First Horizon Corporation (FHN) Q4 2016 Earnings Report, Transcript and Summary

Good morning and welcome to the First Horizon National Corporation Fourth Quarter 2016 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [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, Gary. Please note that the earnings release, financial supplement and slide presentation we'll use in this call are posted on the Investor Relations section of our Web-site 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 is reconciled to GAAP information in those materials. Also, please remember that this Webcast on our Web-site 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'll now turn it over to Bryan.

Thank you, Aarti. Good morning, everyone. Thank you for joining us. I'm really pleased with the progress we saw in 2016 in the fourth quarter. We saw very good customer acquisition. We saw good trends in loan and deposit growth. Overall, our fixed income business was strong. We saw good opportunities to invest in the business in 2016 and we invested in a number of our specialty businesses. We have announced the acquisition merger with Coastal Securities which will occur in 2017. Throughout our banking business, we were able to put in place an additional 50 frontline bankers, which is a substantial increase, and when you look at period-end headcount, we were essentially flat on our headcount. So, we are very pleased with the investments we are able to make in our businesses and what we think that leads to in 2017 and beyond in terms of revenue and profitability growth allowing us to leverage our capital and drive higher returns. I mentioned FTN having a stronger 2016. Obviously, the fourth quarter of 2016 was a little bit softer. October and November were pretty much in line with our expectations. December became very soft. BJ will talk more about it but the markets got very volatile, rates backed up substantially and volumes really fell off. Whether that were the effects of the election, whether that was the effect of the Fed meeting that occurred in mid-December or even the effect of the holidays in December, but revenue was – average daily revenue was very soft in the month of December. Expense control continues to be a primary focus for us. We saw a number of [costs] [ph] as one-time that BJ will talk about in the quarter. We also saw a little bit of what I would call a year-end cleanup in the fourth quarter. We think we've got the processes in place to have very good expense control as we look into 2017. One area of note that came in a little bit higher than we expected would have been are legal costs. We continue to wrestle with two or three matters which we are wrapping up related to the mortgage business in particular. In fact, one of the matters that we spent some money on in the fourth quarter actually is related to a significant recovery opportunity we are pursuing. So, we are very focused on expenses and we think we have the right controls in place and that will continue to be a lever for us in 2017. We continue to be focused very much on how we deploy capital. We continue to deploy it strategically, whether it be through our dividend policy, stock buybacks and/or further acquisitions of portfolios, or further acquisition opportunities. We continue to be thoughtful about how we deploy that capital in an effort to drive higher returns, which we experienced in 2016. So, we are focused on hitting the bonefish metrics, we're making good progress in that regard, very, very happy with the results. I'm optimistic that the operating environment in 2017 will continue to improve. Clearly, there is more optimism in the marketplace. Customers are generally more optimistic as a lot of it is dependent on what may or may not happen in Washington, what may happen in terms of interest rates. But as we look into 2017, we are reasonably optimistic about the operating environment and see a pretty good playing field for us as the coming year unfolds. So with that, I'll stop and turn it over to BJ.

Thanks, Bryan. Good morning, everybody. I'll start on Slide 5 of the earnings deck. For 4Q 2016, we reported net income available to common of $53 million or $0.23 a share, and for the full-year net income to common was $221 million or $0.94 of earnings per share. Relative to both prior year quarter and full-year 2016, the momentum of the franchise is evident. We were pleased with the double-digit loan and deposit growth, strong revenue growth, good expense discipline and excellent credit quality. Linked-quarter, we are pleased with the continued strength and momentum in the regional bank from a balance sheet and net interest income growth perspective, though lower fixed income activity, as Bryan talked about, as well as some legal settlement accruals did moderate our overall earnings in the quarter. Slide 6 provides what we think is a helpful view of the net income and per share impact of our business segments versus both prior year quarter and linked quarter. Versus 4Q 2015, you can see significant growth, 24% in fact, in regional banking earnings driven by double-digit revenue growth leading to positive operating leverage, even with continued investment in new specialty areas and growth markets. Versus linked quarter, you can see regional banking maintained its strong earnings levels while fixed income results were softer. Turning to Slide 7, as we finish up 2016, it's probably a good time to take you through a view of our progress on driving positive operating leverage. For us, that means more than just revenues growing faster than expenses. So that's obviously important and the ultimate goal. It also means maintaining a strong discipline on expenses, as Bryan talked about, by minimizing or eliminating what we call bad costs which are non-revenue-supporting and investing in good costs that do support revenue both now and in the future. For full year 2016, revenue increased 9% while reported expense decreased 12%, and was up 6% on an adjusted basis, resulting in solid positive operating leverage. As you can see on the graph, while expenses are up, the majority of the increases are largely related to revenue supported activity such as higher fixed income revenues, strategic hires in new specialty businesses and expanding our growth markets. The expenses in the corporate support segment and our non-strategic segment were well contained, even with elevated legal costs and settlement accruals. We believe that investing in these high potential businesses and markets now while still maintaining positive operating leverage overall will allow us to continue building momentum towards bonefish level profitability and returns. Let's turn to net interest income and net interest margin trends on Slide 8. As you can see in the upper right-hand chart, over the last two years, we have significantly improved the revenue trajectory and earnings power of the balance sheet. Full year 2016 versus 2015 saw a 12% or $75 million increase in NII through a combination of strong performance from our collective Tennessee markets, expansion of our higher-return specialty businesses and the early results of our investment in new markets and businesses. The majority of the roughly $30 million per quarter increase in NII from 4Q 2015 levels is from strong relationship growth and pricing discipline, with some help from the [indiscernible] rate increase that occurred in late 2015. With continued momentum, as evidenced by our pipelines, the continuing ramp-up of our newer businesses and expansion markets as well as anticipated future rate increases, we are bullish about our prospects. Linked quarter, consolidated net interest income was up a strong 6%, driven by higher commercial loan balances and an increase in short-term rates. Net interest margin expanded 4 basis points linked quarter due to the December rate move, demonstrating the benefits of our asset sensitivity position despite a modest headwind of higher cash balances. The duration of the securities portfolio lengthened from 2.5 years in the third quarter to 4.8 in 4Q 2016, primarily due to the significant rate moves on the longer end of the curve post election as well as some prudent bond swaps we executed in the quarter. Overall, however, our asset sensitivity was unchanged as securities portfolio duration extension was offset by strong deposit growth. As we usually do from fourth to first quarter, we do expect some pressure on the NIM and NII due to several factors; seasonal lower loans to mortgage company balances, which is one of our higher yielding portfolios; higher commercial and public fund deposit inflows; and higher cash levels in anticipation of the closing of the Coastal Securities acquisition. Full year outlook however remains bright. We expect continued solid loan growth from our existing markets and specialty businesses, incremental balances from our newer specialty businesses and markets, and more optimized cash levels. We are now also assuming two rate increases over the course of 2017, which will be accretive as well. On Slide 9, you can see the positive momentum being generated by our regional banking franchise. Linked quarter revenue was up 3% driven by a 5% net interest income increase from the strong balance sheet growth across multiple specialty areas and markets. PPNR and pre-tax income remained strong while we continued to invest in our future profitability and growth. Looking at regional banking balance sheet trends on Slide 10, you can see that average loans were up 5% linked quarter and 20% year-over-year. The growth was primarily driven by an increase in commercial loans from our specialty areas such as private client/wealth management, correspondent banking, commercial real estate and franchise finance. We saw a good momentum in our growth markets as well with Middle Tennessee average loans up 8% year-over-year and Mid-Atlantic average loans up 14%. We saw a steady growth in customer deposits while maintaining pricing discipline. Average core deposits in the bank were up 2% linked quarter and 6% year-over-year. Deposit costs in the bank were only up 1 basis point linked quarter and up 4 basis points year-over-year. We benefited from the rate increase with loan yields in the bank increasing 7 basis points linked quarter and up 20 basis points year-over-year. Turning to Slide [9] [ph], pre-tax income for FTN Financial, our fixed income segment, was $6 million in the fourth quarter compared to $15 million in the third. Lower earnings in the quarter reflected a decrease in fixed income average daily revenues to $718,000 compared with $922,000 in the third quarter. As Bryan talked about a little bit, challenging market conditions began in the latter part of the third quarter with increased expectations of a Fed rate increase and general pre-election market uncertainties leading to muted customer activity levels. This sentiment continued into the fourth quarter and was exacerbated by the sharp increases in rates and overall market dynamics following the November elections. Although performance softened in the fourth quarter, FTN finished full year 2016 with a strong increase in average daily revenue to $919,000 for the full year compared to $780,000 in 2015, and total fee income for FTN at $269 million for the year was the best performance we have seen in the business since 2012. FTN also maintained its position in 2016 as #1 underwriter globally of callable GSE debt with increases in both number of issues and par volume underwritten, and we finished in the top 10 for competitive municipal underwriting as well. As we announced in October, FTN has entered into an agreement to acquire Coastal Securities, a Houston, Texas based broker-dealer that specializes in government guaranteed loan products, principally SBA and USDA loans and securities. Planning activities are progressing well and the acquisition is targeted to close at the beginning of second quarter. Turning to asset quality on Slide 12, consolidated loan loss provision was zero in the fourth quarter, reflecting stable asset quality trends and continued runoff of the non-strategic loan balances. We actually had a net recovery of $500,000 in the quarter compared to net charge-offs of $2 million in the third quarter, and the reserve to loan ratio remained steady at 103 basis points. So obviously our credit quality remained strong and our outlook remains bright. Wrapping up on slides 13 and 14, we made good progress towards our bonefish targets in 2016. Our balance sheet trends were strong with loan and deposit growth evident. Our asset sensitivity paid off with increased net interest income and margin expansion. We improved returns with ROTCE at 10.6% for the full year. We deployed capital with the acquisition of the franchise finance portfolio, share repurchases, dividend payouts, and we entered into the agreement to acquire Coastal Securities which will further leverage our capital base. We will continue to control what we can control by investing in our revenue supporting activities while being disciplined with our overall expense base to drive positive operating leverage. We will continue to have a sharp focus on improving economic profit across all of our businesses through optimized use of our capital and maintaining strong pricing, fee and credit discipline. We remain somewhat optimistic in regards to the positive sentiment post elections for us in banking industry overall and look forward to continuing our strong momentum into 2017. And with that, I'll turn it back over to Bryan.

Thank you, BJ. To summarize, we are really optimistic about 2017. We think we are positioned very well. Our loan pipelines as we turn into the year are very, very strong. Again, we are very optimistic about the trends we see in the business. Fixed income business has begun to stabilize some here in the first quarter, so we are optimistic as we look at the year. I'm very proud of the hard work that our folks have done to build these two fine franchises and the business that we have an opportunity to continue to build on in 2017. Thank you to all of our colleagues for all the hard work that you do and we will continue to stay focused as BJ said on deploying capital in ways to drive higher returns, managing our customer acquisition, our expense control, our credit quality, doing all the blocking and tackling things that we've been about doing for the last eight, nine years. So, thank you all. With that, operator, we will take any questions.

[Operator Instructions] Our first question comes from Steven Alexopoulos with J.P. Morgan. Please go ahead.

To start, I had two questions on loan growth. First, you guys had good growth in C&I ex-mortgage warehouse. Could you give some additional color on the pipeline? I know Bryan, you had some preliminary comments there. And do you see a shift in the commercial pipeline at all post the election?

We are seeing the additional optimism from customers post election, feeling like things around regulation which would affect multiple industries including things like trucking and obviously our industry. So we are seeing some lift from that. And the other thing that we are seeing is, as we have added bankers, and Bryan talked about this earlier, these bankers are bringing opportunities for relationships that they've had for a long time into the pipeline as well. So, those pipelines have really benefited from both of those things.

There is generally more optimism about sort of build another plant, the economy seems to be getting better. In some sense, when the stock markets go up, people feel better about things. So we see more optimism in general and pipelines are looking pretty strong.

Okay. And then on the mortgage warehouse, what was the split this quarter of refi and purchase and where do you see the balances overall migrating to?

We did see toward the end of the quarter a shift more towards purchase than refinance. Earlier in the year, obviously we had a slightly higher percentage of refinance. We also brought in a number of new-to-bank clients during 2016, knowing that as interest rates at some point could go up, which they did later in the year, that continuing to build the number of clients that we have would be a good way to continue to sustain that business. But we would expect, one would expect during the fourth quarter and the first quarter, seasonally you always see some downturn in that business as well as, as long-term rates went up, you are seeing some pullback in terms of refinance. But the home purchase and home buying is also seeing a lift of early [indiscernible] optimism that seems to be in the market.

This is Bryan. We have always acknowledged that the mortgage warehouse lending business will ebb and flow and we've talked a lot about the last couple of years all the work that our team has done to expand and broaden and deepen relationships and bring on new-to-bank clients and we are seeing good traction there. And at least in 2017, while interest rates, particularly 10-year treasury has backed up some 75 to 100 basis points depending on your starting point, will drive lower refinance activity. As Susan said, we think the market for purchase activity can continue to be strong because the economy seems to be strengthening. As I mentioned earlier, with commercial borrowers, consumers, confidence is up. Home buying trend seem to be pretty positive. So, we can't forecast with a higher degree of precision what might happen over the next year or two. We're reasonably optimistic on that business as we turn into 2017.

Okay, that's helpful. Thank you, Bryan. And just for my final question, if we assume that interest rates fall the forward curve, what would your expectations be for average daily revenue in capital markets over the next few quarters?

I'm going to let BJ take that one.

So, Steve, that's a good question. I think we would expect it to potentially be at least at these levels and maybe higher. I think one of the things that we've talked about before is volatility being good in this business. The interesting thing is that there was plenty of volatility post elections but that wasn't necessarily very good to us, and part of the reason was that all the volatility was one way. And when that happened and rates backed up so much so fast, everybody kind of froze and that kind of muted our activity pretty significantly in the later part of the quarter. But if the expectations are that there is going to be some rate increases but they are not going to be nearly as sharp, there is going to be some more orderly trading, there is going to be repositioning of portfolios, then we do think that that's going to be good for our activity levels and our fixed income revenues could be higher. So, we're optimistic that they are at least at the levels that we saw this quarter, but probably trending towards being higher throughout the course of 2017.

Steve, this is Bryan. Listen, I'm going to take the risk of over-answering the question. We can't really forecast it very precisely, and so I'm not issuing a forecast, but we have to put together a plan for 2017 and I would say we are probably looking in our plan something in the 800s at this point. We think it will be a little bit better than the fourth quarter, and it may not be as strong in some parts of 2016, but we think overall we'll have a pretty good year in the fixed income business in 2017.

One more thing I will add, Steve, to what Bryan just said is, that's for our base business, our existing business. Obviously when we layer in Coastal Securities, Coastal we think adds $200,000 to $300,000 a day in average daily revenues, which will be helpful. So, we believe that that will help get us hopefully over the $1 million a day level and beyond.

Great. I appreciate all the color.

The next question comes from John Pancari with Evercore. Please go ahead.

First on the expense side, I know you have your long-term efficiency target in the 60 to 65 range, and then for 2016 full year came in around 72. Can you talk about 2017, I mean how much closer to the long-term target do you think you can get just given the amount of Fed hikes you think and some of this strengthening of balance sheet growth you could see and the expense containment efforts? What type of ratio could we be looking at for full year 2017?

This is BJ. We fully expect to continue to make progress on that. Over the last several years, a lot of our progress or at least in the 2011, 2012, 2013, 2014 timeframe was more on the numerator side of the efficiency ratio taking cost out. 2015 and 2016 has been driven by much stronger revenue growth. I think 2017 is going to be a combination of both. As Bryan and I both talked about, we're very focused on expense discipline on things that don't support revenue, but we are fully willing to pay for things that do support revenue. And so, we do expect it will continue to try to flatten out the expense levels that we have while continuing to expand the revenue line and drive positive operating leverage, which is clearly going to drive a better efficiency ratio. So, I see it continuing to come down from this level hopefully into the 71, 70, even high 60s levels.

John, this is Bryan. I'll add to BJ's comments. I've been in the expense watching/battling business in banking for 25 years now, and while fourth quarter, third and fourth quarter had some higher expense trends, some of it is related to legal for example. You can look at our non-strategic segment and expenses are up year-over-year. Most of that, if not all, but more than 90% is driven by higher legal cost on some of those matters that I mentioned earlier. Fourth quarter T&E expense was a little bit higher. Some of that is just timing in the year, some of it is fourth quarter cleanup. I'm not particularly concerned at this point about our ability to continue to drive the efficiencies that BJ described. The management team and our organization has been working on cost control for eight, nine years. We have achieved significant progress in that regard and we are very focused on it. It's built into our plans for 2017. So, I know that might got some attention in the third quarter, it might get attention this quarter, I'm not particularly concerned about it at this point. I've got a tremendous amount of confidence in our ability to continue to drive efficiency in parts of the business that allow us to invest in other parts of the business, like we've done in 2016, and be smart about building this business for the long term.

All right, Bryan, that's helpful. Thank you. And then if I could just jump to capital, mainly around M&A, just want to get your thoughts, your updated thoughts on M&A, particularly post the election and post this rally in evaluations. I mean you have a currency now to a degree but at the same time sellers maybe feeling a little bit better about remaining independent given the economic outlook and what could be coming. So I just would love to get your thoughts on how you think about it.

I think of your points there, I think everybody is feeling better about the environment in the banking space. I ran into a banker earlier this week who said it's fun again. And I think, as you point out, our currency has moved up, but in some sense everybody else's has, and so I'm not sure on a relative basis. A whole lot has particularly changed. My expectation is that 2017 is likely to start off pretty slow from an M&A perspective. I guess if you had a 'glass is half full' view of the world, 'glass half full' view of the world, you might say, sellers can get prices that they would only dreamed about two years ago and this might be a good time in the next year or two. On the other side, it may be regulation, taxes, everything is about to change, it is fun again, so why now. I just don't think much will happen personally in the first part of the year. I think fundamentally, the same major challenges that existed three or four months ago are still there and that's the cost of technology, the cost of compliance and all the things that are necessary to be cost-effective long term. So, I think the fundamentals are that the industry will move back into further consolidation. I'm not sure whether it will be in the first half of 2017 or not, I sort of don't expect it, but I think about a year from now you'll start to see more activity.

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

I just had one follow-up question first on expenses. Just wanted to make sure I heard you correctly. I get that you are being disciplined on expenses and cutting where you can while reinvesting in the franchise. Should we take that to assume that core expenses outside of sort of comps related costs like to capital markets should be in this 920-ish kind of range as a base case of 2017?

It's BJ. I think we are going to stay away from creating absolute levels of expense guidance because we want to be flexible to take it lower or incrementally invest where we need to. But I mean we're going to be very disciplined on our expense levels trying to flatten them out going forward and driving more positive operating leverage than we have already. So, we are going to be very disciplined looking for cost to take out of the organization and leveraging the investments that we have already made.

This is Bryan. I might add that as we planned for 2017 starting three months ago, everybody went into it with the idea that expenses need to be flat to down in 2017. So, part of the problem is if you pick a number, you stipulate at 920 and then say except capital markets, and that's so hard to reconcile back to particularly with all the ins and outs of one-time stuff. That's why BJ is reluctant, but in terms of what we're managing for, we're managing for flat to down expenses.

That's extremely helpful. Thank you. And another follow-up question just in terms of capital deployment, one, is it safe to assume that if the stock stays where it is, you are unlikely to buy back any shares? And secondly, Bryan, you have talked on and off about MOEs. Do you think it makes sense to wait to see if we get any move on the SIFI legislation before you think about sort of M&A from as an acquirer?

I'll start with the capital question first. We will continue to look at all of the levers, and as we have done in the past, when we see dislocations in the valuation of our stock vis-a-vis the market or historical norms, we are willing to take advantage of those, and so we will continue to use the buyback and I think we have $185 million to $187 million of capacity remaining on that. Then we'll continue to look at our dividend policy. This is the time of the year that our Board looks at that in our January meeting. And then we'll continue to look for opportunities like our restaurant franchise finance business, the ability to expand through our specialized healthcare lending business where we can put capital to work in an organic or semi acquisition fashion. And then we'll look more broadly at the M&A market. I would say that in my view, the industrial logic for merger of the equals is equally relevant today as it was six months ago. I think to your point that the trends, particularly even with the existing bright-line on the SIFI designation, are that SICAR and those elements you're going to see more flexibility. Clearly, I think it is a much better thing to see that threshold raised. I think there is a good likelihood that that will happen. You've heard even the Federal Reserve Governor, Tarullo, in some public speeches acknowledge that that ought to be raised. And so I think Congress will at some point act on that. So, I've always viewed that as important to stay below that bright line. I think that will move up. I think the industrial logic of MOEs are still important and we will continue to look for opportunities to deploy capital smartly in lower or no premium mergers, but at this point it takes I think a little more activity in the market to see anything really start to spin out of that.

Understood. Thanks for taking my questions.

The next question comes from Jennifer Demba with SunTrust. Please go ahead.

I just wondered if you could talk about the provisioning outlook over the next several quarters. The trends continue to be really good. Any areas you are particularly concerned about right now about getting overheated?

Jennifer, credit quality remains very strong. Obviously each quarter we assess what the provision would be in models, looking at economic indicators, but we continue to have very, very strong low charge-offs, reductions in non-performing loans, reductions in non-passed loans. That being said, we are very intentional around making sure that we are looking for any weaknesses in the economy or certain segments of the portfolio, training frontline bankers, portfolio managers on what to look for. We are doing higher scrutiny on certain type loans just to make sure we are ahead of that curve. At this point, all things being equal, I think we would continue to see – we don't manage the coverage – all things being equal, I can't say that we would be increasing at this point, however again we are watching all the time for certain segments. I have said on previous calls, commercial real estate, and I know other bankers do this as well, watching certain product types in certain markets is just part of everyday prudent portfolio management and we remain disciplined around that. So, all that being said, I do at this point would say that the provision outlook would be stable than during 2016.

Thanks so much.

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

BJ, can you talk a little bit about the NIM trajectory going forward? On one hand, I think you guys have had three consecutive quarters of the NIM going up about 4 basis points a quarter, but now it seems like there is a more accommodative rate environment going forward, but you have also talked about peeling back the asset sensitivity, and there is also the element of the warehouse lending coming in or falling in pace and you made the point of that being one of your higher-yielding loan segment. So, I know there are a bunch of variables, but if you can just guide us or help us in how to think about the movement of the margin going forward?

Yes, absolutely. Clearly we are very pleased with the trajectory of what we have seen. We've [indiscernible] trends being able to improve the NIM steadily as we have. Shorter term, for the first quarter, in my opening comments I did want to make sure people understood that seasonally we usually do see a downtick from fourth to first because we have stronger deposit inflows, loans to mortgage companies are seasonally down, we have higher cash balances at the Fed, et cetera. So do not be surprised if you see back up in the first quarter. But if you step back from that and look across 2017, we are very encouraged by the outlook that we have. We see continued strong loan growth coupled with deposit growth. We now have layered in what the futures market is calling for, which is roughly two rate increases for 2017 based on our asset sensitivity that will help us as well. So overall, we continue to believe that the NIM trajectory will be higher. It may fluctuate quarter to quarter, but the trend will continue to get stronger and strengthen, and NII will have the same type of trajectory over the course of 2017 as well.

Okay, BJ. Just on the topic of moderating asset sensitivity, is that more a move that you guys have talked about that in prior quarters, is that more a move that was part of that plan, and going forward would you still be peeling it back or not, would you be holding back on that now with this new outlook on rate increases going forward?

So, by nature we are always going to tend at least in this environment to be more asset sensitive because of the loan book and what we are putting on, which is mostly floating rate. But we did in the fourth quarter execute some pretty attractive bond swaps, about $400 million of notional swaps, that were about four year durations that we swapped to six. So that would add a couple of million dollars over the course of the year to NII. So short term it has a positive benefit. It's attractive from a yield perspective. But the interesting thing as I talked about as well was that theoretically dampened sensitivity but because of the strong deposit growth we had, our overall position didn't change. So, we are able to incrementally take advantage of certain dislocations in the market to improve our NII as well as our balance sheet position itself. You will see us do a few more things like that, though overall we are clearly with what sentiment looks like, what futures are saying and what's coming out of Washington. We are more optimistic now that we could see more rate hikes as opposed to less. So, that is also something we talk about in outcome.

This is Bryan. One thing to keep in mind is that we are very asset sensitive today. At a 100 basis points, it's just under call it 5% of 100 basis points, and if it were up 200, it would be close to 10%. We are able to maintain that because the risk of rates going down is very low. If rates move up, you have to start dealing with the risk that rates can move back down. So, naturally that asset sensitivity has to be narrowed down a little bit depending on what rates do in the future. So as BJ said, we are doing some tactical things that we think will help the margin, but over time if rates move up 200 basis points from here, then we are going to look to bring that asset sensitivity down some simply because at some points you have the risk of recession and rates moving back down and you got to narrow that range in a little bit as well. So, it's hard to answer the question in a long-term basis with a high degree of precision other than to say, yes, we'll bring it down. In the short term though, we continue to look for rates moving up and we expect to benefit from them.

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

I heard your comments. Obviously, the fourth or the next quarter is going to be a little – have a little pressure on the margin, but just in terms of this quarter, are you looking at, Slide 8 you guys have, higher rates drove 6 basis points of NIM expansion, primarily the 6 basis point piece of it. Was there anything else in there besides higher rates, because I guess I was just – like I know you guys are asset sensitive, I guess I was a little surprised of the magnitude this particular quarter of the NIM expansion given rates didn't go up until, you have literally two weeks worth of higher rates in the entire quarter? Just want to make sure I fully get the magnitude there.

Good question. So actually it's not necessarily the Fed rate increase that drives it. It's LIBOR. And what we typically see and what we saw this time for sure because the December rate hike was so telegraphed was that LIBOR started to tick up well before the actual rate increase in December. So we saw much more of a full quarter impact than we normally would from that rate increase because LIBOR started to creep up much sooner. So that's why you saw a pretty upsized impact in the fourth quarter, and so that will obviously continue into the first. And the other thing that helped was the franchise finance acquisition. So that was closed in the third quarter. In the fourth quarter that was slowly layered in. And as we talked about when we made that acquisition, it had much higher rates on the aggregate portfolio than many of our existing portfolios and that certainly helped as well.

Got it, understood, okay. And then just really quick on the franchise piece, how much – if you look at the 4% average loan growth in the quarter, how much of the average loan growth came from sort of the incremental or the full quarter impact of franchise versus organic growth?

On the NII side or the NIM side?

Actually the average balance side.

Okay. Let's see here.

In terms of average to average on balance sheet growth, if you look at franchise finance, it was about $450 million of the increase quarter over quarter for average to average.

Got it, just from the franchise piece, okay.

Yes.

Perfect. All right, thank you very much.

The next question comes from Jefferson Harralson with KBW. Please go ahead.

I wanted to ask you guys about Coastal. In your press release where you talk about it, you say there was a $16 million in trailing 12 month earnings, but there is a reason that that should go up a decent amount as you guys put it onto your platform. It seems like you could use your balance sheet more perhaps cross-sell between Coastal and your legacy bond guys and can you talk about if that run rate has actually increased already since the election?

Good question, Jefferson. Yes, we really like this business, we like the mix of the business. We have already kind of given you some statistics on what we think the business will do. We do think that there are synergies across our existing platform. So we are bullish about that. We do think that there are some funding opportunities. I talked about why first quarter there might be a little bit pressure on the NIM because our cash balance is related to Coastal. So clearly we are trying to reposition their balance sheet to take advantage of some funding opportunities that we think we have. So, I think I'll stick with what we and Aarti kind of gave you on the outlook for that business and hopefully it can be stronger.

And do you think – have you changed out on how much you think the balance sheet can be bigger, I guess what kind of book do you need to run? You've been carrying – before you were saying $500 million to $700 million in inventories on the balance sheet. So, when this deal is closed sometime I guess this quarter, should we expect for the full quarter Q2 the balance sheet to be $500 million to $750 million larger or is that a good starting guess or do you think that's – or would you like to leave us in a higher or lower size?

No, that's about right. We don't necessarily plan at this point at least initially to make any fundamental changes to how they do business. We really like how they do it and it's very complementary to what we do. So we think their inventory needs will be largely the same, and if they have to expand, it will be for a good reason. So we'll stick to that kind of guidance for it.

That in total is margin dilutive to, right, we should put – that will have a heavy impact on the margin I suppose, all things equal?

The trading inventory there?

Yes.

I don't think so. Our trading inventory is a little bit different from their trading inventory. So, there is a little bit more carry, i.e. NII, that is available in that type of business and trading environment versus ours which is virtually fully hedged out. So, no, we don't think it will be nearly as dilutive as maybe our trading inventory is.

Okay, because their trading inventory is mostly SBA loans at 4.25, 4.5 or something, is that how to think about it?

I mean, yes, they are mostly in SBA and USDA lenders, so that's right.

All right, thanks guys.

Jefferson, this is Bryan. I'll add. I was there in really late, mid to late December, I had chance to meet with not only the management team but also with a great cross-section of the organization. We are really excited about the opportunity, and as BJ said, I think it's fair to sort of stick with what we have got because there are some onboarding costs and things like that that need to be dealt with, but we are optimistic that this is going to be a great partnership. It's a great group, a great business model and we are very optimistic that in the out years we will see significant upside in this business.

Okay. I'll leave it there. Thanks, guys.

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

Just a follow-up question on the securities purchases, when did you do the swap in the quarter, is that the beginning of the quarter or is that after the election?

We actually executed two in the quarter. So they weren't actually together. So they were across the quarter.

Okay. And then when you look at the incremental purchases you're making apart from that swap, are you taking on more duration than your standard purchases at this point or is that the duration essentially is limited to the amount you did through the swaps?

So what we did is we had about a four-year duration on what we had and we swapped into about a six-year duration. So we sold CMOs, reinvested in a 30 year MBS.

Okay, thank you. And then finally just on the credit side, how long can you expect you can continue credit recoveries at this point, have you finished through what you expected as [indiscernible] recoveries or should we [indiscernible] few quarters?

Jared, obviously forecasting credit recoveries is a difficult proposition, but we continue to. We will have some opportunities in any given quarter for some recoveries on both the consumer side and the commercial side. On the consumer side, we have benefited from home price appreciation, optimism in the marketplace, but over time we would expect some moderation in that. So we have benefited from that. But we have also had, and it's in the presentation, we've actually had very low gross charge-offs as well. So while we benefited from recoveries, we've also had historically low gross charge-offs in the portfolio too.

That's great. Thank you.

The next question comes from Casey Haire with Jefferies. Please go ahead.

Wanted to circle back on the M&A, I know you guys, we have touched on a bunch and you're not expecting much in the first half of the year, but when activity does pick up, what is sort of your sweet spot in terms of size? I know you guys have been looking for the MOE, that's been tough, and I know you guys want to be, you don't want to be as small as that TrustAtlantic deal. So what is sort of the sweet spot, and then geographically speaking, what would be of interest to you?

This is Bryan. I'd say in some ways you have to think about it on a continuum. If we had another opportunity like TrustAtlantic in a Raleigh or a Nashville, we certainly would consider it, and as we said, it was a long and in some ways a drawn-out process, but we would still consider it. But on an absolute basis, we would prefer to do something with more significant size. If I had to pick a number, I would say something between $5 billion and $10 billion would be more in the ideal sweet spot. But I wouldn't foreclose that we are going to be opportunistic and think about M&A in a broader sense. For example, the acquisition of the franchise finance business was basically a $600 million portfolio acquisition with a lot of really good talent that came along with it we were able to hire. So, we'll think about it in sort of a moving way. We'll look at what markets does it fill in, what market opportunities does it open up for us, and with that how do we build the franchise for the long-term, and again back to our bonefish and what does it drive in terms of improving our ROE in making a decision. So, clearly bigger is better than small, but we have to look at a lot of factors and that's what we do.

Okay, I understood. And on the bonefish topic, so the efficiency ratio target longer-term, that obviously is a pretty big bogie between where we are today and what you guys are aspiring to. What sort of, what kind of Fed funds policy makes that a more achievable metric?

Probably at least 100 basis points higher.

Okay, great. And just last one from me, the tax rate came in a little light versus me. It looks like there are some permanent benefits there. Is 30% a good number to use going forward ex tax reform of course?

Yes, 30% to 32% is probably a good number.

Okay, thank you.

The next question comes from Chris Marinac with FIG Partners. Please go ahead.

BJ, I guess I'll pick up where Casey left off on tax reform. If something were to happen this year, what does that mean for your tax strategy and would there be any one-time adjustments you'd have to implement, even if it's just uncertain at this point?

So we don't necessarily foresee any meaningful impact like to our DTA or DTL or anything like that. We clearly think that tax reform and what's being talked about, a lower tax rate, is going to be significantly beneficial to us. It's unclear, we'd certainly have permanent pre-tax credit that help lower our effective tax rate that may be impacted by corporate tax reform, but net-net we certainly see it as one of the biggest positives that could happen to us in terms of EPS.

Okay, great. And then I guess a question for Susan. What is happening with CECL this year, is there anything that we would see here formally as all of the CECL work kind of happening behind the scenes?

We've probably like many other banks we've got teams examining CECL, working with our accounting partners, and at this point there is a number of different scenarios that show it could have an impact from 0% to 30% on average depending on the bank, and in some cases even could be a positive benefit where you could actually have a release. So, we've got teams working in credit and in accounting and finance working at the potential impact for us, but at this point I don't have a specific amount.

Susan, is that something that you would talk about later this year or probably push that into the future? Just curious kind of when that comes to be a front-burner issue?

I think we'll have more information and analysis completed later in the year.

Okay, that's great. Thank you very much, guys. Appreciate it.

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. Thank you all for taking time to join us this morning. Please feel free to reach out to Aarti, BJ, me, Susan, anybody that can help you with any follow-up questions that you may have. We appreciate your interest in the Company. Thanks again to the First Horizon, First Tennessee, First FTN Financial folks for all that you are doing. Hope you all have a great weekend and look forward to speaking with you soon. Thank you.

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