’m curious about your thoughts on the last few deals like the Pennsylvania transaction, which might not have been as favorable. Regarding your analogy about fishing, if the fish aren’t biting on one side, perhaps it would make sense to explore the other side of the boat. It appears that in-market deals have typically been received more positively than out-of-market ones. How can you assure us that if BB&T pursues acquisitions, they will be more consistent with the prior decades of success versus the recent experience? Additionally, regarding your comments on the increasing M&A activity, how would you define this 'activity'? We haven't seen a lot of movement recently, so can you spell that out a bit?

I can understand your reservations, Mike. I agree that the Southern National merger is a high bar; it was the most successful merger of equals in the country. We’ve seen remarkable results from it. Comparing it to Pennsylvania isn't entirely fair, as they’re fundamentally different transactions. The Pennsylvania deal hasn't performed as strongly as anticipated, but we've seen improvements. My recent visits to the market showed a gradual stabilization. It's a stable market, albeit slower than go-go areas like Atlanta or Dallas, and it's strategically valuable over time. I have no doubts; we can leverage that region, especially given the significant shift in consumer preferences towards digital and online banking. It’s essential to mention that we're seeking well-aligned deals that enhance shareholder value without compromising on diligence. Some recent inquiries we've received express strong interest in partnerships. Specifically, four attractive candidates contacted us in the last couple of months, showcasing a notable level of interest in partnering with us, even when we haven't actively pursued out-of-market acquisitions. As we seek partnerships, we're dedicated to focusing on economic sustainability and shareholder welfare. We'll engage only in deals that are clearly positioned for the long haul.

Thank you very much.

You bet.

Hello, hello.

Hello.

Hello.

Sorry about that. I didn’t realize I was called. I just wanted to circle back on the topic of deposit betas to ensure I interpret your logic correctly. Expectations suggest a decline from the 41% observed this quarter into the 30%-plus range. However, the cumulative beta has remained around 24%. I understand you are modeling around 50%, and frankly, 41% doesn’t appear excessively high considering the cycle we’re currently in. Given that context, how should we view the progression beyond the next couple of quarters? Do you foresee a general decline in betas, particularly as you gradually approach the terminal fed funds rate? Can you describe your perspective on the cumulative deposit betas during this cycle?

What we’re trying to communicate is that we had a rapid spike in the second quarter primarily driven by strategic decisions relative to market conditions. We anticipate this spike to normalize as we move into the third and fourth quarters. Should substantial interest rate increases occur and businesses utilize their available cash—an already observed behavior—we might see further stabilization in betas. Therefore, my assessment is that betas will likely return to a lower normal range in the upcoming quarters, and I agree that the 41% level is not inherently problematic; the rapid increase was the main concern that we aim to address.

Yeah, historically in bad cycles, deposit betas have ranged between 40% to 60%. Our cumulative beta is currently around 24%. I don't foresee it exceeding that 50% threshold cumulatively. The likelihood is it will remain at the lower end of that range. However, as Kelly noted earlier, we should expect a slight uptick in betas over time once the immediate spike lessens.

Okay. That’s helpful. And then just a quick follow-up on Regions; have you disclosed or provided any indication of the extent to which the acquisition could impact your buyback in the third quarter?

We have a best estimate right now. We will probably buy back about $200 million of shares this quarter. It depends on the balance sheet size and the capital ratios we want to maintain. We communicated in the last quarter that we prefer our CET1 to remain above 10%. The primary reason for this is to mitigate the AOCI risk that arises once we cross over $250 billion in total assets. With the current higher interest rates, the capital hit related to our portfolio and pension is about 100 basis points, which would lower our CET1 from approximately 10% to 9% immediately upon crossing that threshold. Thus, our future buyback strategy will hinge on the growth of our balance sheet and how quickly it expands. We will continuously update the market on our plans as we assess share repurchase targets.

Okay. That’s helpful. Thanks a lot.

Yeah.

Okay. Thank you, Kelly. And thanks to everyone for joining us. I apologize to the questioners in the queue that we didn’t have time to get to. We will return your calls later today. Thank you, and I hope everyone has a good day.