First Horizon Corporation (FHN) Q2 2017 Earnings Report, Transcript and Summary

Good morning and welcome to the First Horizon National Corporation Second Quarter 2017 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. Please note this event is being recorded. I would now like to turn the conference over to Aarti Bowman. Please go ahead.

Thank you, Operator. 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 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 materials and in 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 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 website is the only authorized record of this call. This morning's speakers include our CEO, Bryan Jordan, CFO, BJ Losch. And 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 and thank you for joining us. I am very pleased with the results in the second quarter. We continue to see very good momentum in our banking business with good customer acquisition and corresponding loan and deposit growth. We saw a good [indiscernible] in our net interest margin. And we continue to feel very, very good about the credit quality with improvement in our non-performing assets, non-performing loans and our net charge-offs year-over-year. We consistently remain focused on our expenses in our banking business and we also saw good trends there. Our fixed income business continued to be a bit soft in the quarter. We are pleased with the completion of our Coastal acquisition or merger that was integrated very smoothly during the quarter. We’ve got a great team of bankers in Houston in the government guaranteed loan business and we think that is going to be our great asset for us, as we move into the remainder of this year and into the future. We have got three notable exceptions -- three notable transactions in the quarter, which BJ will go into more detail on later. When you exclude those our core EPS continued to be very strong and most importantly we hit another milestone in improving our return on tangible common equity hitting 12% in the quarter. So feel very, very good about the core results for the quarter. Our focus for the rest of the year continues to be on execution in our core businesses banking and FTN Financial. We continue to see good opportunity for loan growth and our loan pipelines look strong, our customer activities and calling efforts continue to be good and we continue to be focused on improving our returns in controlling costs in the business. Our planning for the merger with Capital Bank continues to move along on time and on track. We have made significant progress in the last couple of months, including meeting with over 1,000 employees. Gene and I have spent a good bit of time meeting with employees and we have had very good discussions and also we are very encouraged with the progress we are making there. So, our focus will be on continuing to execute on the things that that we have been focused on and continuing to plan the integration with Capital Bank. As we look into 2018 and 2019, we are excited about the opportunities that we see in our existing business in the combined or merged business. We are very, very focused in the long-term on delivering on our bonefish targets. We believe that the combination of our two firms over the course of the next 18 months or so we will be doing -- we will be hitting our bonefish targets in sometime in 2019, if we get a little bit further help on the interest rate environment. So, we are excited about the progress that we are making, we are excited about the future and we look forward to continuing to focus on those things that we can control in hitting these bonefish targets, improving returns. So with that I’ll stop and turn it over to BJ and then I’ll be back for some comments and we will take questions later. BJ?

Great, thanks Bryan. Good morning, everybody. Take a look at the quarter starting on slide five. For second quarter we reported net income available to common of $91 million or $0.38 a share. And as Bryan talked about and as you can see on the bottom right of this slide, we have few notable items in the quarter, which in aggregate positively impacted our results. These items included first a roughly $20 million mortgage repurchase release from the resolution of the legacy repurchased claim. We had about $6 million or so of acquisition expense related to both our Coastal acquisition, which closed at the beginning of the quarter and our pending Capital Bank merger. And the third was a roughly $20 million benefit from a tax adjustment associated with the reversal of a capital loss deferred tax allowance. Adjusting for those items, we have EPS at about $0.27 and net income available to common shareholders at $63 million. Importantly we saw a meaningful improvement in our returns as Bryan talked about. Our adjusted return on tangible common equity was 12%, up 166 basis points linked quarter and our ROA was 94 basis points or up about 12 basis points linked-quarter, moving us much closer to our bonefish target. This strong performance was driven by healthy revenue increases, as you will see from continued loan growth, improvement in our margins and solid bank fee income supported by good expense discipline and continued excellent credit quality. Specifically second quarter highlights were linked-quarter revenue growth of 7%, NII growth of 6%, fee income growth of 9%, resulting in an adjusted PPNR growth of 14%. Loan growth trends were also solid, with average loans up 2% linked-quarter and up 8% year-over-year with core deposit inflows in the regional bank continuing to be encouraging. As it relates to the tax rate, we will see continued positive impact from this tax adjustment for the remainder of the year. We expect roughly a 23% effective tax rate in both 3Q 2017 and 4Q 2017. And in 2018 we expect that the effective tax rate should normalize back to roughly 32%. Slide six gives you we believe a good contextual view of where the earnings contribution comes from by business segment. You'll see the Regional Bank has and will continue to drive the majority of our earnings and momentum in that business is evident. Fixed income's contribution is modest yet consistently profitable and provides future upside opportunity. And the non-strategic segment has consistently provided a positive impact for several quarters. We remain pleased and encouraged by the strength, diversity and momentum of our business mix. Turning to slide seven, let's take a look at net interest income and net interest margin trends. Year-over-year, NII was up 14% and up 6% linked quarter. The NII increase was driven by quality loan growth, and the capturing of asset sensitivity of short-term rates have risen. The NIM in 2Q, '17 was at 3.07%, up 15 basis points both year-over-year and linked quarter. The uptick in NIM was due to excess cash optimization and the benefit from the increase in short-term rates. We've reduced our average cash levels by over 50% or about $1 billion from first to second quarter as well. Our net interest spread, the difference between loan yields and deposit rates paid increased 10 basis points linked quarter. Loan yields were up 14 basis points and we continue to manage our deposit costs and mix closely. Even with the positive improvements as you can see on the bottom right of this slide, our balance sheet remains well positioned for further rate moves. Turning to slide eight, we highlight the significant profitability improvement in the regional bank that we have seen not just from first to second quarter, but over the last several quarters as well. Linked quarter ROA rose 40 basis points to 1.6% as pre-tax income, PPNR and revenue all improved meaningfully. NII was up 4% linked quarter and 13% year-over-year driven by strong commercial loan growth and higher short-term rates. Fee income was up 10% linked quarter on stronger deposits as well as trust in investment management fees. We maintained good expense discipline in the Bank as well. That discipline coupled with the strong revenue performance drove the efficiency ratio in the Regional Bank down to 57%, a 135 basis points improvement from the first quarter. Excellent asset quality trends continue across our regional banking portfolios as well. Linked quarter non-performing loans were down 13%, 30 days delinquencies improved 11 basis points and our net charge-offs remained relatively stable. Slide nine shows the Regional Bank’s continued healthy loan growth. Average loans in the bank were up 11% year-over-year and up 3% on a linked quarter basis. Areas that drove the growth this quarter were loans to mortgage companies, asset based lending, wealth management, private client and core commercial. Demonstrating the broad strength across our Regional Bank businesses all of our regional markets in Tennessee, Mid-Atlantic and Houston experienced growth on a linked-quarter basis. Particular strength is evident in Southeast Tennessee, Middle Tennessee, Nashville and Mid-Atlantic, which are our Virginia, North Carolina and South Carolina markets. Loans to mortgage companies increased 24% linked-quarter due to a seasonal rebound in purchasing activity and customer growth somewhat offset by lower refi activity. Fundings in new customer activity in the business have been strong. However shorter dwell times and lower refi activity have dampened balanced growth. Overall trend should be steady through the rest of the year and the portfolio remains one of our most economically profitable businesses. Encouragingly, commercial pipelines remained solid even with solid fundings and balance sheet growth and we anticipate this strength through the next quarter. Turning to asset quality on slide 10, you'll see that it remains excellent due to ongoing stable credit trends and strong underwriting discipline. Loan loss provision was a credit of $2 million in the quarter with net charge-offs of $3 million in second quarter of '17 compared to $1 million recovery in the first quarter. NPAs were also down meaningfully and 30 day delinquencies improved and remain low. Slide 11 gives you a quick update on our Capital Bank merger efforts, our integration planning for the Capital Bank acquisition remains on track. In June, we filed regulatory applications and the Preliminary S-4. We've established and staffed our merger project office and it is up and running. We anticipate the deals to close in fourth quarter of ‘17. Wrapping up on slide 12, we’re making meaningful progress towards achieving our bonefish targets as evidenced by our adjusted return on tangible common equity of 12% in the second quarter. And we believe we are well position to continue improving our returns organically and after we close and integrate Capital Bank. We’re seeing great performance in our Regional Bank, our revenue growth is healthy, aided by double-digit loan and deposit growth and our forward pipelines are solid, our asset sensitive balance sheet is benefited from recent rate hikes, our efficiency ratio is improving and our integration planning with Capital Bank is on track. Finally with the help of the positive notable items we discussed coupled with the strong core earnings trends, we were able to fully offset the anticipated tangible booked value dilution from the closing of the Coastal acquisition and actually grow both book value and intangible book value per share in the quarter. With that I’ll turn it back over to Bryan.

Thank you, BJ. Again we’re pleased with the progress and the momentum that we see in our banking business. We believe that is not only been steady and consistent, but it’s ongoing. We think we’re well positioned for the second half of 2017 and that we have good momentum, strong pipelines and we believe we are well positioned to continue to grow not only in Tennessee, but across our entire franchise including the specialty businesses. Our quality of credit continues to look good; we see good opportunities to grow high quality lending relationships. We think there is additional momentum from our past interest rate increases and we think there are opportunities for rate increases in the future. And we think that our continued customer expansion all coupled together will drive our results. While our customers are generally optimistic, the economic backdrop hasn’t changed significantly over the last four, five, six years. Second quarter of 2017 could have been second quarter of any year in the last five. And there is still some optimism in the customer base that we’ll get some fiscal relief in taxes and regulatory costs through our legislative process in DC [ph]. But these customers continue to be optimistic about the future and the business or operating environment. We are continue to be committed to maintaining our focus on expense discipline in driving our bonefish returns and look forward to as BJ and I both said integrating the merger with Capital Bank. Thank you to all of the First Horizon employees for all that you do day-in and day-out taking care of our customers and growing business. We appreciate what you are doing every single day. And with that Bryan we’ll now open it up for questions.

Alright, we will now begin the question-and-answer session. [Operator Instructions] The first question is from Steve Alexopoulos with J.P. Morgan. Please go ahead.

Hey, good morning everybody.

Good morning, Steve.

I want to start on the loan side, if we look at the $167 million of commercial loan growth which you call out on slide nine, seems to be stronger than the HA [ph] that’s showing for banks more broadly. Could you give color why you guys see such strong commercial loan growth again this quarter? The market was doing better is it all share gains, any color there would be appreciated?

Yes, hi, Steve it’s Susan. We’re really seeing good opportunities across the board as Bryan and BJ said in their opening comments. We’ve also had -- we’ve added relationship managers in some of our key markets as well as in some of our specialty areas. Specifically we’re seeing really good opportunities and core asset based lending opportunities. And as you know we have been in that business for 25 plus years continues to be a good business for us. We’re also seeing good momentum as mentioned previously in our core growth markets Mid-Atlantic, middle Tennessee where not only are you in a higher growth market than you would in a Memphis or Knoxville. So Nashville, Raleigh, Charlotte, Richmond have a higher growth than some of our Memphis and Knoxville core markets have. So we're seeing good opportunity there. I can tell you we are remaining disciplined and bringing in customers who've been in those markets or specialty areas and potentially banking with others, there is some increase in market share. And we are seeing some of our existing customers do some expansion whether it's additional business lines, bringing on employees, capital equipment type financing and others. So really it's not any one thing it's across the board.

That's helpful, thank you. And maybe for BJ, you guys had nice margin expansion here in the quarter. I mean look at the 2 to 10 spread it's compressed a bit. How are you thinking about margin moving forward?

Yes, so we were obviously pleased with our margin improvement. I think some of it was driven by our cash optimization, which you can see on that NIM slide that we have in the deck. But we also captured asset sensitivity as we planned as rates continue to go up. And we're getting good pricing on the loans that we're putting on the books as well, so that's contributing. Going forward, I expect the NIM to continue to steadily move up. We're pleased with what we see, we're pleased with how we're managing both the loan side in terms of pricing as well as the deposit side. So we think it will continue to improve.

Okay, thank you. If I could squeeze one more in on credit quality. I appreciate thank you for all the detail on the retail CRE exposure. Can you just talk, are you seeing any current pressure in any of the sub-segments and what's your view on retail CRE. Is this a problem that you expect to see pressure build more broadly over the next year? Thanks.

Steven we spent a good bit of time looking at the various commercial real estate sectors as well as obviously our industries in C&I. We have been and I know other banks have been as well watching the changing dynamics of the retail world for some time. And so we have been adjusting over time how we approach lending to retail properties. We do feel good about the portfolio that we have, it’s well diversified. If you look at our CRE retail exposure, it's over 160 projects make up that portfolio. We have in terms of top three anchor, shadow anchors it's strong necessity based, grocery stores, home improvement stores. So really kind of core retail. And we also in terms of -- we keep – I mentioned 160 projects our largest project in our retail commercial real estate book it’s $24 million. So again well diversified across projects, geographies and you can clearly even hear across anchored, shadow anchored, single tenants. But we do -- we are watching and talking with some of our major customers who have been active in the retail space. And honestly that's some of the best feedback we get and talking to our existing customers about how they're seeing, and how they're repositioning properties that may have had retailers that have left or pulled out or gone out of business completely. And they are using us to reposition some properties in a positive way. All that being said, I do think it's something that we are continuing to watch looking at the Amazon effect as it's called. And I think everyone is watching that to see what's next. Obviously the Whole Foods acquisition and it seems like Amazon Prime day exceeded what people thought it would. And so it's absolutely something that we're watching carefully and are making the appropriate I guess adjustments in terms of our underwriting. Our CRE retail exposure is very strong, the average stable as loan to value is 58%. The debt yield is almost 12%. And the actual debt service coverage on that portfolio is over 2 times. So we do feel good about the portfolio that we have, but again we're watching that.

Terrific, that's really good color Susan. Thanks for taking my questions.

Thanks, Steve.

Alright, the next question comes from Brady Gailey with KBW. Please go ahead.

Hey, good morning guys.

Good morning, Brady.

If you look at ADRs, they have kind of been at the same level, the last three quarters, I know this quarter Coastal came in, so if you back out Coastal, I think you are closer to like $500,000 as far as the legacy First Tennessee. How do you think that trends over the next couple of quarters and into 2018? Do you see anything that makes you think that ADRs are about to come back or is it just more of the same?

Hey, Brady, it’s BJ, good morning. I think our expectation is that we’re going to assume that they’re at these levels for the next couple of quarters. Volatility is low, the way where rates are positioned, what the Fed is talking about does not portend a lot of activity in fixed income. So, we’re going to expect that it’s going to be at these levels. With that said, our business is well positioned to capture any volatility or capture any upside, but we assume that it will be at these levels for a while. And so we talked for a long time about or we put out several years ago $1 million to $1.5 million of ADR. I would say we should call that something more in the $700,000 to $1 million based on these levels in the foreseeable future. That’s what we think it’s probably more appropriate to think about.

BJ, correct me if I am wrong, this is just in Brady’s question, I think you said if we exclude Coastal is about 500 and the core business, I think is actually closer to 600, is that fair.

Yes, I think it was a little bit closer to 600. The agency desk has historically been one of our biggest and that one has been one that has had a significant impact in terms of volume declines year-over-year. But yes, legacy is more around 600 and Coastal made up the rest.

Alright, that’s helpful. And then looking at the provision, it’s been at a pretty low level, if not negative for a while now. The loan loss reserve dipped 1 basis point below the 1% mark now at 99 basis points. Do you think that has room to go any lower, or do you think that from now on out you’re more maintaining that reserve coverage?

Brady, this is Susan. We did believe that we have got strong reserves for our portfolio and want to point out a couple of things that led to the slight relief this quarter. We did have continued non-strategic run-off, mortgage warehouse lending grew quarter-over-quarter. And as we have discussed in the past that portfolio attracts less provisions due to the excellent credit quality historical and current. In addition to that with all -- every asset quality metric that we measure improving and BJ talked about the non-performing loans are down, overall NPAs put no worry, TDRs are down 15% year-over-year, 5% quarter-over-quarter. So when you put all that into an allowance model, it did lead to a slight relief. All that being said, we are very cognizant of making sure that we have adequate coverage every time we revisit the allowance model and feel good about posting analytical and the subjective analysis that we do to determine the appropriate level of coverage each and every quarter. I would point out too that our allowance to non-performing loans actually went up from 1.4 times to 1.52 times quarter-over-quarter and is up even more than that year-over-year from 1.13 times to 1.52 times. So we’re actually increasing coverage as it relates to non-performing loans. And then the last thing, I would mention related to asset quality is, within our non-performing loans we do an analysis and almost 49% of our non-performing loans are actually performing. So all of those things really factor into how we determine the appropriate level of coverage. We do believe as the non-strategic continues to runoff, but we would expect there would be releases in that portfolio if the credit quality remains the same when you see the same kind of run-off. But we are cognizant of the need to next year we continue to maintain the strong reserves that we have today.

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

Good morning, guys.

Good morning.

I wanted to follow up on the margin, BJ. In terms of I guess as we go forward, can you talk about how we should see about additional optimization on the cash on the overnight cash balances that you have. And also how we should be thinking about the run-off in the sort of the LIBOR linked deposits. Because it feels like we might see some give back from I guess margins getting better, but it's of a smaller balance sheet. So just wanted to make sure I understand that correctly as we look into the back half of the year.

Sure, Ebrahim. So our cash balances I think ended the quarter in the $600 million to $700 million range or so down from over $2 billion. And I think that's probably the right level of cash for us in terms of running the business. We did optimize our deposits in our deposit base by reducing our market index deposits pretty meaningfully. And we're using some other funding sources that are probably a little bit more efficient and frankly optically a little bit better, meaning that they're not in the deposit line they’re really other kinds of borrowings. And so what we did just so you know if you look at the financial supplement pages 9 through 12, now have a what we believe is a more helpful breakout for investors between our consumer interest, our commercial interest and our market index deposits. So you can see the trends on those. But we're taking down those market index deposits we're optimizing those, which are the highest cost. We're managing our consumer interest and our commercial interest, which is really our core balances with our customer relationships to a very reasonable level. I think that if you look at our consumer interest data since really the fourth quarter through the -- fourth quarter of '16 through the second quarter of '17, it’s probably about 20% beta and the commercial is about 35%. I would actually expect that the consumer interest gets better meaning the beta gets lower by the end of this year as we optimize some of the things that we've done with deposit pricing. And commercial deposits will have to remain competitive, but we think a 35% beta at this point in the cycle is pretty strong. So if we're maintaining that deposit beta discipline and allowing our floating rate loan yields to continue to move higher, we think that we'll see appropriate expansion in the margin overtime.

And, so in your slide seven, you point out 3 basis points benefit from higher rates. I guess, adjusting for the two things you mentioned more on often the market index deposits. Should the incremental benefit from higher rates be around this 3 to 5 basis points range as we think about 3Q?

Yes, that's probably appropriate. If you looked at the right hand side as well Ebrahim, we kind of give you an idea of what a 25, 50 and 100 bps move means on our existing balance sheet. And so you could translate that back into NIM and that's roughly what it is.

Understood. And just separate question, I think going back to sort of the non-strategic portfolio, looks like you've got about $44 million in reserve against that book. I know through post-crisis it's been more economical to keep retain that portfolio. I'm just wondering if we get as we get closer to the fourth quarter with the CBS deal closing. Is there any thought around disposing that portfolio maybe taking a mark and sort of cleaning the balance sheet as we move forward into '18 or it doesn't make sense?

Ebrahim this is Bryan I think the probability of that is about as close to zero as you can get. It's running all at about 40% CPRs today. The credit quality remains high and we're completely willing to over the next year or so say it run-off most of the portfolio is either at or about to be in amortization. So we don't think that there is any viable way to sell it and we don't think there would probably an economically intelligent way to sell it either. So we'll continue to run it off.

The next question comes from Ken Zerbe. Please go ahead

Great, thanks, good morning.

Good morning, Ken.

When we think about your bonefish targets, sort of and combined registered sort of cost and pressure that we are seeing and the capital markets business with ADR. How much are reaching your bonefish targets requires additional bank M&A or something that’s not let’s just call it part of the core business growth?

Hey, Ken it’s BJ. So, I am assuming that you are talking about other than Capital Bank.

Yes I am not referring to that at all, yes.

Yes, so we have always thought that with our existing business mix forget Capital Bank for a second, with our existing business mix we always believed obviously that we can get to our bonefish targets. We would need even more rate increases so to do that 100, 125 basis points at least of movement. And that would take some time to get there obviously. What we liked about the Capital Bank deal and what we talked about in the announcement was that it helps us accelerate our ability to get to those bonefish targets by optimizing capital and using cost efficiencies and other opportunities to improve our return. So we are excited about that. But as you can see from our second quarter results, we haven’t taken our foot off the gas in the least, in terms of our organic growth, regional bank is excellent and continuing its momentum and we are excited about that and we will continue to leverage that. Last thing I’ll say on FTN is, as we have said before, we like the business, the business is very well run, it does contribute positively to our results. But if you go back to page six in our slide deck, we kind of try to put FTN in a little bit more context than maybe we have in the past. The bank is really the 800 pound gorilla that drives our results and those are the things that we focused on and talk about. And FTN is going to contribute and contribute positively to that, but the other areas are the ones that are going to really be the engine that drives our returns in performance.

Okay great, I’ll leave it there, so, other people can ask questions. Thank you very much.

Thanks, Ken.

The next question comes from Emlen Harmon with JMP Securities. Please go ahead.

Hey, good morning guys.

Good morning.

Maybe, just to continue on the capital markets business, sort of just discussing that. With the reduced outlook for that business in the near-term, I mean is there anything that you can do on the fixed expense side of things to try and improve the profitability there?

Absolutely. Our leaders over in that business have already made very difficult decisions over the last quarter and actually over the last year as we saw certain structural changes in some of our business segments out there, they have already taken a lot of cost out of the fixed expense base were appropriate and they’ll continue to do that. So the business is what we are trying to do is make sure that we take as much cost out of that business as we can without sacrificing some of the differentiation in terms of customer service that we provide to our fixed income institutional clients. And so we will continue to do that. I want to say that over the last year, we have taken about 6 plus spend of the fixed expense base out of FTN. And so that’s fairly meaningful and they are not -- they are going to continue to look for opportunities to become more efficient.

Hey Emlen, this is Bryan, I sort of tag on to your question and maybe a little bit in Ken. What BJ has said, we think that is a good profitable business, we’ve been in it a long time, we think it’s well managed and it is going to ebb and flow based on what’s going on in the market particularly in the agency business, which has had an impact on the pressing revenues particularly callable agency business, which has had an impact on pressing revenues. In the recent past, we do think that there is a bit of a transition going on by adding the Coastal acquisition and the products set of the government guarantee loan portfolio and we think that will be a good opportunity for us to continue the momentum in that business. As we look out across the future, we look at our models and we look at our estimates and we realized that probably every line item in there is off a little bit, but in aggregate we think that we’ve got a high degree of confidents of hitting these bonefish targets. And so as we’ve demonstrated a little bit in the last quarter, while fixed income can be down, something is going to be very good in the banking business and these thinks are going to sort of trend or offset and it’s going to ebb and flow. And we are focused on the long-term hitting these targets and we think that the FTN financial fixed income business will continue to be a critical part of that. I don’t know what it’s going to do next quarter or next year, but I think consistently it’s going to be a profitable business and that we tend to be at the cyclical low and that things will improve as we adjust the nature and the mix of the business.

Next question comes from Jennifer Demba with SunTrust. Please go ahead.

Thank you, good morning.

Good morning.

I am just wondering if you could give us some color on your specialty lending businesses and how they have grown for you the last few quarters? Particularly franchise and equipment finance that kind of thing.

Sure. I’ll be glad to take that Jennifer. As we have mentioned before we’ve seen some good growth in a number of our specialty businesses. I mentioned earlier asset based lending continues to see good opportunities. We saw really good new commitments to new customers as well as increased commitments to existing customers the last quarter, which should result in additional outstandings over the next couple of quarters in that business. We’ve seen good growth in correspondent banking. It’s not a big business for us it’s a little over $400 million today, but it’s up to 31% year-over-year. There have been opportunities to work with bank holding companies as they have government type that could be refinanced. Mortgage warehouse lending I think we touch on that a lot that’s seasonal as well as cyclical, although we have grown the number of customers there and feel good about that business. Our commercial real estate business actually quarter-over-quarter is flat. And I mentioned earlier, but we do still see good opportunities in commercial real estate, but we’re being I think appropriately cautious with certain property types in certain sub-market. But we do still see good opportunities with the right customers in the right market to continue to do business. We are seeing some good increases in yield opportunities in spread in the commercial real estate business. The energy business is it actually declined quarter-over-quarter due to a customer that was sold and we are I think seeing some of that with some of the energy customers in and around the Houston market where there’re opportunities for them to potentially sell out. That being said we’ve got a good pipeline there, and feel good about the level where we are at that point. Franchise finance, franchise finance is really working on optimizing that portfolio. We’ve had some run-offs that we wanted to happen as we’ve kind of print the portfolio based on where we really wanted to head. But at the same time, since bringing on the GE Capital, Bank and [ph] Trust finance portfolio we’ve issued over $200 million in new commitments to borrowers. So although it was down quarter-over-quarter due to some expected run-offs some of which was some non-past run-off which we’d like to see that and we believe that is a business that will have some good growth opportunities in the future due to the fact that we’ve got new commitments there. So all-in-all I believe that the specialty businesses will continue to be very important for us and we have good opportunities with existing customers, as well as key prospects in all those specialty lines.

Thanks for the color.

Next question comes from Casey Haire with Jefferies. Please go ahead.

Hey, good morning guys this is Elan Zanger on for Casey.

Good morning.

Good morning.

I wanted to just touch back in mortgage warehouse. You mentioned customer growth has helped keep the balance levels up. So I wanted to know if we get a steady as it goes purchase market. Could we see the back half of the year kind of mirror or may obviously down a little bit versus last year's levels, but just kind of hanging there, just given the customer growth you guys have.

Yes, we certainly think so. Our customer account is up as you can see on the slide. Fundings actually what's coming through the warehouse are up as well, up around the same amount as the customer levels around 20% or so. The issue is they’re not staying in the warehouses long that’s the dwell time issue. So that's damping it. The other is refi activity last year would have been little bit more towards 50-50 purchase refi now at 70-30 purchase refi. And so we're very pleased with the business you can see the commitments are up materially year-over-year. And so our clients have capacity when they do have origination volumes come up. Summer is usually a healthy time for the business as well so we're optimistic on that. But, as I said in my opening comments, we do think that balances should remain steady from where we are in the second quarter in terms of the average balances. But certainly probably down from some elevated levels that we saw last year.

Okay. And could you guys just remind us what the yield is on this book and have the yields for this type of loan been able to track the Fed hikes?

Yes they have. Because they are all floating rate loans based off LIBOR. And the rate is about 4.75%. And so it's one of our highest yielding books.

Okay, thank you.

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

Thanks, good morning guys. I wanted to drill back on deposit costs. Do you think that the sort of linkage and I guess the beta that we saw this quarter. Should that be similar over the next two quarters or will that maybe vary as we're further along on the tightening phase.

Hey Chris it's BJ. There are couple of components to the answer. One is I think that we'll probably see the same betas on our commercial interest book. And again as I said earlier we broke it out to make it a little easier we believe for investors to understand our trends. So I think that will remain steady. I think consumer betas will get better. We talked about in the first quarter that we ran a promo and so that promo was started in the first quarter ran through part of the second quarter. But that those promo balances will step down over the rest of the year. So I would actually expect our consumer deposit betas if you look at 4Q '16 to 4Q '17 to probably actually be more like a 10% beta versus the 20-ish% or so beta that we look like right now. And so I'm encouraged again by the discipline that our people are showing. And on the third bucket the market index deposits you saw a pretty substantial decline in those deposits, which are really used to fund the non-strategic balances, which are coming down trading inventory at FTN and et cetera. And so we can optimize our use of those market index deposits and bring them down and also use other fundings to fund that stuff. So again, I'm very pleased with how we're managing deposits and expect that our betas will very competitive with others.

Great, that's helpful. Thanks for all that. And I guess just a quick follow-up is, I know you outlined a little bit this about the integration of Capital Bank and what's happening across the teams. How quickly after the merger closes do you think you can start to incrementally grow business from the relationships that you inherit and being able to offer more services and products to them?

Hey Chris, this is Bryan. The short answer is on day one we'll start to grow relationships and to offer more services, the integration will take a little bit longer than that and the sort of repeat blinding glimpse of the obvious as BJ said our applications are in we don’t know the exact timing on regulatory approval. We are assuming and we believe fourth quarter is reasonable. So our conversion integration timeline planning is around the first half of 2018. So some of the system things will take a little bit of time. But as it relates to revenue synergies in terms of whole positions, calling opportunities, lending arrangement those things can start day one and we think we will very actively hit the ground running in those opportunities. Some of the product opportunities will take us maybe another five or six months, but we still feel very, very good about the work from our due diligence and the findings there about the euphemism of handing glove fit between these two franchise as we think that we are going to hit the ground running. And I mentioned earlier, we have been out and we have talked to a lot of people, it wasn’t just Jane [ph] and me, there was a large group of us, we spend a lot of time working with folks from both organization to think about how we do business and we think we’re going to hit the ground running with a good bit of momentum in 2018.

Great fine. Thanks very much for the background, appreciate it.

Sure, thank you.

The next question comes from Brian Zabora with Hovde Group. Please go ahead.

Good morning.

Good morning.

Good morning.

So just a follow-up question on this market index deposits, are you at the point now, where you think it’s completely optimized or could we see further reductions there and maybe higher shorter term borrowings going forward?

It all continue to fluctuate based on our funding needs for those other pieces of business that I talked about the non-strategic balances or fixed income inventory. But we’ll look to continually optimize those market index deposits to obviously lower our overall cost of funds.

Great. And then just on the loan yield side, you had bigger enquiries this quarter than last couple. It sounds like maybe those loans to mortgage companies was a big driver it looks like higher yield than the rest of the portfolio. Is that the only I guess the main driver for that acceleration or are there other factors that you saw for the increase in the yields at a higher pace than last quarter?

I think loans to mortgage companies certainly helped, but our business mix is also helping as well. The things that that are growing are the things that that are more economically profitable on higher yielding businesses. So we are pleased with that, the things like loans to mortgage companies as you mentioned, asset based lending has healthy yields, we have been getting good pricing on our core commercial business. Our loan yields on a commercial real estate have been healthy. So again we are pleased with how our bankers are going to market and getting fair pricing.

This is Bryan. The other thing I will add is that the substantial portion of our portfolio that is floating rate, does not re-price instantaneously, there is a bit of lag and particularly when you hit some of these consumer contracts about when the rate changes and things of that nature. So we have had a bit of drift on that as we have had a couple of quarters of rate increases and we should see a little bit more benefit in the third quarter from that.

Great, thanks for taking my questions.

Sure, thank you.

The last question comes from Tyler Stafford with Stephens. Please go ahead.

Hey, good morning guys.

Good morning.

Good morning, Tyler.

I just wanted to follow-up on the FTN expenses. With the ADRs expected to stay relatively flat for the next few quarters, with Coastal in next. Is this a good run rate to think about for FTN expenses? And then the 90% efficiency ratio this quarter at FTN, is that the right range to think about with Coastal in next?

Tyler I think generally speaking yes, as I -- as we talked about earlier the business is constantly looking to optimize our expense base wherever we can and I am sure we will continue to do that. But the biggest driver of course is going to be the variable compensation piece in that business. And now with a full quarter of Coastal this is kind of what our business is right now. And so if we expect ADRs to be roughly flat you should generally expect that the expenses would follow that.

Okay, thanks guys.

Thank you.

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, Brian. Thank you all for participating on the call this morning. We appreciate your interest in the company. Please let any of us know if you have any follow-up questions or you need any additional information. Thank you again to all of the First Tennessee, First Horizon, FTN Financial folks on the phone. Again for all you do to take care of our customers and grow the business day-in day-out. Hope everyone has a great weekend. Thank you very much.

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