Solidion Technology Inc. (STI) Q3 2016 Earnings Report, Transcript and Summary

Welcome to the SunTrust Third Quarter 2016 Earnings Conference Call. [Operator Instructions]. I'd like to inform you that the call is being recorded and if you have any objections, you may disconnect at this time. Now I will turn the call over to Ankur Vyas, Director of Investor Relations. Thank you, you may begin.

Thank you, Iris. Good morning, everyone and welcome to our third quarter 2016 earnings conference call. Thank you 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'll turn it over to Aleem for additional details including our results at the business segment level. I'll conclude with some perspectives on how this quarter's performance fits into our long term strategy and overall investment thesis. We reported $0.91 of earnings this quarter which represents a 2% increase relative to the core earnings of the prior quarter and prior year. Overall, I'd characterize this as a good quarter. Revenue growth in particular was very strong, up 8% compared to the prior year and reflects the ongoing investments we've made in each of our businesses over the past few years. Noninterest income was up 10% year-over-year, driven by strength in mortgage and another record quarter in capital markets which is clear that we're increasingly becoming a preferred strategic advisor to our clients. Net interest income was up 1% sequentially and 8% year-over-year. Our businesses remain focused on managing the balance sheet in a strategic, profitable manner which has allowed us to overcome much of the margin compression. The $1 billion auto loan sale we executed this quarter is fully consistent with our commitment to meet our clients' needs, while also optimizing the balance sheet by staying disciplined on returns. Overall, our strong revenue growth helped offset the increase in expenses and keeps us on track to meet our goal of improving the efficiency of the Company, evidenced by the fact that our year-to-date tangible efficiency ratio is 100 basis points better relative to all of 2015. Now with that said, absolute expenses this quarter came in higher than I feel is acceptable. Some of this was related to revenue and some were anticipated increases, but overall, we did not fully demonstrate the strong expense control I think we're capable of. Asset quality improved as we made further progress in working through certain energy credits. The net charge-off ratio declined to 35 basis points. Non-performing loans were stable and provision expense declined. I consider our overall asset quality to be strong which is a testament to the solid economic conditions in our markets and businesses and our continued underwriting discipline. Our capital position was stable with our Common Equity Tier 1 ratio estimated to be 9.7% on a Basel III fully phased-in basis. Tangible book value per share increased 1% sequentially and 9% from the prior year. Additionally, we began executing our 2016 capital plan this quarter, of which we will return 23% more capital to our shareholders relative to the previous plan. In addition, I'll highlight the acquisition of Pillar Financial which was announced yesterday. As you've heard us say in the past, the types of acquisitions we're focused on today are businesses that complement and leverage our existing capabilities, while also being accretive to our return profile. Pillar Financial does just that. They're a multi-family agency lending and servicing Company that holds Fannie Mae, Freddie Mac and FHA licenses with an originate to distribute focus. This acquisition broadens the capabilities of our commercial real estate team, increases the velocity of our balance sheet and allows us to meet more of our client's permanent financing needs. Lastly, I'm pleased to provide an update regarding our onUp Movement which is focused on sparking a conversation with all Americans about money and giving them the tools and resources they need to move from financial stress to financial confidence. We formally launched this movement with our Super Bowl ad back in February. But it's truly is an extension of our Company's purpose of lighting the way to financial well-being. I'm pleased to announce that over 700,000 people have joined the movement, by taking a first step towards financial confidence. This is just one symbol of our commitment to put our purpose in action every day. So with that, let me turn it over to Aleem.

Thanks, Bill. Good morning, everybody. Thank you for joining us this morning. Let's move on to slide 4 and take a look at our net interest margin. You can see that it declined by 3 basis points compared to the prior quarter, primarily due to the continued low interest rate environment which negatively impacted both residential mortgage loan and security yields. In addition, the full effect of last quarter's subordinated debt issuance, along with slightly higher deposit costs, also contributed to the sequential decline. These negative impacts were partially offset by an increase in LIBOR and further favorable mix shift in our loan portfolio, as a result of our continuous balance sheet optimization efforts. Net interest income increased $19 million from prior quarter, as solid 1% average loan and deposit growth counteracted the reduction in NIM. Assuming a static rate environment, we expect the net interest margin to decline 2 to 3 basis points next quarter. We're continuing to carefully manage the duration of the balance sheet, given the prolonged low rate environment, while also being cognizant of controlling interest rate risk. Moving on to slide 5, you can see that despite the recognition of $44 million in net asset-related gains last quarter, noninterest income declined only $9 million, due to strength in both capital markets and mortgage. Capital markets-related income had another record quarter, increasing $52 million sequentially and exhibiting strong returns on the strategic investments we have made in this business over many years. In addition, as a reminder, we had $17 million in CVA-related charges last quarter which suppressed the income. Mortgage production income increased $7 million from an already strong second quarter, benefiting from increases in both purchase and refinancing activity. As a reminder, we're now fully implementing our enhanced posting order process and expect to see a reduction in service charges of approximately $10 million per quarter starting now. Moving on to expenses on slide 6, noninterest expense increased $64 million relative to the prior quarter, primarily due to higher regulatory and compliance-related costs, higher costs associated with increased revenue and business activity and increased net occupancy expenses. In terms of the specific expense categories, outside processing and software costs increased $23 million sequentially, primarily due to increased technology investments, higher regulatory-related costs, higher levels of business activity and normal quarterly variability. Net occupancy expense increased from the prior quarter due to a $6 million discrete benefit in the second quarter and a reduction in amortized gains from prior sale leaseback transactions. Over time, these amortized gains will further dissipate. However, we will be able to offset most of this with a more efficient branch network, resulting in net occupancy costs that are generally stable from here on. Lastly, the improved levels of revenue and business activity resulted in increased incentive compensation and also partially impacted the growth in outside processing, as I noted earlier. In comparison to the third quarter of last year, noninterest expense was up 11%, not only due to the same reasons as the sequential increase, but also due to roughly $30 million of discrete mortgage-related recoveries and roughly $30 million of lower incentive and benefit costs in the prior year. Overall, while a portion of the expense growth this quarter was related to revenue and a portion was anticipated increases, we do not view the absolute level of expenses we reported this quarter to be our new run rate and we will continue to work diligently to improve our execution and effectiveness. On slide 7, as we had discussed last quarter, the tangible efficiency ratio increased and was 62.5% for the third quarter. Year-to-date, the tangible efficiency ratio is 61.6%, 100 basis points better than the full year 2015 and we're well on track to meet our 2016 commitment. Going forward, we've continue to remain focused on continuous improvement towards achieving our long term goal of a sub-60% efficiency ratio. Moving on to slide 8, asset quality trends were generally similar to previous quarters and we saw visible improvement in energy-related charge-offs which drove the 4 basis point reduction in the total net charge-off ratio. Assuming oil prices do not decline significantly, we still expect a remaining $40 million to $60 million of energy-related charge-offs over the coming two or three quarters. Nonperforming loans were flat from the prior quarter at 67 basis points, as slightly lower energy NPLs were offset by modest increases in other categories. The ALLL ratio decreased 2 basis points from the prior quarter, as a result of continued improvements in the asset quality of our residential loan portfolio. This improvement, combined with slower loan growth and a lower energy-related provision resulted in total provision expense that declined $49 million compared to the second quarter. Given good progress so far, we're now able to tighten our expected range for the Company's overall net charge-off ratio to be between 30 and 35 basis points for the full year 2016. We expect a relatively stable allowance ratio in the near- to medium term which should result in a provision expense that modestly exceeds net charge-offs, although there will always be some of level of quarterly variability. Turning to balance sheet trends on slide 9, average performing loans increased 1% from the prior quarter, primarily due to growth in consumer banking, as our lending strategies continue to produce growth through each of our major channels. In addition, we completed a $1 billion auto loan sale, consistent with our strategic goals to optimize the balance sheet and increase velocity, while also allowing us to continue to meet the financing needs of our auto dealer clients. Separately, we reclassified approximately $1 billion of loans from commercial real estate to commercial construction this quarter, in accordance with a revised interpretation of regulatory classification requirements. On a year-over-year basis, average performing loans grew $8.9 billion or 7%, driven by broad-based growth in C&I, CRE, residential and consumer loans. Let's take a look at deposits. Average client deposits increased 1% compared to the prior quarter and 7% year-over-year, primarily due to growth in NOW, DDA and money market accounts. More impressively, average client deposits are up a full 17% over the past two years, amongst the highest of our peers. This success reflects our overall strategic focus on meeting more clients' deposit and payment needs, our investments in technology platforms and teammates in each of our three operating segments. Rates paid on deposits increased 1 basis point sequentially, a reflection of a slight mix shift towards wholesale banking versus consumer banking clients. We continue to maintain a disciplined approach to pricing, with a focus on maximizing the value proposition outside of rate paid for our clients. Slide 11 provides an update on our capital position. We commenced our 2016 capital plan this quarter which included an increase in our quarterly share buyback amount from $175 million to $240 million and an increase in our dividend from $0.24 per share to $0.26, the combination of which was a 23% increase in total capital return. Despite this increase in capital return and lower AOCI as a result of higher long term rates in the quarter, we still grew tangible book value per share 1% sequentially and 9% year-over-year and maintained strong capital levels, evidenced by a 9.7% fully phased-in Basel III CET1 ratio. Separately, we have reviewed the Federal Reserve's notice of proposed rulemaking regarding capital and stress test rules. And while there are still details to be ironed out next year, we believe the new rules and comments are a positive development in tailoring regulations towards actual risk profile and complexity. Lastly, our liquidity coverage ratio exceeds current regulatory requirements and we expect to add approximately $1 billion of high quality liquid securities in the fourth quarter to finalize our progress towards the increased 2017 requirements. Moving on to the segment overviews, let's begin with consumer banking and private wealth management on slide 12. Net income increased $14 million sequentially, as a result of higher revenue and lower credit costs, but was $21 million lower compared to the prior year, as higher noninterest expense and provision expense offset a 3% increase in revenue. Net interest income was up 2% sequentially and 5% versus the prior year, driven by strong loan and deposit growth. More specifically, excuse me, our investments in direct consumer lending continue to yield positive results. Consumer loans are up 20% year-over-year, as our product offerings and strong client experience have driven continued market share gains. Noninterest income was up 6% sequentially as a result of discrete items in the current quarter and prior quarter, in addition to seasonally higher trust and investment management fees. Retail investment income is down sequentially and year-over-year, as reduced transaction-related activity has been partially offset by growth in our retail brokerage managed money product, a strategic shift we've been working on for over a year now and one that will continue over the medium term. While this is negative for near term retail investment income growth trends, it is positive for our clients and the long term health of our business. Overall asset quality remains strong, with delinquencies and net charge-offs remaining near historically low levels. The sequential decline in provision expense was primarily due to improvements in the home equity portfolio. Noninterest expense increased 4% sequentially and 8% compared to the prior year, generally driven by higher FDIC and regulatory costs, higher occupancy costs and other discrete costs and investments. We continue to see opportunities to improve the efficiency and effectiveness of our consumer banking business, as we make further investments in talent and technology, while also realizing the benefits of a reduced physical real estate footprint. Moving on to wholesale banking on slide 13, we had another strong quarter, in part due to strong market conditions, but more reflective of the continued strategic momentum we're having with our clients. Revenues were up 4%, both sequentially and year-over-year, primarily due to capital markets record performance where we continue to see the results of our consistent focus on expanding and deepening client relationships and meeting the capital market needs of all wholesale banking clients. More specifically, M&A, a business which takes a long time to develop and has been a key area of investment for us, had a record quarter, another proof point that our clients increasingly view us as a trusted strategic advisor. Additionally, capital markets income from non-CIB clients is up 34% year-to-date and we feel confident that this will become a more meaningful contributor to the bottom line, as we work together as a team to become the preferred advisor to our commercial, CRE and private wealth clients. Net interest income was up 2% sequentially, as a result of modest increases in loan spreads and continued deposit growth. Net income was up sequentially and down year-over-year, largely due to the variance in provision expense which decreased sequentially as a result of the decline in energy net charge-offs, but increased on a year-over-year basis, also driven by energy. Overall, we believe our wholesale banking business is highly differentiated and we'll capitalize on this positive momentum to deliver profitable growth. Additionally, with the acquisition of Pillar Financial, wholesale's annual revenue should increase by roughly $90 million beginning in 2017. Pillar's efficiency ratio is roughly 80% to 85%. And while this will be dilutive to the overall efficiency ratio, the acquisition of Pillar will be accretive to our capabilities, ROA, ROE and net income. Moving to mortgage on slide 14, mortgage was once again a key contributor to our performance this quarter. Revenue was up 1% sequentially and 20% year-over-year, driven by higher noninterest income. As you may remember last quarter, mortgage production income had a $10 million benefit from a product offering change which altered the timing of revenue recognition. Despite this benefit in the second quarter, production income increased another $7 million sequentially, as a result of higher volumes. Compared to the prior year, production income increased $60 million, driven by higher volume and higher gain on sale margins. Servicing income decreased sequentially as a result of anticipated increases in decay expense, but increased by $9 million compared to the prior year, as a result of improved hedge performance and portfolio acquisitions. Our servicing UPB is up 2% year-over-year and we have purchased an additional $3 billion which will transfer in the fourth quarter. Net income was down $12 million sequentially and $54 million year-over-year. The sequential decrease was driven by higher noninterest expense, while the year-over-year decrease was due to approximately $50 million in after-tax discrete benefits recognized in the third quarter of 2015. At a high level, our continued focus on originating high quality mortgages, maintaining executional excellence and gaining smart market share has positively benefited both our clients and our shareholders. Looking to the next quarter, pipelines and application activity point to softening, albeit still good momentum in mortgage production volumes. While we don't expect to match this quarter's results, mortgage production income should demonstrate improvement, relative to the fourth quarter of last year. I'll now turn the call over to Bill for some concluding remarks.

Thanks, Aleem. And to conclude, I'll point to slide 15 which highlights how this quarter's performance aligns with our overall investment thesis and the strategies we have in place. But first, the diversity of our business model helped us mitigate risk and achieve 8% year-over-year revenue growth. We delivered good revenue momentum across both net interest income and noninterest income and in each business segment. Second, while we had an increase in expenses this quarter, some of which was tied to revenue growth, the year-to-date tangible efficiency ratio is 100 basis points better relative to 2015 and we remain absolutely steadfast in our commitment to achieving our long term sub-60% efficiency ratio target. Third, the revenue growth we produced this quarter is a reflection of the consistent strategic investments we've been making in each of our businesses for now many years. As an example, this quarter was another record quarter for capital markets, an area where we've been making investments in talent, technology and resources for over 10 years. More recently, we've also been investing in corporate finance and industry specialists within commercial banking. These investments, combined with our heightened focus on working better together to meet the capital markets needs of all of our wholesale banking clients, continue to contribute to SunTrust Robinson Humphrey's success. In mortgage, we've been making targeted investments in both people and technology, across both origination and servicing. Our origination market share has increased and we continue to make servicing acquisitions. Similarly, consumer lending has been another key area of investment over the last few years and it's demonstrating strong, consistent momentum, evidenced by the 20% year-over-year increase in consumer loans. This growth has also resulted in a positive mix shift within the loan portfolio, helping to of offset some of the margin compression in other areas. And fourth, our strong capital position has afforded us the opportunity to grow capital returns and make targeted acquisitions like Pillar Financial. Pillar is accretive to SunTrust's capabilities and our financial position and is also fully consistent with our purpose by helping finance critically-needed affordable housing and senior housing for the communities we serve. So to conclude, I'm pleased with our Company's performance in the third quarter, though as always, there are things we can improve upon. Our strategic consistency has helped us improve execution and financial performance across the organization. Remaining focused on purpose of moving clients from financial stress to financial competence will continue to be our guiding principle. In living this principle daily, will result in improved financial well-being for our clients, our teammates, our communities and of course, our shareholders. So with that, let me turn the call back over to Ankur and begin the Q&A.

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

[Operator Instructions]. Our first question will be coming from the line of Mr. Matt O'Connor from Deutsche Bank. Sir, your line is open.

You were pretty clear in your prepared remarks, that expenses were a bit higher than expected this quarter and you expect them to go down. And maybe it's just semantics, but I'm wondering, do you view the expenses as disappointing this quarter? Did it kind of catch you off guard or was there some discretion there, given the strong revenue?

Well, expenses sort of lie where they lie, in terms of discretion. But maybe I'd say it this way, Matt, so to start at the high level. So it's fall in the southeast, so I'm going to use a football analogy. So we didn't over-spike the ball in the second quarter and similarly, we're not conceding our ability to get in the end zone based on the third quarter and the end zone being improved efficiency ratio for the year. There were things that were positive from the expense side, so obviously expense tied to revenue. There were things that were strategic investments from the technology side that we wanted to make sure that we continued to do, to support our businesses. There were investments in people and other resources. And then, there were things like, there were some -- you saw the increase in operating loss, some small legal components as part of that. And those are consistent things, but if they're disappointing, yes, absolutely, they're disappointing. And I want to make sure that we continue to keep and I'm confident we've got it, the stringent focus on achieving the overall efficiency ratio. Remember, it's not the expense target. I think the good news, I think the expense target, so to what we talked about at the beginning of the year, probably is going to go up a little bit. But the good news is, it's going up for the right reasons. It's going up, because we've got more revenue, we've got more capability. And the efficiency ratio target improvement this year over last year and improvement next year over this year, is a consistent theme that we've done for five years. And I don't plan on breaking it.

And then, just my follow-up would be, what's the magnitude of the decline, costs of [Technical Difficulty] and how can you maybe frame next year's expense run rate?

Magnitude of decline.

I'm sorry, Matt, say that again, I didn't quite get that.

Yes, how much do you expect costs to go down in the fourth quarter versus 3Q and how do we think about the run rate in 2017, if you have anything to share there?

All right. Well, let me take that one. So as Bill said, look, we're not happy about the expense level this quarter in and of itself and we're working on ways to bring that down. But I do want to take a step back and look at expenses overall in the context of the Company. You recall, at the beginning of this year, we thought that expenses could be around $5.4 billion for the year, if we had good revenue growth and if we were able to also deliver some operating leverage. I think when you look now, nine months through the year, we can probably say that revenue growth is actually ahead of expectations and thus, so are expenses. And you can see the improvement in the overall efficiency ratio for the year so far and we expect that to continue for this year. From an operating leverage perspective, our revenues this year are up, north of $400 million and compared to expense growth of about $200 million. So we've delivered $200 million more PP&R and a business that's about 100 basis points more efficient overall. As I think about now Q4 and looking at next year, I don't think that we're going to consistently operate with an expense base that's north of $1.4 billion per quarter, although it is to some extent going to be revenue dependent. If we continue to deliver revenue growth the way we have this year, obviously our expense base is going to climb for comp, outside processing and other volume-related costs. We've also had some step-ups in expenses, things like the new FDIC assessment and we continue to make investments in technology and talent to help grow revenue. But as I look to next year, we have delivered I think, Matt, counting this year, five years of continued efficiency ratio improvements. We expect to be able to do that again next year and we've also very consistently said, if it takes $1 of expense to generate $2 of revenue, that is, that's going to be a trade we're willing to make. You can see we did that pretty well exactly in the nine months this year, relative to last year, right? We had $200 million more expenses and $400 million more revenue. So that, we've done that. We're going to try to continue to grow revenue more than expenses and we're going to continue to try to make this Company more efficient and look to bring our efficiency ratio down next year, relative to this year.

Our next question will be coming from the line of John McDonald of Bernstein. Your line is open.

I wanted to follow up on the comments around the net interest margin line. You mentioned in a static rate environment, you'd likely see 2 to 3 basis points of NIM compression in the current rate environment. What's driving that? And then, I'll just ask my follow-up now. And if you do get one Fed rate hike, how much would that help incrementally?

Well, John, what drove the reduction or what will drive the reduction of a couple basis points in the short term, I think is going to continue to be that, new production yields are generally equal to or slightly lower than portfolio yields. So that volume inevitably is going to grind into NIM and bring margins down just a little bit. But I think in the context of net interest income, if you look at the last several years, we've been able to despite the decline in NIM continue to bring net interest income generally up. And if we continue to get solid loan growth the way that we have been and expect, we do expect that we'll be able to bring net interest income up somewhat. I think net interest income can grow. It will be modest, perhaps, relative to where we were this quarter, but I do expect net income to climb, despite the slight decline in NIMs.

Okay. And the impact from a fed hike if we do get one in December, what kind of impact would you expect late in the quarter and maybe into first quarter from a hike?

Well, probably no impact in Q4 for a hike in December. But if there's a 25 basis point hike in December and then I look to Q1 coming out of that, if you look at our overall asset sensitivity numbers, you see we're about 2.1% asset sensitive. That would translate, given a fed hike of 25 basis points and given the profile of the rate risk we have across the curve, probably to about a couple of basis points of NIM in Q1.

And John, this is Bill. By the way, I would really characterize that, if we get a rate increase post-election and that results in consumer confidence and business confidence and that's exponentially more beneficial to us than a 25 basis point increase, running through the balance sheet and the income statement. So if it's a signal of a positive development and gets people off the sidelines and into the queue, I think we're just, never been better positioned to take advantage of that.

Our next question will be coming from the line of [indiscernible] of CLSA. Your line is open.

Can you give more color on capital markets? I mean, when I look at the largest banks and then I look at you, your growth rates are a lot more for trading and investment banking. And so, would you describe that as product mix, geographic mix? Are you getting share gains? And the retreat of the European banks, do you see that at all or are you taking more risk?

I'd say yes to all the other -- the first questions and no to the last one.

So I do think, Mike, it's as you said, it's a combination of a lot of things. And the great news is that, the diversity of the increase, so it's not sort of coming from one thing. It's not coming one geography. Even on the trading line, it's pretty diverse. I mean, for us, fixed income is 30% or so of that. So you also get the benefit of the derivative part. So just the core part of running our business better, foreign exchange, whatever, all the components that go into trading. And then across investment banking, as Aleem said, I mean, M&A had a great quarter. If you put sort of M&A, equity, equity sales and trading all into some bucket, that's 30%-plus of our contribution this quarter. So it's well-distributed. I think the part that I mentioned also in my comments that we're starting to see and I'm excited about for the future, is what we've built in the commercial side, really sort of to try to really replicate what we're doing in the -- in CIB and get that same advisory type primary positioning in the commercial market. And we made a lot of investments there, somewhere between commercial and CRE, I mean, we're up 20%-plus and really building good momentum in that segment as well which is like to me, like building a whole new industry vertical in our business. And it's doing it without having to take more risk, because we already have the balance sheet. We've already committed the balance sheet to those clients. We're really now getting the additional fee-based advisory business from that.

Mike, the reason that trading might look like it's a very high growth rate to you, is because of that CVA charge in Q2. That was a $17 million amount as a result of a methodology change. And so, that might be one of the reasons why trading looks high to you now. But from a risk perspective, if you think about it in VaR terms, our daily VaR in capital markets is about $5 million or less. So we're not a risk-taking business as such. We're very much a client facilitation business.

Our next question will be coming from the line of [indiscernible] of Jefferies. Your line is open.

I heard in the prepared comments that you're still expecting pretty good loan growth this quarter. Obviously, we saw the $1 billion moved out on the auto side. Sequentially, C&I was down and a lot of other banks have seen that. Can you just talk about the opportunity set, still that you see out. And Bill, I heard your point to John's question about the, was a rate hike indicate better things out there, can you just talk about end demand in C&I? And then your philosophy of kind of maintaining the ROE potential of each relationship, versus what you're seeing in the market?

Yes, I think we've been really clear, is we don't manage to loan growth. I mean, that's an outcome. So if I look and I'll get to C&I, but if I look sort of corporately for the quarter, relative to this quarter last year, production was up 6.5% or so. And overall, we have really good pipelines, paydowns were up a bit and then we had the $1 billion loan sale. So that sort of balances out sort of where the total piece is. As it relates to C&I, there's some seasonal things. So for example, the dealer portfolio goes down a little bit in the third quarter, revolver utilization goes down a bit. We had some more paydowns. Our production in C&I is fine. The CRE production is down which you would expect. And then, if I look at sort of the pipeline, the pipeline looks -- in C&I looks good. So the pipeline looks okay. So we did have sort of flattish, but I think some of that's seasonal. And the metrics that I look at, production and pipelines is sort of where I start with, those look okay.

And I think the auto loan sales helps us look flattish. Otherwise, we certainly would have grown our average more than you see here. And I think that's a demonstration as Bill said, Ken, of we don't manage to loan growth. If we wanted to show loans up, we would have just not sold those loans. But the reason we sold them was, it was the right thing to do. They're relatively low ROA assets for us. And we can improve our returns for the Company overall, even though it might look optically, like our loan growth isn't as high as some would want.

And then, you also asked a question about ROE by relationship. And we have I think, an incredible amount of intensity on that focus. That's something that we've engrained into the system, sort of from day one. And what you can see is the, the benefit of that, is you can see that fee income growing, without the balance sheet having to grow. And over time, we would hope that can continue to be disproportionate. So that discipline is well-engrained in the system and we see it in the velocity of the balance sheet. That's another thing that I look at. So things that are low yielding and we're not achieving the hurdle rates, we're pretty quick to take action. And we hold our relationship managers, I would put in the category of highly accountable, to achieving the things that we've both set out for and taking advantage of all the investments that we've made.

Our next question will be coming from the line of John Pancari of Evercore ISI. Your line is open.

A quick question again around expenses, I know you indicated that the fourth quarter level was elevated. When it comes to the regulatory compliance costs, could you give us an idea of the, if those costs have are peaked and the timing of when you could really see an abatement in those levels and if you've quantified the annualized compliance and regulatory costs that you're incurring at this point? Thanks.

Well, let me answer your second one first or perhaps not answer your second one first. We don't actually quantify our regulatory and compliance costs, in and of themselves, because they sit on so many different line items and are part of our total Company. If you think about investments in technology, if we need to add a module onto a system to make sure that it's completely regulatory compliant, that, the cost of investing in that module we don't show as regulatory or compliance costs specifically and call that out. So that's kind of a non-answer to your second question. But in terms of overall regulatory and compliance costs, if I look forward, John, I don't think that in the short- to medium term I would think of regulatory costs in general abating or declining. I think we're in an environment, where we would expect regulatory and compliance costs to be generally stable or increasing over time. And just the environment that we're in, I don't see realistically that anybody in the industry is going to see regulatory and compliance costs fall off.

I might add to that, maybe the slope might change a little bit, but I think the slope will still be positive. We continue to look for efficiencies as well, in the compliance and regulatory and risk components of what we do. And then, it's offset. So if we just sat here over year ago, we wouldn't have been talking about DOL and the FDIC increase, as an example. So there are things that are going to continue to be new in the fabric of what you do and how you run the business. And I think we've got the scale and the competence to absorb those and continue to execute our business. And all the commitments we make around efficiency ratio are anticipating that it would be increased.

Now, you've alluded to the potential to mitigate some of that upside pressure, not only in regulatory, but also in the occupancy side and you indicated the ability to address the footprint. Can you talk a little about branch consolidation plans and the timing and potential magnitude there? Thanks.

Yes, if you look at us, since 2011, I mean, our branches are down 17%. So this is not some of a new thing for us, we've been in the branch consolidation and branch maximization and optimization mode for now quite a few years. And I would anticipate over the next three plus years, we'd have another 15% or so in branches. There'll be some opening of new branches. There'll be some closing of branches. There'll be some shrinking of branches. As Aleem talked out about, we have sale leaseback opportunity within our portfolio. I think you know that our markets are such, that they're concentrated. Our branches are generally concentrated in urban centers, so that gives us -- affords us a lot more opportunity I think to optimize. We've got the combination of in-store and traditional banking centers which also gives us an opportunity to optimize. So we feel that the branches will continue to go down, the investments in digital will offset that. And I would think, as Aleem alluded to, occupancy expense will sort of level out, because some of those increases will be offset by the efficiencies that we're going to achieve.

And Bill, that 15%, that's net?

Yes, that's net of new branches that we're opening, yes.

[Operator Instructions]. Our next question will be coming from the line of Mr. Matt Burnell of Wells Fargo Securities.

It's actually Jason Harbes on for Matt. So a question on fees. A very, really impressive results this quarter, fee income up about, I think 13% year-over-year. And you gave us some good guidance around some of the different line items. Sounds like deposit charges will be down sequentially from the posting order change, mortgage will be down seasonally as well. But and I guess, you're going to get the benefit of Pillar Financial which I don't think you disclosed the potential impact. But just adding everything together, I mean, maybe could you comment on the sustainability of the fee income growth that you saw this quarter, as we head into the fourth quarter?

Sure thing, Jason and I think you've already called several of them. If I think about overall consumer banking and private wealth, there's pluses and minuses in there. With the effect of the posting order, that will be a little bit of a negative. But as we continue to bring in more clients into our private wealth business and move them into an asset management model, they're very good long term fees that I think are going to be generated, as we help that set of clients. Mortgage overall, as you know, seasonally Q2 and Q3 are the best seasons for mortgage. Q4 and Q1 are typically slower. So as we move into Q4, mortgage fees probably come off. But looking out over the course of the next year or two, we've built a terrific mortgage business and we're gaining market share. And as we do that, I feel good about where our mortgage business is going overall. Within the wholesale banking business, we've already talked a fair bit about the growth in capital markets, about our business model that brings big bank capabilities and expertise to our core commercial client base. And as we continue to work more with that client base, I think you're going to see fees and wholesale banking grow, as we gain market share there. So if I try to put all of those things together over time, Jason, the net fees for us even excluding Pillar, I think are going to be going up over time. Adding Pillar to that is only a positive. And as I said earlier about Pillar specifically, I think in 2017, we'll see about $90 million of fee revenue from Pillar.

Okay.

It will be a little bit different from fourth quarter of 2015. And the IB side, we have more momentum and we've expanded our scope and our business is just bigger. So I expect it to be better than fourth quarter of 2015. And on the mortgage side, while purchases are sort of following a seasonal pattern and it will and we're a good, strong purchase player, we also have still some refinance left in there. So I expect fourth quarter of 2016, to be better than fourth quarter of 2015 in mortgage. So maybe a slight from the third quarter, but both probably better than the fourth quarter of last year.

Just drilling down, if I could on the card business within fee income, that's been pretty flattish, despite some pretty impressive growth in the receivables side. So I mean, is that a function of the increasingly generous rewards that you're offering to kind of drive greater card member engagement?

You're right, it is a highly competitive business overall, but as we grow our card business, we'll get the benefits of scale. And as we continue to build that business out, both in consumer and in our wholesale banking business, those scale synergies are going to be picking up and we expect the fee income from card to start to do better.

Yes and we'll start seeing the outstandings. So we've got a lot more cards in people's wallets. And I think as you accurately pointed out, the way the card business works is when you're growing, you tend to push on the fee side, because rewards sort of offset the growth in fees. But then the outstandings follow and they follow on a multi quarter basis. So I think, at overall, we'll see the growth, but we're just going to see it in some different categories.

Okay. And if I can just sneak one last one in on cards again. Have you guys set a target for where you'd like that to be? It's about 1% of the loan book today, so still small, it's a $1 billion portfolio. But do you have a longer term target for where you'd like to grow that business? Thanks.

Yes, I mean, we don't set a target as it relates to credit cards. So we've kept a philosophy that this is a relationship-oriented business for our client base. So as our client base grows and our card product becomes more relevant and it's part of lighting the way to financial well-being for more of our clients, then it will grow proportionately.

Our next question will be coming from the line of Steve Scouten of Sandler O'Neill. Your line is open.

I wanted to get a little clarity there on Pillar. I know you just mentioned it could add about $90 million in fees in 2017. But what kind of expense load would you expect there as well or maybe what kind of generic efficiency ratio does that business tend to possess?

Steve, Pillar has about, what I expect to see in 2017 from Pillar as the first year, is about an 80% or 85% efficiency ratio. So it's not going to be accretive to the Company's overall efficiency ratio in the first year, but it will be accretive to our return on equity. It will be accretive to our net income. And it will allow us to get into businesses that we're not in today, cover more clients and satisfy them in new ways that we can't do today. And then, if I start to look out to 2018 and 2019, as we build better connections through Pillar with new clients, I expect the growth rate in net income to be better from there.

And then, just one other drill-down on the expenses, sounded like you said $1.4 billion is probably not a number you'll be materially higher than heading into 2017. But 1Q 2017 tends to be a high quarter for you guys on employee comp and benefits. So how can we think about that and your ability to manage 1Q expenses in particular, with that seasonal increase?

Well, you're right, first quarter for us is always going to be higher. That's just the way it works in our industry. And so, I do expect that for that quarter, in and of itself we'll have -- if you look at one line item being expenses, it will be higher than you would see otherwise, but we don't really think about one quarter in and of itself, in the context of running the overall business. Our commitment has been, we're going to continue to make this business more efficient over time. We've done that now for five years in a row. And right now, looking out into 2017, I fully expect that our 2017 efficiency ratio is going to look the same or better than 2016 does. And on a full year basis, across the entire income statement, that's what we try to do.

Our next question will be coming from the line of Marty Mosby, Vining Sparks. Your line is open.

We can wrap it up with a couple questions here. You mentioned the higher operating losses this quarter and potentially the litigation that might have been in there. I'm looking at the prior quarter, it was around $20 million, this quarter was $35 million. Is that about the right delta or were there other expenses that were kind of unusual like that, that were embedded in the numbers this quarter?

Marty, that is indeed right about the right delta and there's not one big thing in there. We're talking about several small items, none of which in and of themselves, were worth calling out.

And Aleem, I'm going to dig into two subjects here. First, on the net interest margin, when you talk about the compression you've had in the last two quarters, you always mention the balance sheet repricing. But yet there's a lot of financial events that are going on that, I think are affecting the run rate of the margin right now. First, you have the debt issuance. That would have been dilutive to your NIM, while if you're matching it up, wouldn't affect NII so bad. And then you talked about in the fourth quarter adding $1 billion in liquid assets for finalizing your liquidity coverage ratio which would also be punitive to your net interest margin, while not as effective on your net interest income. So it seems like there's some things behind that are -- which are exaggerating the compression related to the balance sheet repricing. I just wanted to make sure I was reading that right.

Marty, again, you've got it exactly right. There's lots of things going on in there, some positive, some negative. And while if I look at NIM, I can see NIM declining a couple basis points in Q4. When I look at NII for all of those reasons, including the growth in securities, I do think that NII, we can continue to increase from the levels you saw in Q3 this year.

And then lastly and this may be too detailed for the call, but your segments are all showing declines year-over-year, with expenses growing faster than revenues. However, the segment you don't show is corporate which when you look at the net interest income is up almost $70 million over the last year. So is there some transfer of pricing or some mechanism that is creating, somehow reallocating more to the corporate versus the other segments and then kind of creating somewhat of a misleading picture when you look at the segment reports?

Marty, your previous training is causing you to look into this with a lot of detail and again, you're exactly right. If you think about how FTP works over time, the effect of FTP changes can be exaggerated at turns in rates. So when rates are moving up and they turn and go down, you kind of have an exaggerated FTP effect for a year. When rates have been going down and they kind of turn and start to go up, you see that same effect. And in our case for 2016, you're seeing exactly some of that in FTP for 2016. I would expect some of that to dissipate, as we start to get a trend in rates, with rates going up over time.

This concludes our call. Thank you to everyone for joining us today. If you have any further questions, please feel free to contact the IR department.

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