First Horizon Corporation (FHN) Q1 2016 Earnings Report, Transcript and Summary

Good day and welcome to First Horizon National Corp First Quarter 2016 Conference Call and Webcast. [Operator Instructions] Please note this event is being recorded. I would now like to turn the conference over to Aarti Bowman, Investor Relations. Please go ahead.

Thank you, Austin. Please note that the earnings release, financial supplement and slide presentation we will use in this call this morning are posted on the Investor Relations section of our website at www.firsthorizon.com. In this call, we will mention forward-looking and non-GAAP information. Actual results may differ from the forward-looking information for a number of reasons outlined in our earnings announcement materials and our most recent annual and quarterly reports. Our forward-looking statements reflect our views today and we are not obligated to update them. The non-GAAP information is identified as such in our earnings announcement materials and in the slide presentation for this call and it is reconciled to GAAP information in those materials. Also, please remember that this webcast on our website is the only authorized record of this call. This morning’s speakers include our CEO, Bryan Jordan and our CFO, BJ Losch. Additionally, our Chief Credit Officer, Susan Springfield, will be available with Bryan and BJ for questions. I will now turn it over to Bryan.

Thanks, Aarti. Good morning, everyone. Thank you for joining us. We are very pleased with the results of the first quarter and our start to 2016. We saw strength across all of our core businesses. We felt very, very good about the balance sheet growth, loan and deposit growth and our banking business. We saw improvement in our net interest income. Credit quality, in spite of a little normalization, continues to look strong and we feel very good about the outlook over the remainder of this year. As I mentioned, we feel good about the revenue and really the expense control we saw. We saw very positive operating leverage in the quarter. We saw the benefit of the rate increase begin to trickle through the balance sheet in the fourth – that occurred in the fourth quarter of this past year. We also started to take some actions to create further operating leverage. We took a charge for just under $4 million to facilitate the closing of some branches, consolidation of some branches that will occur over the remainder of 2016 and should generate further operating leverage into the future. We also took the opportunity with lower stock prices in the quarter to buyback $75 million worth of stock. We bought shares in the quarter reasonably aggressively as the price was down. And I believe we realized an average price of just over $12.30, $12.32 for the quarter. It will have a positive impact on EPS and return on common equity as we look out across the rest of the year. Overall, we feel that the economy continues to move forward at a reasonable level. It’s a little slower than we would like. I referred to it in the past as a plow-horse economy. It seems to be very steady and somewhat strong. This little downturn we have had in the fourth quarter and the first quarter in terms of lower growth does feel a little bit more real than we have seen in previous years and that customer sentiment is down just a little bit. It’s not clear whether that is related solely to the economy or the election season that we are caught up in and some of the uncertainty that, that presents. But overall, we feel good. We are positive about the economic outlook over the remainder of 2016 and we are still looking for a couple of rate increases later in this year. We continue to focus our business and our efforts on improving profitability and returns. We think we are making good progress there and we will continue to be focused. We have got the tools to disaggregate the business, to look horizontally across functions in the business process. We think there is further leverage and revenue opportunities that we can realize and that we can continue to build on the momentum there. So, while we are making good progress, we are committed to driving our bonefish goals and we will continue to focus all of our efforts in that regard. So with that, let me stop and turn it over to BJ and let him cover the details in the quarter.

Alright. Thanks, Bryan. Good morning, everybody. I will start on Slide 5. For the first quarter, we reported net income available to common of $48 million or $0.20 a share. Pre-tax income was strong, both linked quarter and year-over-year. You can see on the page adjusting for notable items, our adjusted pre-tax income was up 9% and 18%, respectively linked quarter and year-over-year. You will note that even with meaningfully higher pre-tax income, the net income was relatively flat to the fourth quarter. As you recall, we had well below normal effective tax rate of 5% in fourth quarter. This quarter’s effective tax rate was 32%, more in line with what should be expected. And given the variability in the tax rate over the last several quarters, no one is more pleased that we had a reasonable effective tax rate than I am. We achieved positive linked quarter operating leverage, as Bryan talked about, with consolidated revenue up over 2% and adjusted expenses down linked quarter. We saw strong top line revenue growth in the quarter. Net interest income growth was up 3% linked and 10% year-over-year, as we captured some of the benefit of our asset sensitivity and saw the positive impact of the strong balance sheet growth we have been experiencing. As you can see, total loans for the company were up 2% linked quarter and 7% year-over-year. Fixed income fee revenues were strong. They were up 8% linked quarter and 9% year-over-year, which I believe demonstrates the difference between our business model and fixed income relative to other firms across the industry. Expenses were down linked quarter. The notable item in the current quarter, as Bryan talked about, was a $3.7 million impairment charge related to future branch closures. The adjusted expense of $223 million includes higher variable compensation related to fixed income revenues and the normal seasonal impact of first quarter FICA reset. Loan loss provision totaled $3 million in total. Non-strategic portfolio had a provision credit, but we increased loan loss provision in the bank and I will go into more details on credit in just a few slides. As Bryan mentioned, we were thoughtfully active in the first quarter with share repurchases. We sought to take advantage of the heavy sell-off in the equity markets at the beginning of the year. We ramped up and frontloaded our share repurchases in the quarter, ultimately buying back $75 million worth of common stock, which was a little over 6 million shares or about 2% of the company’s outstanding shares. The repurchases were executed at a volume weighted average price of $12.32 over a 10% discount to yesterday’s closing price of $13.74. So, we are obviously pleased with that result. Slide 6 shows an overview of our segment highlights and some variance analysis for each. But let’s go straight to some more detail on the core businesses in the next few slides. So, starting on the regional bank on Slide 7, we saw continued solid performance from the bank. Balance sheet growth is nice, but it needs to translate well into top line growth and that’s exactly what we have seen. Net interest income in the bank was up 2% linked quarter and 12% year-over-year largely driven by benefit from December’s rate hike and continued commercial loan growth. Non-interest income was down linked quarter, primarily on seasonal declines and deposit transaction fees. The loan loss provision in the bank was $15 million in the quarter on $9 million of net charge-offs. While credit quality trends in the bank remain historically strong, we may be seeing the beginning of some normalization in the credit cycle. In the commercial loan portfolio, we experienced deterioration in a handful of credits and the number of commercial loans upgrades moderated compared to the amount of downgrades. Expenses decreased 2%, mainly down from lower – on lower pension and advertising expenses as well as good overall expense control, which were somewhat offset by the branch impairment charge. Turning to the regional banks balance sheet on Slide 8, we see strong growth continuing across all of our commercial portfolios. The average loans in the bank were up 3% linked quarter, 13% from prior year. Linked quarter loan growth came from our economically profitable specialty lending areas, such as asset-based lending, commercial real estate and our loans-to-mortgage companies business. We are gaining market share in asset-based lending and loans-to-mortgage companies continue to benefit from relatively low rates. Commercial real estate balances reflected the funding up of commitments and the inclusion of commercial real estate loans from our TrustAtlantic acquisition. Average core deposits in the bank were up 1% linked quarter and 8% year-over-year. The increases were related to seasonal inflow of public funds and year-over-year deposit growth reflected in the TrustAtlantic acquisition. As Bryan alluded to, customer sentiments mixed across our markets and industries. Business strength is evident across our specialty lending businesses. Our West and East Tennessee markets are generally stable. Middle Tennessee is strong given the areas above-average employment rates and growth in the entertainment and healthcare industries. In the Mid-Atlantic, we see customer sentiment slightly improving and recent borrowing trends are more correlated with capital spending versus M&A. Obviously, Houston is stressed with energy issues, but we think waiting out the cycle will give us opportunity to build a quality pipeline and the overall Houston economy remains relatively healthy at this point. Moving on to our fixed income business on Slide 9, we saw improved performance as average daily revenues were $944,000, up 11% from the fourth quarter. While the increase in volatility and significant interest rate movements intra-quarter was difficult for the broader fixed income industry, our sales and distribution models have delivered strong outperformance. As you can see with the chart at the top right of Slide 9, close to 40% of the trading days in the quarter, we saw over $1 million of average daily revenues. Our agency desk, in particular, performed well, where we remained the number one underwriter of callable GSE debt and increased our market share from 4Q ‘15. And our corporate debts saw strength – particular strength as well. As our fixed income platform continues to be very attractive in the marketplace, we also continue to have success recruiting experienced sales reps and we expect that to continue. Moving on to net interest income and net interest margin trends on Slide 10, our asset sensitive balance sheet, coupled with profitable loan and deposit growth, paid off with NII and NIM up nicely in the first quarter. You see linked quarter NII was up 3% and the margin expanded 6 basis points to 2.88%. Year-over-year, NII was up 10% and the margin was up 14 basis points. As you can see on this chart, we have managed to keep NIM and NII fairly stable to growing over the past 2 years despite the low rate environment. Since 1Q ‘14, we have grown loans 15%. Our focus on making profitable relationship-oriented loans has paid off with a resulting NII growth of 13% over that same time period. Our loan growth asset sensitivity and solid funding base as well as a higher mix of floating rate loans are all factors that have contributed to the stable margin and positive NII trends. Turning to asset quality on Slide 11, net charge-offs were $9 million in the first quarter compared to $2 million in 4Q ‘15. You will recall that 4Q ‘15 included a $6 million recovery. And in the first quarter, it included a single energy-related charge-off of $6 million. As the chart in the upper right illustrates, combined with the information I just gave you, net charge-off levels remained relatively stable over the last several quarters. Linked quarter, we did see an uptick in 30-day delinquencies, which were up 12 basis points. The increase was in the regional bank, but half of these are related to administrative delinquencies that we expect to be resolved favorably early in the second quarter. The consolidated allowance-to-loan ratio was 116 basis points as of the end of the quarter. And as I mentioned earlier, we added to loan loss provision in the bank as the number of downgrades modestly outpaced upgrades and we saw continued loan growth. The non-strategic portfolios credit trends remained strong and the non-strategic balances continue to decline and comprised only 11% of average total loans at the end of the quarter. And I think the chart in the bottom left offers a good illustration of the major components of our allowance. Our bankers remain disciplined in their underwriting, within our risk appetite and are focused on relationship banking with a good understanding of the key drivers from risks of our clients. We will continue to operate within the prudent framework of portfolio diversification and policy exception limitations. And we feel good about how we are managing our risk. Wrapping up on Slides 12 and 13, as you can see with our first quarter results, we continue to execute successfully on our key strategic priorities. We saw strong loan and deposit growth translate into very good net interest income growth and margin expansion. Our fixed income business took advantage of its strength to book a quality quarter and we were able to smartly deploy capital with our share repurchases. So, with that, I will turn it back to Bryan.

Thanks, BJ. We feel very, very good about the strength of our franchise. We have continued to build on it. As BJ noted, we have hired very good people in both our fixed income and our core banking businesses. Our loan and deposit growth has been very strong. And as BJ said, we are targeting the heart of the market in building good core deep relationship-oriented business that we feel good about for the long-term. Pleased with the revenue growth that we saw in the quarter and the operating leverage in the bank with the improvement in net interest income and expense control. As BJ noted, we continued to see improvement at FTN Financial, $944,000 in average daily revenue. We feel very good about our distribution-oriented model and its ability to continue to perform strongly in this environment. We saw good expense control across the business and we continue to feel good about the credit outlook in the business. As we did in the last cycle, we got out early in trying to tackle credit problems and we are in the – we commit to doing that again in this cycle. We feel good about our credit outlook for the year. We think it will be a little more balanced than it’s been, but we do feel good. We have a strong capital base. Our Tier 1 common at 10.3 is strong. We have used the opportunity in the first quarter with lower stock prices to continue to repatriate capital to our shareholders. We think we have the ability to continue to do that throughout 2016, and we will look for opportunity to be opportunistic to buyback the stock. Thank you to the First Horizon, First Tennessee, FTN Financial people both on the line and the support groups all they are doing to build the organization and add strength to our model and deliver our customers a differentiated customer experience. And with that, Austin, we will open up the call for any questions folks might have.

Thank you. [Operator Instructions] And our first question comes from John Pancari with Evercore. Please go ahead.

Good morning.

Good morning, John.

Hi, John.

I wanted to ask first about the margin, just want to get some thoughts on the outlook here. Is it sustainable at this level? Is the – are the Fed – was the Fed hike largely in the run-rate by now? And what would be your outlook for the margin here without Fed hike? It sounds like you have got two additional Fed hikes. So, if you could just confirm that. But I was just wondering what your outlook would be if we did not get any? Thanks.

Sure, John. It’s BJ. Good morning. Yes, we are currently still projecting in our internal forecast two rate hikes. And if that occurs, we could see meaningful continued margin expansion, meaningful, meaning probably over 10 basis points throughout the rest of the year. With rates flat, we still think that we can defend the margin at this level and maybe even modestly expand it over the course of the rest of this year. The margin and what we are booking as well as keeping our deposit cost low is allowing us to continue to improve our margin and most importantly drive NII in this environment. And so we are pleased with how our bankers are booking loans and we think that we can continue to have positive results.

Okay, alright. That’s helpful. Thanks. And then on the credit side, I wanted to just get a little bit of color on the increase in the non-accruals. I know you indicated there was a couple of C&I credits. Was that – was any of that energy? And then if there was anything else other than energy, what sectors was that in? Thanks.

John, it’s Susan. The increase in the non-accruals was in the C&I regional bank portfolio. One was an energy credit reserve base credit and the other was just a corporate credit that has been classified actually for several years and just went into a nonperforming status.

Okay, alright. And then do you have what industry that one was?

It’s just – it’s a manufacturer of sports equipment.

Okay, alright. Okay. And then lastly was on the expense side, I just want to get your thoughts on your total expense outlook for the full year. I know your previous guidance was in the 8.60 to 8.70 range. The new run rate, if you look at this quarter, would imply around 8.90 and you certainly sound a little bit more upbeat on the capital markets outlook. So therefore, I guess, capital markets related compensation could remain elevated. So, if you could just talk about your thoughts on the full year outlook on the expenses given that? Thanks.

Hey, John, it’s BJ. Sure. So, as we have always talked about 8.60 to 8.70 included certain assumptions around fixed income. And we would be very happy if the delta to the upside on expenses was because of fixed income driven by higher revenues. That’s what we saw this quarter. We would certainly hope it would continue. There was – there has been continued strength in the business throughout the first part of the quarter. So hopefully, that lasts. The second half of the year is a little bit harder to project. But as Bryan kind of alluded to, there is probably $3 million to $4 million of increased variable comp that came from fixed income in the quarter. So, if you annualize that and you assume that may or may not normalize, you get back down into our range that we talked about previously. So, ex that variable type cost, we think that expenses are well maintained, well controlled. The branch impairments that we took this quarter should actually help us to the tune of $4 million to $5 million a year annualized in terms of run-rate savings. So, we are doing a lot of things under the surface as well to keep our expenses in the range that we talked about previously.

Our next question comes from Ryan Nash with Goldman Sachs. Please go ahead.

Hey, good morning guys.

Good morning.

Maybe I could just start off with a question on credit, when I look at gross charge-offs, they have been stable in the $18 million to $20 million a quarter. You highlighted recovery slowing a bit, but yes, we did see the provision in the regional bank up to $15 million. So, I guess I was just wondering we think about the moving pieces of credit given the moderating of upgrades and downgrades, would you expect the provision in the regional bank to level off closer tier? And then just specifically on the reserve, obviously the gap between the regional bank and the consolidated have been converging, can we continue to see that? And maybe just comment on the pace of what you think that can happen?

Well, Ryan, as you noted, we did have an increase in provisioning in the regional bank and it’s driven by several things. BJ mentioned some of these. The moderation in terms of upgrades at slightly more downgrades, so when you look at models for average loss rates probably default grades that leads to a higher provision. We also really do have a conservative spring approach when we look at loss modeling. We did, as you recall, extend the look-back period in the loss emergence periods last year to maintain that conservative and then in our reserve methodology. We also have as we continue to see loan growth in the regional bank. You could expect to see provision grow along with loan growth. So, I would expect that coverage ratio, all things being like they look today, to remain relatively stable. And we will be conservative in our approach if we start to see things turn. In credit, you could see that go up. Non-strategic, we have continued to see not only an increase in the prepayment runoff rate. You will notice in a chart in the appendix on Page 19 that the consumer non-strategic runoff is now at a 32% prepayment rate. Just 2 years ago, it’s only 19%. So, you have had an accelerated prepayment rate in the non-strategic. In addition to that, the non-strategic consumer portfolio is continuing to perform better than we would have expected in terms of charge-offs, even for those non-strategic home equity borrowers that have entered prepayment. We have actually seen several consecutive quarters of charge-off rates in that prepayment portfolio go down. So, that’s allowed us to release reserves in that non-strategic portfolio.

Got it. Maybe Bryan or BJ, in terms of the capital return, we obviously saw an acceleration in the quarter given the stock had gone on sale. When I think about the pace of buybacks from here, your $58 million remaining on the authorization, how do we think about how much with that we frontloaded this quarter, because what the stock price did versus a more ongoing rate of buyback?

Well, Ryan, this is Bryan. We will continue to be opportunistic. We have bought back and we have had the approval of the board in a number of authorizations in the past to buyback stock at attractive prices. And as we said many times and in many different forms, we are freeing up a lot of capital as the non-strategic portfolio winds down in addition to the reserves that Susan just talked about. And we think that our strong starting capital position and the strength of earnings is going to allow us to continue to repatriate capital to our shareholders. We will pick our spot. We think stock buyback is one of the key mechanisms for executing on capital repatriation. And so you can expect that we will continue to pick our spots and buy stock throughout the year.

Our next question is from Steven Alexopoulos with JPMorgan. Please go ahead.

Hey, good morning everybody.

Good morning, Steve.

I want to start on the capital markets business, which obviously had a nice quarter. But since then, market volatility has trended down quite a bit. BJ, you sounded somewhat upbeat on prospects near term, curious how you guys are thinking about ADR heading into 2Q?

Yes. Steve, it’s BJ. So like I said, the beginning of this quarter has continued to be strong, probably at the levels that we saw in aggregate for the quarter. And as I talked to our leaders out in FTN, we have had a few larger trades here and there. But generally, it’s been fairly broad based, which is a good sign. So, volatility has helped. Rates are still at a level that helps us. We are a leader in agency callable. So, we see and are able to underwrite a lot of deals there. I talked about the strength of our corporate desk. If you know, as spreads have been moving around quite a bit between treasuries and investment or even high-grade spreads. There has been a lot of activity there that we have been able to capture. So, our model works well in an environment like this without proprietary trading. So all of that said, I think right now, we are optimistic about the second quarter and levels that are similar to the first, but we will continue to monitor.

Okay, that’s very helpful. Thanks, BJ. Just one question on loan growth, ex-mortgage warehouse, C&I was flat in the quarter. Could you give more color on what you are seeing? I know Bryan you said customer sentiment seemed to step down and maybe talk about where the pipeline currently stands? Thanks.

Yes. I will start and then Susan can pick up. As I said, customer sentiment is a little more uncertain at this point. Pipelines seasonally drop a little bit in the first quarter. They are not soft by any far stretch. They are down a little bit, I think, from the end of the fourth quarter, but we feel good about sort of the positioning in the marketplace. We think we are going to get our fair share of the deal flow and the footprint. We think that outside of mortgage warehouse lending, in addition to just the core C&I in the Tennessee footprint, we think there are opportunities to continue to look for growth in our ABL business, our correspondent business. We still think even with the sort of the transition that’s going on in energy lending, we think there will be opportunities for us to grow in a prudent way our lending portfolio in Houston as other people reposition their portfolios. So, we feel pretty good about the outlook for credit – I mean for loan growth over the remainder of 2016 time horizon.

In addition, in the Middle Tennessee, we have set out lot of focus in Middle Tennessee. Our commercial pipeline there is double what it was this time last year. So, it’s a robust economy, but we have also – we have got a great group of bankers and we have hired some additional great bankers in that market. So, outlet payers are good. Raleigh and Richmond also have some good opportunities in the pipeline. And as you recall, we had the TrustAtlantic acquisition in the Raleigh Greensville market firm last year. So, we do see some areas, where the pipeline is ahead of where it was last year and some areas where it’s a little softer.

Our next question comes from Ebrahim Poonawala with Bank of America Merrill Lynch. Please go ahead.

Good morning, guys.

Good morning.

I think due to first question, BJ if I can follow-up on your comments around the ability to maintain the margin around these levels even if we don’t get a rate hike. If you can help us sort of give a sense of maybe try booking in new loans, which are coming in both on the commercial and the consumer side? That will be helpful.

Yes. It’s going to obviously vary by the different portfolios. But relatively speaking, booking in the yield to 3.5 range or something like that. By and large, loans-to-mortgage companies, is going to be higher yielding. There are going to be certain pockets of core C&I that are going to be higher. But generally speaking, that’s kind of where we are booking. And so it was the challenge to book fixed rate loans as we were earlier in the low rate cycle, because re-pricing was an issue, but we have gotten to the point where re-pricing relative – pricing of new originations relative to our existing portfolio, there is not a material difference. And as a matter of fact, in certain pockets, we are able to start to improve that as we see renewals and other new origination. So, that’s why I think we are a little bit more confident about our ability to first defend the margin and then modestly improve it as we continue with good solid pricing discipline that our bankers are showing.

Ebrahim, you also asked about consumer and consumer goods opportunities. We are seeing some of that very good growth in our private client focused consumer areas. Middle Tennessee, as I mentioned earlier on the commercial side, is also seeing strong growth in private client consumer-focused loans and also good growth in our Mid-Atlantic private client areas as well.

Got it. And on the consumer side, we are essentially booking home equity lines or unsecured loans?

It’s mostly real estate installment loans. It’s the predominance there of what we are booking.

Our next question comes from Emlen Harmon with Jefferies. Please go ahead.

Hey, good morning, everyone.

Good morning.

Good morning, Emlen.

In capital markets, despite the increase in ADR is a profitability the net income held flat this quarter, obviously component of that is probably FICA. Could you give us a sense just for how much of an effect FICA had and kind of what the profitability increase would have been without that?

Yes. So, FICA reset in aggregate from the company is just probably under $4 million or so. So, maybe a third of that maybe or so might be FTN.

Okay. So, were there other expense items outside of just the variable comp increase that would have been a drag on profitability there?

Yes, it all depends on the dynamics of how our commission model works. Everybody is on commission. And depending on volume of certain salespeople, their grids could go higher or lower. And so larger producers are going to hit grids higher in markets that are more favorable and they are doing more business. And so it’s just simply a mix of who is selling and where their compensation grid is falling out. It’s nothing more than that.

Got it. Okay. And then either Bryan or Susan, well, I guess, Bryan you sounded relatively comparable with most of the geographies and business lines. I would guess maybe a little bit more cautious tone on the credit outlook than we have heard from some others kind of where are the areas where you are more concerned in terms of other businesses or geographies outside of Houston?

Yes, I will start, Emlen this is Bryan and then turn it over to Susan. In broad terms, we are not particularly concerned in a broad way about softness in the credit markets. There are a few pockets here. We think multifamily housing is an area to be cautious around. Houston is being to some extent affected by the transition of pricing, particularly in the oil and gas economy and what that does. But Houston is a huge economy. One and two, it’s still a very strong economy. And I guess the third point is we have a very small presence there. So, much like commercial real estate in 2009, 2010 where we were underexposed, we think there is an opportunity to look for deal flow in Houston that we can pick up on. Our outlook around credit, maybe we sound more cautious more relative to others. I don’t intend to say we think that the sky is falling, because we certainly don’t. We think that credit is about where it ought to be at this stage in the cycle and Susan mentioned upgrades and downgrades slightly more downgrade this quarter. But at the end of the day, we expect it to be more balanced this year. We think there would be as many upgrades as there are downgrades in sort of the maturing of the credit cycle. Now, so there are no real pockets that we are concerned about. We see growth opportunities across the footprint. We think C&I opportunity will continue to be steady. As I said, the economy continues to move forward maybe at a little slower pace in the early part of this year. But overall, it continues to move forward and we think we are comfortable continuing to lend into that.

Yes. As Bryan said, we will continue to be patient and cautious in Houston related to what’s going on in energy. We have invested pretty good way to do it. That being said, we have got a great group of bankers and we do believe that the Houston economy will for us some good opportunities in the future. We are watching, as Bryan said, we have slowed new exposure in multifamily and somewhat to hospitality. We watch closely in commercial real estate, not only product types, but also geography. We remain well diversified in those product types and geographies in commercial real estate. In addition to that and Bryan said this earlier, we did this in the last credit cycle that we are prepared to get out ahead of this credit cycle. We continue to have good oversight as it relates to servicing exception management, portfolio limit, processes and training. We believe that ongoing credit training is an important part of asset quality maintenance. And it’s like red flags training where we make sure that our bankers get refresh training on looking for early signs of deterioration versus recognizing those in the later stage. So, we remain cautiously optimistic, but want to make sure we are prepared to look for something as the economy did take a downturn.

Our next question comes from Ken Zerbe with Morgan Stanley. Please go ahead.

Great, thank you. I guess, first of all, just want to address energy really quick. So, I know you have a really small portfolio. It’s even quantified, but I think it was just over $100 million. But my question is you have just ran-off about 6% of a very small portfolio. What was the path of that deterioration? For example, like last quarter, was it already on nonperforming or criticized? Was this say complete surprise or was this a really fast new issue for you? Just wondering how the deterioration actually happened over the last few months.

Yes, it was – I will take that. We did have it classified last quarter. It is a reserve baseline. It was done earlier in our entrée into Houston. The charge-offs and taking it nonperforming this quarter were a result of the spring re-determination, which showed from not only issues with the price of oil, but also the production out of the specific wells related to that credit. So, that’s – it was not – it certainly wasn’t a complete surprise this quarter. It’s one they have been watching for several quarters and we already had it classified prior to this quarter. We do take the opportunity for any credit where we have a downgrade to non-path. And certainly when we take a charge-off, we take the opportunity to look at origination, servicing any type of that and to look at do we need to be more cautious in the future. In this case, we believe this was largely driven by the issues in the energy industry.

Got it. Okay. And then just the other question I had just in terms of margin. I did hear that you said that you expect sort of stability and hopefully a little bit out from here. Does any of that depend on external factors such as additional debts coming due or something other than sort of higher rates or where your current loan yields? Thanks.

Hey, Ken, it’s BJ. Short answer is no.

Okay. So, it’s just purely organic stability given where loan yields are.

Yes.

Okay, thank you much.

Sure. Thanks, Ken.

Our next question is from Marty Mosby with Vining Sparks. Please go ahead.

Thanks. BJ, I wanted to look at high sensitivity analysis that you gave. And I wanted to compare the actual impact that you highlighted for the first quarter of $3.3 million to the $7 million impact for the 25 basis points when you get the next hike. It looks like the $7 million is annualized, $3.3 million is a quarterly number. So the actual benefit you are estimating is about half of what you just got in this last rate hike. Are you still being relatively conservative on deposit basis and the way you look at that?

Hey, Marty. Good morning. So, three or so the impact as you said was from the December rate hike we had gotten a modest amount of the benefit in – excuse me, in the fourth quarter as well. We still think that we have got a pretty prudent strategy to manage the asset sensitivity and rates going forward. We definitely saw yield expansion from the first rate hike. So, that was positive. If you look at our deposit cost, they were up a little bit more than what you would have maybe expected. Those were related to a couple things that are going to re-price immediately that we would have thought about, public funds deposits, our promontory and shared network deposits, some correspondent banking-related interest checking deposits, so all of those were things that we expected. But by and large, we think the margin expansion was about where we thought it was going to be. And we think it will continue to improve from here and expand if there are more rate hikes.

Marty, this is Bryan. I will add to BJ’s comments. Some of it too is timing. LIBOR tended to drive up loan yields and they built a little bit faster. They re-priced contractually some of the deposit base. BJ talked about some of the elements that do re-price contractually. Some of it will have a little bit of lag in the re-pricing. Yes, you ask or sort of alluded to conservatism and deposit base. We think we are modeling them reasonably conservatively. There is some degree of uncertainty, because we have never come off of zero before and we have never done it with a liquidity coverage ratio and so on and so forth. But we think we have been reasonably conservative in the way we model our deposit base and feel pretty good about how they ought to perform. We are paying a lot of attention to deposit pricing and that’s something that gets a tremendous amount of focus, not only from me and BJ and David Popwell and others, but throughout the banking organization, because we recognized that managing that deposit cost is very, very important to driving profitability from rising rates.

Yes. I want to make sure that you understood the kind of comparison was that you did 2x better on this last rate hike than what you are estimating on the next one. So, the 1% sensitivity was actually a 2% pickup this last time. So, this seems like you are haircutting as you move into the next rate hike. There is some upside there that might be beneficial.

There – yes, Marty, but there are couple of factors. One of them I alluded to was the timing and loans re-priced contractually. Deposit cost will trickle at a slower pace. So, some of that will be more normalized throughout the remainder of the year. And we have always believed that the first rate hike was more profitable than the second rate hike simply because of that lag in deposit rates. So, between those two factors, I think you will see it’s tracked more with that sensitivity that we are modeling there on the slides.

Okay. And then BJ, I just want to ask you about the corporate number, the $15 million. Is that coming back in history that’s had some volatility to it? Is this kind of a more normal kind of run-rate that you would expect from the drag in the corporate segment?

Probably not. What we have got in the corporate segment that drives a lot of the negative is not just corporate overhead expenses that are not allocated to businesses, but also central money book and the net interest income or lack thereof that sits in the central money book relative to what its funds transfer priced out to the businesses. So, in the low rate environment that we have, we actually have negative net interest income in the corporate segment. And as rates continue to normalize, you should actually see that negative abate in the corporate segment such that the corporate net income should actually improve over time.

Our next question comes from Jared Shaw with Wells Fargo Securities. Please go ahead.

Hi, good morning.

Good morning.

Just looking at the branch closures and the potential for additional location consolidation, how should we be looking at that going out over the course of this year? Should we see continued opportunistic consolidation or is there more of a bigger plan for bigger push?

On the branch network?

Yes, right.

I think we have been talking about this for a while. And Dave Miller and our folks in our consumer bank do an excellent job really thinking through the changing consumer preferences and behaviors of what we have got going on. We have got as you would know, number one market share across the state. And that affords us an opportunity to be very smart about where we have our physical network and also start to change the way that physical network looks and transfer investment to things like digital, online banking, mobile banking, call centers, etcetera where customer preferences continue to shift. So, we have done a great job of bringing down our branch network smartly, not just to provide cost savings, which it certainly does, but also to reinvest elsewhere. 5 years ago, our branch network would have been 50 branches higher than where it is today. And so we expect that, that will continue to come down, not just this year, but over the next several years again as customer preferences change. And we see more of a move to digital. The important thing that we watch is what happens to customers. Where do they go? What’s the revenue attrition, etcetera? And I will tell you that on the last 40 or 50 branches that we have done, the revenue attrition has been less than 5%. So, that kind of tells us that are – the accepting branches that we have are doing a great job of being as convenient as what the closing branch was as well as the wrapper that we have around mobile banking, online banking, etcetera. So, you should expect us over time to continue to optimize that branch network and we think that’s just a smart thing to do to follow our customer preferences.

So, when we look at the $3.7 million from write-downs that happened this quarter, was that actual branch closing or was that more preparing in implementing some of these additional strategies to prepare for either downsizing or consolidation?

Sure. Yes. So, when you make a definitive decision to close the branch and start to send out notices to customers about a change in a branch, accounting wise, you have to then look at the physical assets like beyond building, etcetera and mark it down to what its salable value would be. And so as we looked at the branches that we were closing, we were marking that as physical facilities down to that market value. So, that’s what the impairment is. And then ongoing you get the business saves as you actually execute on those plans.

Jared, this is Bryan. To put a number on, as BJ said we have noticed and communicated with customers and started the transition process, I think the number of branches that were actually in the process of noticing and communicating and transitioning today is about 10. We will probably close somewhere between 15 and 17 over the course of the year. But as BJ said, this is an area where the use of Southern colloquialism, we measure twice and count once. And so we pay a lot of attention to the impact on customers and the behaviors. And we think with the work that we are doing with our mobile tools, our Internet tools, the investments we are making there, what we are seeing and continue to see developing customer patterns and branch behaviors, the technology that we put in branches, like cash recyclers, etcetera that free up people to handle more customer transactions and the branches in particular and doing in a more personal and thoughtful way. We think there is an opportunity to continue to rationalize the branch network over the remainder of this year. And I wouldn’t suggest that there won’t be opportunities in 2017. I think we will have additional opportunities in the future.

Our next question comes from Kevin Fitzsimmons with Hovde Group. Please go ahead.

Good morning, everyone.

Good morning, Kevin.

Could you just – you mentioned that I believe once when you were talking about loan growth, but can you just give us a little sense on how the Mid-Atlantic region is going? I know you were already at lending there, but then with the TrustAtlantic deal and how that’s going, what your expectations are and maybe if you can Bryan dovetail into if M&A or acquisitions will play any part in the expansion in that region? Thanks.

I will start, Kevin. We – as I mentioned a few minutes ago, we are seeing some good growth in the private client growth in Mid-Atlantic. We also think that several of the markets based on just what’s going on in those markets seeing vibrant growth markets that there are opportunities as well as hard great caliber bankers and leaders in those markets. So Richmond, we believe has additional potential. It’s a great market for us. Raleigh Greenville, which we picked up additional depth in terms of bankers and branch locations with TrustAtlantic. The Raleigh metropolitan area is a very good growth market with diversified industries. We believe that we can continue to capitalize there. And then also seeing some increases in requests out of the Charleston and Jacksonville markets. And we believe that the Mid-Atlantic still has a lot of upside potential based on what’s going on in those individual markets as well as the bankers that we have hired in those markets.

Kevin, this is Bryan. We feel very, very good about the progress that we are making with TrustAtlantic. We feel good about the team that has joined us and what we see in terms of the opportunities in Raleigh and the triangle area in particular. It’s a huge growth area. It has a lot of similar demographics to Nashville for example in terms of disaggregate inflow of people and growth and opportunity. And from an M&A perspective, it’s still an environment where we think that appropriately priced, lower premium transactions on a larger scale makes sense and would be an opportunity to grow. And as in TrustAtlantic, where we have opportunities to fill in, in a targeted fashion, we would continue to look at them. I would say that our discipline around M&A will continue to be just to make sure we are getting into markets that are truly important to get into and that our pricing and our structure reflects the benefit to our shareholders as well as the selling shareholders. But it’s not something in the Mid-Atlantic area that is a key part of our strategy in the short run – excuse me, chokes me up, I will get these allergies on dealing with, in the short run, we will continue to execute on TrustAtlantic. We will continue to do what we are doing in the marketplace. And as opportunities present themselves, we will continue to consider all around our footprint and in the contiguous markets.

Our next question comes from Christopher Marinac with FIG Partners. Please go ahead.

Thanks. Good morning. Bryan and BJ, I was wondering if you could give us a little more breakdown on the loan growth as it pertains to Tennessee versus non-Tennessee. And then also within Tennessee, what would be sort of the just a rough split between the four major markets that you serve?

Yes. I will start and BJ can clean it up a little bit. A lot of the loan growth in the specialized businesses would either be in our mortgage space or – and/or some of these businesses like CRE and ABL. The CRE growth has largely been in the footprint of our existing franchise. Now, that would include Tennessee, Mid-Atlantic, and to some extent, some small exposure in the Houston marketplace. The sort of outlook we think for the core C&I business in the space is going to split out. We think all of the markets are doing pretty well. Middle Tennessee and Chattanooga are very strong right now. Knoxville, Northeast Tennessee and Memphis have been steady. As Susan pointed out earlier in the call, our pipeline in Middle Tennessee continues to be very strong, so we think that can be a good driver of core growth. Carol Yochem and her team, the folks we have added to that team, are doing a fantastic job and we think we will continue to build share there. So BJ, you may need to clean up some aspects of that.

No, I think that’s right. If you think about where we have been focusing our growth efforts, they have been in the specialty businesses, which have always historically been regional. And so you think about where we are getting our growth, it’s probably disproportionately outside the state of Tennessee. The books that we have in Tennessee that Bryan talked about, the core C&I books in the West and the East are very strong and stable and seeing good steady growth, but not as outsized of a growth opportunity that we are seeing from the specialty. So, it’s to be expected and that’s kind of how we manage our risk appetite to be able to take advantage of the more regional calling efforts. And we think that, that will continue.

Okay, great. That’s helpful. Thanks for that. And I guess just a quick follow-up has to do with the efficiency ratio at the regional bank unit. A couple of quarters ago that broke through 60, I was just curious if that’s a realistic that it gets back there this year or would that be more of intermediate term goal?

No, I think we have got our sight sets on something more in the mid 50s or below for the regional bank. And I think we believe that that’s entirely possible. If you look at the good momentum on the top line as well as the good expense control that you can see in the bank, clearly, those are the two components that are going to drive a better efficiency ratio and we talk a lot about in the bank, positive operating leverage. And the more that we can get that, the quicker we can get to those mid-50s levels. So, we think we may continue progress on.

This concludes our question-and-answer session. I would like to turn the conference back over to Bryan Jordan for any closing remarks.

Thank you, Austin. Thank you all for joining us today. We appreciate your interest and value your time. Please follow-up with Aarti, me, BJ, Susan if you have any follow-up questions or need any additional information. Again, thank you to the First Horizon, First Tennessee, FTN Financial folks for all you are doing to build our company and I hope you all have a wonderful weekend. Thank you.

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.