Solidion Technology Inc. (STI) Q2 2015 Earnings Report, Transcript and Summary

Welcome to the SunTrust Second Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode until the question-and-answer session of the call. [Operator Instructions] Today’s conference is being recorded. If you have any objections you may disconnect at this time. Now I’d like to turn over the call to Ankur Vyas, Director of Investor Relations. Thank you. You may begin.

Thank you, Angela. Good morning. And welcome to SunTrust second quarter 2015 earnings conference call. Thanks for joining us. In addition to today's press release, we've also provided a presentation that covers the topics we plan to address during our call. The press release, presentation, and detailed financial schedules can be accessed at investors.suntrust.com. With me today, among other members of our executive management team, are Bill Rogers, our Chairman and Chief Executive Officer; and Aleem Gillani, our Chief Financial Officer. Before we get started, I need to remind you that our comments today may include forward-looking statements. These statements are subject to risks and uncertainty, and actual results could differ materially. We list the factors that might cause actual results to differ materially in our SEC filings, which are available on our website. During the call, we will discuss non-GAAP financial measures when talking about the company's performance. You can find the reconciliation of these measures to GAAP financial measures in our press release and on our website, investors.suntrust.com. Finally, SunTrust is not responsible for, and does not edit, nor guarantee the accuracy of our earnings teleconference transcripts provided by third parties. The only authorized live and archived webcasts are located on our website. With that, I'll turn the call over to Bill.

Thanks, Ankur, and good morning, everyone. I'll begin with a brief overview of the quarter, and then I am going to turn over to Aleem for some additional details. Following Aleem's comments, I'll review our performance at the business segment level. Earnings per share for the quarter were $0.89 on net income to common of $467 million, up 14% per share sequentially and 10% compared to the prior year adjusted EPS. We demonstrated good progress this quarter on key strategies and goals, including optimizing our business mix and balance sheet, investing in growth opportunities, improving efficiency and growing capital returns. Revenue improved 4% over the previous quarter, but declined 2% from the prior year adjusted level. The sequential quarter increase can be attributed to both higher net interest income and non-interest income. Net interest margin benefited from targeted balance sheet actions during the quarter, in addition to slight improvement in core loan yields and continued growth in deposits. Average performing loans were down slightly from the prior quarter due primarily the loan sale activity driven by our continued focus on returns and pay downs of certain loan categories. We remained confident in our ability to generate targeted growth in segments where returns are appropriate and our relationships are deeper and we will continue to closely manage areas where the competitive environment is driving down returns. Average client deposits were up 2% compared to the prior quarter and 9% year-over-year with continued broad-based growth driven by improved focus, better execution and enhanced capabilities. Growing deposits remains an important part of our strategic efforts to strengthen client relationships and improve profitability. Adjusted non-interest income grew 7% sequentially as we deepen client relationships across the company evidenced by growth in investment banking, retail investment income and card fees. Mortgage related income declined sequentially, largely as a result of higher rates in the quarter, which drove lower refinance activity and higher hedging-related costs. Adjusted expenses were down 2% from the prior year driven by lower operating losses on the sale of RidgeWorth. Sequentially adjusted expenses increased 3%, a strong overall performance, higher client activity levels and typical seasonal patterns generated increases in certain variable expense categories. In addition, we continue to invest in key growth areas. The combination of these revenue and expense trends resulted in an adjusted tangible efficiency ratio 63.4% for the current quarter, which improved sequentially and year-over-year, and we are continue to work towards the very challenging goal of being sub 63 for the full year 2015. Our asset quality performance remained strong, with NPLs down 21% as we transfer the portion of the portfolio to held for sale. The net charge-off ratio declined to 26 basis points reaching new multiyear lows. Our asset quality performance can be attributed in part to the significant actions we have taken over the past several years to de-risk and diversify, and improve the quality of our production. ROI was 103 basis points this quarter, an 11% -- 11 basis points increase sequentially and a 3 basis point improvement relative to last year’s adjusted performance. Return metrics are important to us and we continue to focus on strategies to deepen client relationships and optimize the usage and mix of the balance sheet. Our capital position improved slightly with our common equity Tier 1 ratio estimated to be 9.8% on all Basel III fully phased-in basis. Growth in tangible book value per share also continued, up slightly from prior quarter and 7% compared to the prior year. Sequential increases in capital ratio and tangible book value occurred alongside of 36% increase in our total capital return to shareholders. So to recap, net interest margin is beginning to show signs of stabilization, partially as a result of our balance sheet management efforts as we are cautiously optimistic that we are seeing the trough in net interest income. Conversely provision expense is likely at or near the bottom even if asset quality continues a condition remains strong. Non-interest income trends were positive and reflective of our continued efforts to meet more client needs the quarterly variability can be expected. Our focus on expense management and improving efficiency will remain high. Overall, I'm optimistic about our company strategic direction and our ability to deliver further value of our shareholders. So with that as a brief overview, I will turn it over to Aleem to provide some more details on the results.

Thanks, Bill. Good morning, everybody. Thank you for joining us this morning. Earnings per share in the second quarter were $0.89, which was 14% higher than the first quarter and also 10% higher than adjusted EPS in the second quarter of last year. As you'll recall, adjustments to the second quarter of 2014 included the settlement of certain legacy mortgage matters, partially offset by the gain on sale of RidgeWorth, the net of which was a negative $0.09 per share impact to earnings. Sequential quarter increase was driven by 4% revenue growth, a decline in the provision expense and a $0.03 discrete tax benefit in the current quarter. Non-interest expense did increase sequentially, but this was primarily related to business performance and activity levels, in addition to certain discrete items in the current and prior quarter, which I will discuss later. Compared to the second quarter of last year, EPS growth was driven by improved asset quality performance, continued expense discipline and higher mortgage and capital markets-related revenue, which together more than offset the loss of RidgeWorth revenue and lower commercial loan swap income. We will now review the underlying trends in more detail starting on slide five. Net interest income increased to 2% sequentially, driven by one additional day, an improvement in core loan yields and higher commercial loan swap income. The premium amortization expense related to the securities portfolio was stable sequentially, but will slightly decline next quarter due to portfolio actions we undertook during the period. Net interest margin improved to 3 basis points, primarily due to commercial loan swap income and a slight increase in consumer and mortgage loan yields. Relative to the guidance we have provided in April, balance sheet management actions in the quarter, including adjusting duration and repaying higher cost wholesale funding benefited NIM. Core C&I loan yields were stable sequentially, a positive sign after multiple quarters of continuous declines. With that said, new production C&I yields continued to be lower than portfolio yields and thus will likely put further pressure on the overall margin. We remained intensely focused on ensuring that we meet the full suite of our wholesale banking clients needs, particularly with respect to capital markets, and treasury and payment products. On a year-over-year basis, net interest income declined $41 million, driven entirely by lower commercial loan swap income. Core margin compression due to the continued low rate environment was offset by positive loan and deposit growth. Looking forward, we expect third quarter net interest margin to be relatively stable to the second quarter level, as the balance sheet management actions of the second quarter will fully be in the run rate and potentially offset core loan yield compression. Despite the potential for stability next quarter, NIM will likely still grind down after that, until interest rate begin to rise. Overall, we continue to manage the balance sheet to have a positive tilt towards rising rates and expect any increase in rates to be gradual and deliberately paced. Moving on to slide six, non-interest income increased $57 million from the prior quarter, primarily driven by higher investment banking activity, growth in retail investment income and seasonal increases in other non-interest income categories, which offset the decline in mortgage-related income. Investment banking had a strong quarter with revenues increasing $48 million as growth occurred across almost all product area. Trading income was stable as lower core client driven activity was offset by higher fair value marks on our debt. Mortgage production income declined $7 million due to lower lock volume and reduced gain-on sale margins. We record gain-on sale revenue at the time of rate lock and thus the majority of revenues related to the refinance activity of the prior quarter were recorded at that time. Mortgage servicing income declined $13 million due to higher decay expense as a result of the increase in closed loans and higher hedging costs given the increase rate volatility throughout the quarter. Retail investment income and card fees combined increased $12 million sequentially as we continue to deepen client relationships in the consumer related businesses. We also recorded $14 million in net securities gains and a similar amount of debt extinguishment cost, which are recorded in noninterest expense to slightly reposition the balance sheet. Net lease transactions had no upfront P&L impact but modestly improved our forward NIM and net interest income profile. Compared to the second quarter of last year, adjusted net interest income increased slightly as growth in capital markets and mortgage related income was able to offset the loss of RidgeWorth revenue. Let’s move on to expenses on slide seven. Adjusted noninterest expense increased $34 million sequentially due to business activity and performance in the second quarter, in addition to typical seasonal trends. Personnel expense declined $15 million due mainly to the seasonal decline in benefits costs and FICA taxes, partially offset by higher incentive-based compensation given improved business performance. Outside processing and software costs increased $15 million as a result of higher business activity levels and continued investments in technology as well as typical quarterly variability associated with the timing of rendering service. Marketing and customer development expense also increased $7 million as the first quarter typically has lower advertising cost. Other noninterest expense increased $38 million, primarily due to $14 million of debt extinguishment costs recorded in the current quarter and $17 million of discrete recoveries recognized in the prior quarter. Compared to the second quarter of last year, adjusted noninterest expense was down 2%, driven by the sale of RidgeWorth, lower operating losses and our continued overall focus around expense management. As you can see on slide eight, the adjusted tangible efficiency ratio improved to 63.4% in the second quarter, down 110 basis points compared to the prior quarter and 20 basis points better than last year. We delivered year-over-year improvement despite of $40 million decline in commercial loan swap income as we were able to grow noninterest income and reduced expense. As we've indicated in the prior two earnings calls, improvement in 2015 will be difficult given our significant progress last year in addition to lower commercial loan swap income this year. We will need to deliver strong efficiency and PPNR performance in the second half of the year to achieve our goal of being below 63% for 2015. We are working diligently to achieve this goal but as Bill indicated earlier, it will be challenging. Turning to credit quality on slide nine where our performance continues to be strong. Nonperforming loans declined 21% sequentially, primarily driven by the transfer of $110 million of loans to held-for-sale status. In addition, the net charge-off ratio was 26 basis points in the quarter, down 4 basis points from the prior quarter and 9 basis points from the prior year. The allowance for loan and lease losses and provision expense declined $59 million and $29 million, respectively, compared to the previous quarter. These reductions were driven by the even further improvements in asset quality combined with more moderate loan growth during the second quarter. In addition, the results of the recent shared international credit exam are already reflected in our June 30th allowance. With respect to the energy portfolio, we have taken proactive actions in prior quarters to build reserves. And we will continue to remain vigilant given the uncertainty associated with oil and gas prices. Asset quality conditions are likely to remain favorable over the medium term given the economic environment combined with the proactive actions we've taken to derisk, diversify and improve the quality of production. With that said, any given quarter may be impacted by discrete items, particularly given today’s low overall net charge-off and nonperforming ratio. Over the next couple of quarters, we expect provision expense to increase relative to the current quarter but remain lower than similar periods in 2014 given continued improvements in asset quality. After that, improvements in asset quality will abate and economic and growth conditions will normalize. And thus we would expect provision expense to much more closely match in that charge-off. The ultimate level of reserves will be determined by our rigorous quarterly review processes, which are informed by trends in the loan portfolio combined with a view on economic conditions. Let’s turn to the balance sheet, average performing loans declined slightly, primarily due to the $1 billion auto loan securitization we completed during the quarter, combined with continued elevated pay downs in certain segments, given the low interest rates and credit spread environment. The auto loan securitization was our inaugural transaction and its success can be attributed to the strong one team approach we have across many units within the company. Going forward, we will periodically conduct additional securitization transactions as they allow us to more efficiently use the balance sheet and diversify our funding sources, well still being an active loan originator and partner to our auto dealers and clients. C&I loans were relatively stable as growth in the number of industry verticals and the client segments was offset by targeted reductions in lower return areas. Consumer direct loans were higher, given continued growth in our online businesses. On a year-over-year basis, average performing loans grew $2.4 billion or 2%, driven by strong 9% growth in the C&I portfolio partially offset by reductions in residential mortgage, indirect auto and student loans, largely due to the balance sheet management and optimization activities we have executed over the past few quarters. Consumer loans were unchanged year-over-year. However, the mix has improved with growth in higher return direct segments offset by reductions in lower return indirect segment. Going forward, we continue to seek opportunities to help finance our clients’ growth plans, particularly given the solid economic conditions in our markets. Production trends and client activity levels remain healthy. And we will continue to keep a high focus on improving returns and ensuring new business exceeds our cost of capital. Let’s turn to deposits on slide 11. Average client deposits were up $2.4 billion or 2% compared to the prior quarter and 9% compared to the prior year driven by growth across most lines of business. We’re pleased with the improving momentum on the deposit front. Our success here reflects the overall focus on meeting more clients deposit and payment needs, supplemented by the investments in technology platforms and client facing bankers across both the consumer and private wealth, and wholesale segments. Our corporate liquidity specialist within wholesale banking, our premier bankers within retail and our SummitView product are all specific examples of investments in talent and technology that have supported this deposit growth. Importantly, the solid growth we’ve delivered has not resulted in any adverse change in rates paid or mix. Low growth -- low cost deposit growth continues to be strong, while higher cost deposits continue to gradually decline. As interest rates rise, some of these trends will normalize. However, we will maintain a disciplined approach to pricing with a focus on maximizing the non-rate based value proposition for clients. Slide 12 provides an update on our capital position. Common equity Tier 1 expanded by approximately $200 million during the quarter as a result of growth in retained earnings. While the estimated Basel III common equity Tier 1 ratio on a fully phased-in basis was fairly stable at 9.8%. Tangible book value per share increased slightly from the prior quarter as growth in retained earnings offset the lower AOCI. Importantly, tangible book value per share is up a solid 7% year-over-year. The second quarter also marks the beginning of our 2015 capital plan. We repurchased $175 million of common stock, up from a $115 million in the prior quarter and paid the $0.24 dividend, up 20% from the previous levels. Our capital return program combined with disciplined usage of employee stock-based compensation continues to gradually drive down share counts. Average fully diluted shares outstanding were down 4 million sequentially and 13 million year-over-year. And lastly, our liquidity coverage ratio continued to exceed the January 1, 2016 requirement for 90%. With that, I'll now turn things back over to Bill to cover performance at the business segment level.

Okay. Thanks, Aleem. In our Consumer Banking and Private Wealth Management segment, net income increased meaningfully relative to prior quarter and prior year, with a lower provision expense being the key driver. Core operating performance was also solid with revenue up 4%, which when combined with stable expenses resulted in strong operating leverage, a 220 basis point improvement in the efficiency ratio and 13% year-over-year growth on pre-provision net revenue. Net interest income has been steadily driving higher in this segment, both due to our balance sheet optimization efforts aimed at improving returns and deposit growth momentum. Average loans declined sequentially due to the $1 billion auto loan securitization and also a $350 million student loan sale that was completed in April. Offsetting these reductions were solid growth on higher return portfolios, including consumer direct and credit card. The loan sale activity and growth in the direct portfolios are consistent with our overall strategy to improve returns across the company. Profits were up 1% sequentially and 7% year-over-year, with growth being driven by continued execution of our strategy of deepening client relationships, particularly in our mass affluent and high net worth segment. Our premier bankers in the Summitview platform are examples of talent and technology that are enabling this growth. Non-interest income growth was solid, both sequentially and compared to a year ago. Retail investment income continues to grow, up 5% year-over-year, in large part due to increased client assets under management in our brokerage platform as we are meeting more of our client’s wealth management needs. Card fees and credit card balances are also on a positive track. Continued growth in these areas will be important, particularly given the downward pressure on traditional service charges. Expenses were flat compared to the prior quarter and year, as we maintained a disciplined approach to expense management, while investing in areas associated with revenue growth initiatives. As I stated earlier, this strategy has been paying off as we're achieving positive operating leverage in this business. Bigger picture, the prolonged low rate environment continues to place pressure on the value of deposits. However, the balance sheet management strategies we have executed had mitigated some of this pressure. Our continued focus on meeting more client needs has generated positive momentum with regard to non-interest income and deposits and we have further opportunity here. We continued to invest in our various digital platforms and we are seeing results with steady increases in digital penetration and self-service deposits. The Southeast and Mid-Atlantic economies continued to perform well and are well positioned to meet -- and we are well positioned to meet the growing needs of each of our client segments. Now moving onto wholesale banking, which has been the key growth engine for the company and it posted a very strong quarter with net income up 11% sequentially and 10% year-over-year. Revenues grew 9% relative to the prior year and were record, driven by broad-based growth across life of businesses and products. Net interest income was up 8% over the prior year, driven by strong loan and deposit growth, but this was partially offset by decline in loan spreads. While loan yields did stabilized sequentially, we would still expect modest downward pressure going forward given the current environment for new production yields. Average loans were flat sequentially and up 10% year-over-year, driven by gains across most of our client segments. Our markets remain competitive and we are being more selective to ensure we earn appropriate overall relationship returns. Loan pipelines are healthy and commitments are growing, both of which demonstrate increased activity in both new client acquisition and expanding existing relationships. Deposits were up 2% sequentially and 13% year-over-year and the success here can be attributed to enhancements in our treasury and payments product offerings along with the success of our liquidity specialist effort, allowing us to uncover and meet more of our wholesale clients’ deposit needs. Non-interest income was up 10% over the prior year, driven by record performances in multiple investment, banking product groups, including syndications, high-yield investment grade and equity capital markets. Our market share gains are direct result of the continued investment and talent to expand and diversify our capabilities, but also due to our continued move towards the less lead on deals as bankers continue to have more strategic dialogue with clients. This is further evidenced by the fact that our M&A and equity related revenues in the first half of 2015 were up 38%, compared to the same period a year ago and higher than they were in all of 2012. We continued to leverage our One Team approach to better deliver our capital markets capabilities to not only our larger corporate client base, but also to commercial banking, commercial real estate and private wealth class, a value proposition that has been very well received. Non-interest expense was up over the prior year, largely due to continued strategic investments in CIB. However, this business continues to have an efficiency ratio, which is very accretive to the overall company. We believe our Wholesale Banking business is highly differentiated, and that we have large bank capabilities and talent with a focus on mid corporate and middle-market clients. Near-term investment banking income will likely decline given the record performance this quarter and normal seasonality, but we remain bullish on the long-term growth outlook for the overall Wholesale Banking segment. Now moving into the mortgage segment where adjusted net income was stable sequentially and up $24 million over the prior year. Sequential revenue trends were impacted by higher rates in the quarter. However, expenses were flat and our risk profile continued to improve, both of which were important components to maintaining solid overall profitability trends. Getting into the details, revenues were down year-over-year, driven primarily by $19 million gain on the sale of loans in the prior year. Otherwise the increase and production related income due to a 60% increase in closed loan volume was mostly offset by a decline in servicing income, which occurred because of the higher prepayment activity. Compared to the prior quarter, revenues declined due to lower production income as a result of the lower refinance activity and reduced all-in gain on sale of margins and lower servicing income. While servicing income decline given prepayment activity and higher hedging costs, the overall servicing portfolio increased sequentially and is up 12% year-over-year largely due to continued portfolio acquisitions. Application volume declined 10% sequentially though it’s up 31% over the prior year, which will support solid year-over-year growth, rates and production. Refinance activity abated as rates rose in the second quarter. However, purchase activity levels continue to be healthy from applications and closed loans up 20% and 27% respectively compared to the prior year. Asset quality improved further this quarter as we continued to derisk the portfolio, primarily evidenced by a 42% reduction in non-performing loans as a result of the $110 million transfer of loans to held for sale. Provision expense was again negative this quarter as the pace of asset quality improvement remained strong. Given the quality of new production, we would expect overall asset quality in the mortgage business to continue to trend positively. Adjusted expenses were stable sequentially and year-over-year because cost saving efforts on lower operating losses have offset growth and production related costs and investments and technology. In particular, we deployed a new origination system for our retail and consumer direct channels during the quarter. Over time, this new technology will facilitate a faster and simpler loan process for our clients while also improving teammate productivity. Mortgages continued to be an important financial product for our clients and we are committed to continuing to improve the client experience and stay true to our purpose of lighting the way to financial wellbeing. So in summary, our company’s performance this quarter reflects its solid progress across key strategies, including optimizing our business mix and balance sheet, investing in growth opportunities, improving efficiency and growing capital returns. Net interest income and margin are beginning to stabilize and our focus on returns will remain a priority. Non-interest income trends are positive and reflective of our consisted strategy to meet more client needs. In addition, we are mindful of the intense expense discipline required to operate in this environment and to support continued growth investments so that we can deliver on our efficiency goals and provide further long-term value of our clients and our shareholders. As I said earlier, I continue to be very optimistic about our company strategic direction and our ability to execute against those strategies. So with that, I will turn the call back over to Ankur and we will begin the Q&A.

Thanks, Bill. Angelo, we are now ready to begin the Q&A portion of the call. As we do so, I’d like to ask participants to please limit yourself to one primary question and one follow-up so that we can accommodate as many of you as possible today.

Thank you. [Operator Instructions] Our first question comes from Ken Usdin with Jefferies. Your line is open.

Thanks. Good morning, guys.

Good morning, Ken.

I was wondering if you could talk to us little bit more about that mixing on the balance sheet. You are obviously continuing to be very aggressive on moving up into those less attractive consumer loans. And you’ve also mentioned just focusing on the ROEs on the commercial side. So how should we think about just loan growth going forward? And could you help us understand when we get to that kind of right bottom in terms of optimization of mix?

Hi, Ken. As we think about our businesses overall, particularly in consumer, what we’re enjoying right now is the ability to grow our direct consumer business at a nice pace and that business generates not only new consumer relationships for us, it generates them at a relatively low cost and relatively high ROA. Along with that, we’re able to move the lower ROA businesses or loans off our balance sheet. I guess part of your question might relate to the auto securitization that we did in the second quarter, and this is the first time we have entered that market in about eight years or so. And we’re able to take $1 billion of relatively lower ROA, low coupon loans off our balance sheet completely and improve the ROE dramatically in that business while continuing to enjoy the benefits of our strong origination engines and be a partner to our auto dealers. So this is an area of focus for us for some time. As you know, we have been doing this with government guaranteed loans. We have been doing this with student loans. We are now doing this with indirect auto. So this isn’t a change in philosophy for us. But we’re able to continue moving down the path and grow ROA overall across the company by focusing on business after business after business and improving ROAs across the board.

And Ken, it’s Bill. I’d sort of say we also sort of look at the health metrics and defined as sort of pipeline production and commitment growth. And our production virtually in every area, CRE would be an exception and indirect for the reasons we noted, but virtually in every area we’re up sequentially. So production is up, and that’s the important health metric. Pipelines are up. And our commitments are up. So the things that we look at to see that we have a healthy business and opportunities to increase our total needs met and continue to be healthy. So when we make the pivot, I don’t know, I would say we are always in that matter. And as long as the production and other health metrics stay healthy, I am pretty happy with where we are and generating noninterest income and continuing to improve returns.

Understood. And my just follow-up question is just to your point about it being tough to get to that sub-63 efficiency ratio. If the revenue area doesn’t quite turn out, do you pull harder on expense or you just deal with it and continue that longer-term focus to get it down over time just in terms of your balance and urgency? Thanks guys.

Yes. We’re always being making those trade-offs. And I think you’ve seen now consistently over the last few years that we got an ability to make those trade-offs, they are hard to do quarter-to-quarter, but they are easier to do over time. We said at the offset on January 1st that 63 was going to be hard, it’s hard on July 17th, then it will probably be hard till December 31st at midnight. So we are going to continue the diligent approach to match that and continue to improve overall on the commitments we paid on the efficiency side.

I think Ken on that also we set this as a tough target. We knew it was going to be a tough target, but we rather set difficult targets and be challenged in achieving them than set easy targets and just hit them constantly.

Next question comes from Ryan Nash with Goldman Sachs.

Hey, good morning, guys.

Good morning, Ryan.

Bill, maybe I can ask a question about the decision to extend the duration on the balance sheet and reduce the rate sensitivity. I know you guys have been one of the more dovish in terms of rate expectations and it looks like that outlook is proving to be correct. But can you just help us understand what the balance sheet is now positioned for in terms of rate expectations and do you see any further changes coming to the swap portfolio?

Yes, I will turn it to Aleem, but I will sort of start with. I think we are fundamentally in sort of the same zone we’ve always talked about. And maybe I will let Aleem go into some more of the details.

All right. To give you a couple of seconds of context, the general philosophy, we don’t make big bets on rates. If you think back a few years ago, we’re sort of modestly liability sensitive as rates were coming down. Today, we are modestly asset sensitive as we think rates are going up. And that’s generally the way we run the overall balance sheet. Our expectation today, which is sort of unchanged from the fall of 2014, is that there will be a rate hike around the end of this year and the rate rise will overall be deliberately paced after that for the first year or two. If you look at the swap books specifically and you think about the decline in income in the swap book, the largest driver of the decline there hasn’t been declining notionals. We have been generally consistently in the size of the book. But it’s simply the effect of the lower rate environment as the old swap coupons with higher rates are rolling off and we are putting new ones on at lower coupons. So overall you are right, we have been generally dovish on rates. We do expect that overall rate hike will be deliberately paced and I think [Cherry Allen] [ph] confirmed that view earlier this week. So we’re continuing to manage the balance sheet in that context to mitigate the risk that we have as a company to lower for longer and to prevent the balance sheet risk profile from becoming too asset sensitive too quickly.

Got it. That’s helpful. And then maybe I could just ask a quick one on expenses, which were up seasonally. I was wondering how much of the increase was driven by performance and vendors. I know you mentioned it was the majority of it versus core inflation. When I look on past years, we did see a nice step-down in the back half of the year in cost. I was wondering if we should expect to see a similar type of step-down for 2015.

Yes. We did get some of that step-down on compensation Ryan that did show up. Against that, also remember some of the increase quarter-on-quarter was due to the discrete that we had in Q1, the recognition of the gain on affordable housing, but some of the increase certainly was an increase in comp and that break that up into two pieces. One piece was April 1 standard merit increase date and that showed up. And then part two is the increase due to higher performance and the accrual for higher incentives this year as the result of the dramatic increase we saw in fee income. As you know, we are overall focused not as much on the expense number itself, but much more so on the efficiency ratio and continuing to improve the efficiency of the company overall. So I am actually pretty pleased that we got enough of an increase in revenue that despite the increase in expense we’re able to bring the efficiency ratio down some more.

Yes. So in other way, I mean, what you have seen is the pattern on the latter half of the year as the efficiency ratio coming down and obviously the fact that we’re above 63 now, we want to be below 63 that would be our expectation as we said here today.

Thanks for taking my question.

Next question comes from Erika Najarian with Bank of America.

Hi, good morning.

Good morning, Erika.

Hi, Erika.

The first question, as we also think about your rate sensitivity heading into next year, could you give us a sense in a deliberate increase in rates slowly paced increase in rates? How do you expect the past-through from both the pace and magnitude perspective in terms of your deposit data? And do you think that there is a shift change in terms of LCR essentially saying retail deposits are better than everything else? Is that a factor that we should take into account that could be a game changer relative to the last time the Fed raised rates?

Yes, Erika, there certainly appear to be lots of differing views on this issue all over the industry. And as you know, people are making the very reasonable and logical arguments for past at both ends of that spectrum. It’s going to be difficult to know how this plays out I think for several years before we see exactly what happens. But if you look at where we are, I think we fall sort of somewhere near the middle view overall. With the industry overall today enjoying this abundance of deposits and liquidity, it does seem reasonable to us to assume the deposits rates on the way up will lag a little bit. If you go back and look at history and the last 2004-2006 rate cycle, our own experience there was that our data range was between 20% and 50%, and that range is sort of differing products, differing products generated a range like that. As we look at this next rate cycle, a slow and deliberate move up would argue along with liquidity for us -- for deposit betas to be, perhaps, toward the bottom end of that, but that’s not necessarily what we're assuming. We're taking a more conservative view than that and as we model out different scenarios, we’re tending to be a little bit mote conservative and modeling in ALCO, perhaps, toward the top end of that range, which I think is somewhat sort of in the middle of where the industry is overall.

Yeah. And I think for, we spend a lot of time on this topic as you might imagine in our ALCO committee and among our executive team and but for our frontline team mates, we’re pretty clear. I mean, we want more deposits of high value and we want them better cross sold. And I think you can really see that in the last couple years in our portfolio and I think, overtime that’s the best way we can impact sort of what is an uncertain deposit beta future.

Got it. And just a follow-up to that and a follow-up to Ken’s question about remixing the balance sheet, the consumer direct business that you talk about, you highlighted in the past two calls, is that the LightStream business and if so, can you give us a sense in terms of how much -- in terms of contribution to growth do you see in your budget and what the credit in your characteristics are of typical LightStream borrower and can you get their deposits, have you been successful in able to get those deposits as well?

Erika, that’s a lot of questions in there.

Sorry. I -- just give us, I was trying to sneak them all in, I am sorry.

We’ve got them cataloged.

When you think about those businesses, our digital and online businesses, the credit characteristics are exceedingly good. We are running in FICO terms generally north of 700. And our history so far, well, let me say that, well, north of 700. And our history so far on those businesses in terms of charge-offs is exceedingly good. Total charge-offs in that business so far this year are less than a $1 million. And current 30-day plus delinquency in LightStream are also less than a $1 million. So it’s exceedingly good credit quality. The growth rate is very good. The expense of generating those loans given the digital platform tends to be lower, so the ROAs tend to be higher there. Given that LightStream is a national platform. It’s more difficult for us to generate deposit businesses from those clients. But we’ve been able to get some and we're very focused on continuing to be more client needs driven by originations wherever they are across our platform.

Yeah. And just to be clear on sort of the total direct and it is almost in thirds, but its pretty close. It’s really LightStream, GreenSky and our credit card business. So and they all have similar kind of characteristics that Aleem was talking about, certainly high FICO score, obviously, the credit cards much more fully cross-sold from a [indiscernible] standpoint. So it’s really a several different categories of high credit quality, better yield and client-oriented assets that have the opportunity for future cross-sale.

Our next question comes from Betsy Graseck with Morgan Stanley.

Hi. Good morning.

Hi, Betsy.

I have a question on the deposit growth and how you utilized it this quarter. So you, as indicated, had some nice deposit growth in the quarter. It looks like you used it to pay down some of the short-term borrowings and I was wondering why you chose to do that, as opposed to utilize it in potentially paying down some of the higher cost debt?

Yeah. Actually, but we did paid, use it to pay down long-term debt. I think, quarter-over-quarter if you take a look our long-term debt is down about $3 billion and our short-term debt is about a -- is up about a $1.5 billion.

Right.

So generally we did use it to pay-off long-term higher cost debt and restructured that a little bit, which will help NIM going forward.

Okay. And plans to continue that…

To the extent…

… as opposed, yeah.

… that we continue to get great deposit growth, our first use of cash is always loans. So we just love to do more client business and underlying loans first and to the extent that we need cash for other things we might use it for example to grow HQLA. But paying off debt and focusing on growing NIM, obviously, is going to be high on our priority list.

Right. Okay. And then just on the swap income book, would you consider increasing the size in the event that we get a slower pace of uplift in the fed funds?

Well, it’s really -- is going to depend on a lot of things then, right. What the forward curve looks like at that time? Where the value looks like at that time? What our overall loan to deposit ratio and floating rate to fixed rate book looks like at that time? So it’s on the table. But the decision on whether to do it will really be taken by our ALCO based on a whole host of current events.

All right. Okay. Thanks.

Next question comes from John Pancari with Evercore ISI.

Good morning.

Good morning, John.

Just back to expenses really quick, I know -- again back to that 63% number. In terms of the difficulty in getting there, how much of that is rate because it sounds like you said you weren’t really betting on rates anyway, so what is it that really drove the shortfall in your eyes? Is it other related margin pressures or sluggish pickup in loan growth, what really contributed to that?

John, let me sort of start that. We don’t perceive we had a shortfall, so the 63 is the full year goal as we indicated earlier. This tends to have some seasonality attached to it. You look at the last couple of years. The last two quarters tend to be lower on the efficiency ratio side. So, we are not perceiving or indicating, or highlighting a shortfall. We're just talking about it all. We have said earlier, we don't anticipate a rate increase impact to our efficiency ratio target. I think that keeps the discipline tight for us internally. So it’s sort of a no excuses commitment that we make to ourselves and we don't look to exogenous factors to get it. We've got to sort of do it internally within our business. So, I think just really all we were trying to indicate is that it is hard and that we have a lot of things that we have to do. We have commitments that we have to make and we have got execution that we have got to make sure that we accomplish. I think I’ve indicated before, every single one of our lines of businesses have a short-term and a long-term efficiency ratio target. And they have specific initiatives that they have to undertake against those. And I’m sort of looking around the rooms here in the eyes of all of them and they know it is hard. But I don’t want you to think that we think we are behind.

Okay. All right. That’s fair. And then on the competitive commentary that you provided, sorry if you already elaborated on it, but on the commercial side, we are seeing a lot of your peer banks that are starting to step to the sidelines in terms of some of the most competitive mid-market commercial type of lending. Are you seeing competitive pressures that are keeping you out of that space as well?

Yeah. I think it always depends on how you define the space. Everybody sort of defines corporate mid-market in different ways. If we sort of talk about our commercial market, I don’t think we’re stepping away from anything. I mean, like we’re sort of stepping into the opportunities. If we talk about the upper end of large corporate, or maybe seeing some leverage that’s reaching some new thin air, yeah, I think there are things that we’re stepping away from in terms of a structural leverage kind of standpoint but we see lots of opportunities. So, we still see lots of things that we can stay involved in. The market, I guess, particularly in our markets and then the businesses that we’re in, I guess was, is and will be continue to be competitive.

Our next question comes from Mike Mayo with CLSA.

Hi. Could you elaborate more on investment banking? I look at the four largest banks that reported so far this quarter. Traditional investment banking is kind of flat or tiny a bit quarter-over-quarter, year-over-year. If I look at total capital markets, it’s down. I know you look at SunTrust, which is up by half linked quarter and by a fifth year-over-year. So the question is how are you doing that? Are you taking on more risk? Is it because maybe your category includes syndicated finance? Maybe that’s not apples-to-apples. Or just can you just give us more transparency on what's underneath that investment banking line item?

Yeah. Sure, Mike. And the good news is it is not one thing. So, we’re hitting on a lot of cylinders. Syndication was clearly up, high-yield bond origination clearly up, investment-grade bond origination up, equity offerings and M&A both up significantly. So for us, I think it’s just an execution, continued execution of the strategy that we've been on now for multi, multi years. It’s mainly a mid-market business. For us, we still operate in a mid-market zone. I mean that’s how we build this business. And I think it maybe a good harbinger of positive development, that, that kind of activity in that market is getting better, particularly in the areas of M&A and syndications.

So of the $145 million this quarter, I mean just roughly, how much is syndications versus some of the other areas?

Mike, syndication is about third of that in terms of total revenue.

Okay. And the other two thirds just in a broad brush?

Yeah. That would be investment grade bonds, high yield bonds, M&A and equity offerings would be the majority of the remainder.

Okay. And lastly, you said you putting on new C&I loans yields at lower yields than the existing. How do you consider pricing your commercial loans in the context of having the capital market business like you have?

It’s clearly part of our calculus. Whenever we look at new business or new clients. part of our philosophy is always we want to be a relevant supplier for that client. So to be relevant that’s not necessarily just lending the money. It’s understanding their entire business, understanding their needs, and being there as in -- as a strategic advisor to them to help them to grow their business. And in that context, we’re very aware of how our investment banking and capital market business might be able to help them do that. And we make them aware of that and we hope that there is a good synergy there.

Yes, Mike. I mean every new commitment of any size has got a go through in ROA, ROE and RAROC lens. All of which are very disciplined and we hold our teammates accountable for achieving those.

Our next question comes from Geoffrey Elliott with Autonomous Research.

Hello there. Thank you for taking the question. I wanted to ask about high-to-low transaction processing on checking accounts. Do you have any thoughts on whether you are going to be moving more into line with other banks in the industry and discontinuing that at some points over the next few quarters and years?

Yeah. I’m going to apologize I had a hard time hearing your question, but I’m sure, it was high-to-low related. So let me…

It was. Are you going to move more into line with other banks over the next few quarters and years?

Yeah. So couple of comments to clarify the statements that we’ve made in the past as we currently are high to low. But we have some very significant differences that we process deposit before debits. We have limits on OD numbers and we have a no small OD type policy. So those are important sort of in context. Now that been said what we have said is that we are going to transition to moreover time based system. We are going to be doing that through 2016. So we are doing right now a lot of client research. We are doing a lot of product research. We are modeling lots of different activities. So sometime in the later half of 2016, we’ll be in sort of implementation mode. So I think the financial impact yet to be determined but clearly predicate on some of the other things I said. We won’t start feeling that probably until full year ‘17.

And can you give any kind of range at all around what the financial impact could be once we get into 2017?

Yeah. I don’t want to do that yet, because we really got to finish the modeling process. We remember sort of ODs as a total or about 3% of our total revenue base. This would only impact a portion of that. So this is not a substantial change but we’ve really got to finish the modeling part and determine what client response will be and making sure that we are responsive to clients. So sometime later, we’ll be able to quantify that I think a little more specifically. But for now we are not viewing this as given away we currently process, doing this as a major, major shift from a revenue perspective.

Angela, we have a time for one more question.

Thank you. Our final question comes from Matt Burnell with Wells Fargo Securities.

Good morning. Thanks for taking my call. Just a couple of follow-ups. Aleem on the mortgage outlook, how are you thinking about that? I mean the production revenues were down a little bit quarter-over-quarter. I think that was partly due to lower gain on sale, but also I think you had some MSR, higher MSR hit in the servicing income. How are you thinking about mortgage revenue over the next couple of quarters?

Yes. Thanks, Matt. As we think about our patterns in the mortgage business, as rates have moved up as and I look forward to Q3, I would probably think about the refi business, the refi activity continuing to decline and continuing that pattern that we saw in Q2. But I would think that purchase activity will continue to remain strong sort of within seasonal patterns. So perhaps, this is a stronger Q3, followed by slower Q4. And in our markets, the economies are doing well, unemployment is down, GDP is up, and so the purchase business I think there is looking pretty good. In terms of MSR and servicing, Q2 was a little bit difficult for us because of all of the rate volatility that we had in Q2. You recall the way you normally see rate volatility affecting us is in a particularly volatile quarter. Our servicing income is generally down. And if rates are relatively stable, our servicing income is generally up. So looking forward to Q3, I was thinking about refi activity being down, purchase activity remaining strong, and the MSR or servicing income being partially contingent on rate volatility.

Yes. I think all things being equal, I mean I think 2015 will certainly be better than 2014, somewhat balance if you want to sort of try to net all that out as you look forward. And particularly in our markets, I mean we are seeing good housing recovery, we are seeing good purchase activity, and we are seeing a very good improvement. And I think the most important is the job creation. So we feel good about the purchase activity, while transition is lame settle have a seasonal component to it, but '15 will be better on balance than '14.

Okay. That’s helpful color. And then for my follow-up. I guess I just want to follow up on Mike’s train of thought in terms of the capital markets business. You have mentioned that obviously that’s a sort of a client focus business. You want to be a strategic advisor to your customers. I want to put some numbers to that. I mean, can you demonstrate or show sort of what the percentage of customers that you're doing capital markets activity for now versus, let’s say two years ago and sort of what the momentum in that metric might be?

Matt, I don’t know if we got that exactly metric, but maybe another way of showing the momentum and our success in becoming a strategic partner to our clients is actually the line of business revenue out of our corporate and investment banking unit. And if you look at that over time, go back to the start of 2014 that was around 90 million. And as you saw this quarter was around 145 million. So that about of 50% increase in revenue coming out of that business, which might be a good indicator for you as to our success in meeting client needs, not just in terms of broadening and covering more clients but getting deeper with the clients we have.

Yes. I mean, if you just try to put some numbers around sort of where we’re moving, I mean we’re four times more left lead, 44 times more joint bookrunner or one time more left lead on investment grade, 27 times more joint bookrunner. So these are good, I mean big numbers. I mean, we have lots of penetration not only within the client base but for those clients we are moving to the left side.

Angela, this concludes our call. Thanks to everyone for joining us today. If you have any further questions, please feel free to contact the Investor Relations department.

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