Solidion Technology Inc. (STI) Q2 2018 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. Welcome to the SunTrust Second Quarter Earnings Call. At this time, all participants are in a listen-only mode. Later there will be an opportunity for questions with instructions being given at that time. [Operator Instructions] As a reminder, today's conference is being recorded. I’d now like to turn the conference over to your host, Ankur Vyas. Please go ahead, sir.

Thank you, Julia. Good morning, everyone, and welcome to SunTrust Second Quarter 2018 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 Allison Dukes, 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, let me turn the call over to Bill.

Great. Thanks, Ankur, and good morning, everyone. I'll begin with an overview of the second quarter, which we highlight on Slide 3. Earnings per share for the quarter was $1.49, which represents a 16% increase compared to the prior quarter and a 45% increase compared to the prior year. Overall, we had a strong quarter. This performance is driven by our focus on continuous improvement and consistent investments in growth, in addition to the favorable operating environment. On the revenue front, we saw a pickup in both capital markets revenues and commercial lending activity as was anticipated by the pipelines we had leading into the quarter. These improvements, when combined with a 4 basis point expansion in our net interest margin, resulted in a 4% sequential revenue growth. Bigger picture, this growth is the direct result of the ongoing investments we have made and continue to make in our key areas of differentiation, including SunTrust Robinson Humphrey, the broader wholesale banking segment, and our consumer lending business. In addition to the revenue growth we delivered, our continued discipline on both expenses and returns is driving improvement in our profitability and, ultimately, enhancing the earnings power of the company. Specifically, this quarter, our tangible efficiency ratio was 58.7%, and for the first half of the year, it was 60.4%, down 220 basis points relative to the first half of last year. Given our strong performance this year, I'm confident in our ability to reach our sub-60% target somewhat sooner than we originally anticipated. More importantly, I can certainly see a path for several hundred basis points of additional improvement beyond sub-60% over the medium term. However, improvement in efficiency ratio will not be our only measurement of success. I believe across the company, we have significant opportunities to grow our client base and improve the client experience, and we will ensure that we have the agility and flexibility to invest in those opportunities as well. Separately, credit quality continues to be a strength for us, not only because of the favorable operating environment, but also because our risk culture and discipline that's instilled across the company. This quarter, our consistently low charge-off ratio and improved outlook for credit losses across the portfolio, including potential hurricane losses, drove a 5 basis point decline in our ALLL ratio. Our credit quality is also validated by our results in our most recent CCAR process, where our loan losses in the severely adverse scenario continue to be among the lowest relative to peers. Given this performance, the Federal Reserve did not object to our 2018 capital plan, which calls for a 52% increase in share repurchases and a 25% increase in the dividend, thereby keeping us on track to increase capital returns for the seventh consecutive year. This is a direct result of our consistent performance in CCAR, our strong capital position and the significant progress we've made in improving our core earnings power. The quarter had good success on multiple fronts, revenue growth, efficiency, credit quality and capital returns, all of which have a compounding effect for our owners, evidenced by the 17.7% return on tangible common equity. So with that as a quick overview, let me turn it over to Allison.

Thanks, Bill, and good morning, everyone. Moving to Slide 4. As Bill indicated, our net interest margin improved 4 basis points this quarter, primarily as a result of the increase in short-term rates following the March rate hike. We also benefited from positive mix shift within the loan portfolio as consumer direct continues to grow faster than the rest of the book. These benefits were partially offset by higher deposit costs and higher levels of wholesale funding, given the pickup in loan growth. This improvement in the net interest margin, when combined with the 1% growth in average loan, resulted in a 3% sequential increase in net interest income. Looking to the third quarter, we expect the net interest margin to increase by 0 to 2 basis points relative to the second quarter. Largely as a result of the June rate hike and inclusive of our expectations, the deposit cost will continue to increase. More broadly, the pace of NIM expansion going forward is likely to be lower than what we have experienced in the recent past due to rising interest rates and higher loan-to-deposit ratios, both of which will negatively impact funding costs. However, this environment is also likely correlated to solid loan growth, which will support continued growth in net interest income. Moving to Slide 5. Non-interest income increased by $33 million sequentially, driven entirely by strength in capital markets, which was up $47 million relative to the first quarter. This was due to broad-based growth across most investment banking and trading businesses. Some of this increase was offset by lower mortgage servicing income, which declined by $14 million as a result of higher decay expense, most of which was driven by higher prepaid fees in connection with the spring and summer purchase season. Additionally, other non-interest income included a $12 million gain related to our investment in GreenSky of approximately 1 million shares. This is $11 million lower than the $23 million gain we recorded in the first quarter related to a separate fintech investment. As you can see on Slide 6, the solid expense discipline we've been delivering continued into the second quarter. Expenses were down by $27 million sequentially, with most of the decline driven by the seasonal trends in employee compensation and benefit cost in addition to a $13 million gain related to the sale of former branch properties, which was recorded in other non-interest expense. Some of this was offset by higher outside processing and software expense as a result of ongoing investment in data and technology, in addition to higher operating losses, which benefited from a $10 million legal accrual reversal in the first quarter. Compared to the prior year, expenses were stable, even after the 3% revenue growth. This is a reflection of our ongoing efficiency efforts and higher branch closure costs in the second quarter of last year. Separately, now that we are two quarters into the year and have a better understanding of the impact of the new tax laws -- that the new tax laws have on our company, we're slightly revising our tax rate guidance. We now expect our effective tax rate to be approximately 19% and between 20% and 21%, if you model us on a fully taxable equivalent basis. As you can see on Slide 7, the tangible efficiency ratio for the quarter was 58.7%, which represents solid improvement relative to the prior quarter and prior year. As Bill mentioned, we will achieve our full year sub-60% target somewhat sooner than we originally anticipated, but we aren't focused on the exact quarter in which we achieve this goal. Rather we are much more focused on continuing to create capacity to invest in technology and talent to meet more client needs, which we believe will create the most long-term value for our clients and our shareholders. Moving now to Slide 8. Our net charge-off ratio decreased by 2 basis points sequentially. The low level of net charge-offs reflects the relative strength we're seeing across our C&I and CRE portfolios, performance we are extremely pleased with, but we remain cognizant that there could be both variability and normalization going forward. The ALLL ratio declined by 5 basis points sequentially as a result of our improved outlook for hurricane-related losses. This decline, when combined with the low charge-offs, resulted in a very low provision expense of $32 million. While our net charge-off ratio has come in below expectation for the last few quarters, we still expect to operate with a 25 to 35 basis point net charge-off ratio for the rest of the year as C&I and CRE charge-offs have been de minimis in the recent past. In addition, if the current asset quality conditions sustain, then the ALLL ratio could decline modestly. Now moving to the balance sheet on Slide 9. As Bill mentioned, lending trends improved this quarter, with average loans up 1% and period-end loans up 2% sequentially. The growth was broad-based across C&I, CRE and consumer lending. Looking ahead, we've got good momentum across both commercial and consumer lending, and our pipeline supports this. On the deposit side, average balances were stable sequentially and year-over-year. As anticipated, we continue to see a migration from lower cost deposits to CDs in part due to our targeted offers, and we would expect this migration to continue as interest rates rise. Separately, within our wholesale business, we also had several depositors use cash for acquisitions and business investment, a good sign of client confidence. Relatively, deposit costs increased given both the continued increases in rates, the migration towards higher cost deposits and the pickup in lending activity. We expect betas to continue to trend upwards, but the trajectory will be influenced by the absolute level of rates in addition to the lending environment. We remain focused on maximizing the value proposition for our clients outside of rate paid, and that's improving our deposit growth trajectory in a responsible fashion. However, if deposit growth remains slow, our access to alternative funding sources is strong. Moving to Slide 10, which provides an update on our capital position. As Bill noted, the Federal Reserve did not object to the capital plan we submitted in conjunction with the 2018 CCAR process, and our relative performance within the CCAR bank group continues to be strong, further validation of the quality and diversity of our loan portfolio. Our improved planning, analytics and risk profile allowed us to maximize the level of capital returns in this year's CCAR cycle while still meeting the minimum required stressed capital levels. The capital plan includes a share buyback program of up to $2 billion over the coming four quarters. Also, subject to board approval, we will increase our annual common stock dividend from $1.60 to a full $2 per share, representing an attractive 3% dividend yield for investors in SunTrust. In addition, this represents a 39% increase in capital returns relative to our previous plan, a meaningful benefit for our owners. Our estimated Basel III Common Equity Tier 1 ratio was 9.7%, and the Tier 1 ratio was 10.9%. Both are down slightly relative to the prior quarter due to growth in risk-weighted assets. Our capital plan does contemplate a preferred issuance as we work towards optimizing our capital ratios. However, the timing of that issuance will be dependent upon asset growth and our views on the interest rate environment. Moving to the segment overviews. We'll begin with the Consumer segment on Slide 11, where we continue to have solid momentum. One of our primary strategic priorities has been to improve our balance sheet diversity and enhance returns. Thus far, we feel good about the results we've delivered, the investments we've made across consumer lending, especially in LightStream, our third-party partnerships and credit card are driving solid growth and improvements in our risk-adjusted returns. Our momentum in LightStream, in particular, is improving, given the work we've done to enhance our analytics, new product offerings and growth in partnerships and referrals. We also added an additional third-party lending partner in the second quarter, a reflection of our strong digital and partnership capabilities. Some of this collective growth has been offset by the continued declines in home equity and our intentional pullback from certain lower-return portfolios, like auto. While we're seeing strong growth in net interest income and Consumer, mortgage-related income has been pressured, particularly when looking at year-over-year trends. On the production side, this is driven by lower volumes and lower gain on sale margins. On the servicing side, MSR decay expense has been rising due to the fact that the MSR asset has significantly increased in value over the past few quarters as a result of the increase in rates, and thus incoming cash flow creates a larger level of decay expense, all things being equal. Our wealth management business, however, is demonstrating positive underlying trends, with AUM up 1% sequentially and 7% year-over-year, a reflection that our value proposition for our targeted client segments is resonating in the marketplace, driving growth in new clients and greater wallet share with existing clients. In addition to the solid revenue growth in Consumer, the actions we've taken to improve efficiency drove an 11% year-over-year improvement in PPNR and a 200 basis point improvement in our tangible efficiency ratio. Our branch count is down by 5% in the past year, which is largely enabled by our increasing digital adoption rate. We're also making significant strides in leveraging technology to enhance our agility and efficiency. As an example, since we introduced our new cloud-based digital mortgage application, called SmartGUIDE, in March, we've added several new capabilities and enhancements, including a seamless integration with Salesforce to pre-fill existing client information, and we're constantly working to refine and improve the client experience. Thus far, the feedback from our clients has been very positive, and this new digital application already accounts for approximately 45% of our total applications, surpassing our internal expectations. This is just one example of the work that's being done to not only improve efficiency, but also to enhance the client experience. Bigger picture, we're just over a year into our journey of creating a more integrated consumer business, and we're very pleased with the initial results. We've made good strides in appropriately wiring the ecosystem, so we're delivering the right solution at the right time. This not only enhances the client experience, it also generates operational efficiencies. We still have more work to do, but we've got a great team in place. We have a very clear strategy, and we're in some of the highest growth markets in the country. Moving to Wholesale Banking on Slide 12, where we had another good quarter in part due to strong capital market conditions, but also reflective of the continued strategic momentum we have with our clients. On the lending side, we saw solid growth across CIB, commercial and CRE. Our growth in CRE, in particular, is a reflection of the investments we've made to meet more clients' needs. Specifically, at the end of 2017, we added permanent financing and bridge loan capability to our platform, the latter of which was developed to support our agency lending business, which we acquired at the end of 2016. The growth in these two products is more than offsetting the run-off in our construction portfolio and giving us the capability to support our CRE clients through the full life cycle of a project, not just the construction phase. More broadly, the growth in our wholesale lending portfolio is a reflection of our clients' increased optimism, which has driven more M&A activity and incremental investments. Within capital markets, we had another strong quarter, with broad-based growth across most products, including debt capital markets, M&A, equity and derivatives, the latter of which reflect increased interest rate hedging activity amongst our clients. Importantly, our breadth of reach continues to increase, reflected by the fact that year-to-date, capital markets fees from commercial banking, CRE and private wealth clients are up 30%. We're still in the early innings of executing this strategy, but we are highly encouraged by the momentum and believe we are uniquely positioned to succeed in this space, given our full set of capabilities and our One Team approach. The partnership between our commercial bankers, investment bankers, product and industry specialists, and corporate finance team is a great reflection of our culture. Like Consumer, wholesale is approving -- improving its efficiency levels while investing in the business. This quarter, specifically, we completed the transition to SunView, our new treasury management platform, and we're working on future enhancements to our cash and treasury management capabilities. In connection with our strategy to expand the scope of our commercial banking business, we also announced the national expansion of our aging services vertical to better capture the significant opportunity we have to support this industry, given our capability set and demographic trends. We're also delivering on our purpose of Lighting the Way to Financial Well-Being. We now have 120 corporate and commercial clients that have signed up for Momentum on up. That's our program which aims to help companies equip their employees with the tools they need for financial success. It's been especially impactful in our expansion markets and has allowed us to have differentiated conversation, focused on how to help these prospective clients grow their business via a more engaged workforce, not just alone. Our success thus far has also validated our belief that the combination of purpose, talent, technology and a One Team approach can overcome the legacy advantages, such as physical presence and brand. And finally, we're benefiting from continued low charge-off levels, which are a reflection of the overall strength of the economy, in addition to our consistent underwriting discipline around credit, structure and diversity. Big picture, while market conditions can and do create quarterly variability, pipelines are healthy, and we remain optimistic about the growth opportunities we have in wholesale as we bring our differentiated business model to clients in new and existing markets. Now I'll turn the call back over to Bill.

Great. Thanks, Allison. So to conclude, I'll point to Slide 13, which highlights how our performance this quarter aligns with our investment thesis. Overall, this was a well rounded quarter and one where our performance is the direct result of the strategies we've put in place and the investments we've made. Much of our investment strategy has been to focus on growing and supporting our key areas of differentiation, which has proven to be highly effective and is reflected in this quarter's results. So more specifically, the investments we've made in LightStream and third-party partnerships are providing top-notch experiences for our clients and attractive risk-adjusted returns for our shareholders. Within CIB, we've been particularly focused on investing in our M&A and equity platforms to allow us to increasingly become the strategic adviser of choice. The advisory capabilities continue to grow at a faster pace than the traditional debt business, which, obviously, ultimately, improves our ROE. Within commercial banking and the broader wholesale platform, we've invested heavily in developing our industry and corporate finance expertise such that we can deliver increasingly sophisticated solutions to all of our clients. As Allison mentioned, we took another step in the geographic expansion of commercial banking by broadening the scope of our aging services vertical, an area where we already have demonstrated a clear competitive advantage in the marketplace. More broadly, our focus on continuing to improve our technology infrastructure both for clients and teammates remains high. As discussed earlier, we saw good initial adoption of SmartGUIDE and completed the transition of all of our wholesale clients to SunView, our improved treasury management platform. In addition, we recently brought our mobile app in-house, which gives us the ability to add new features at a much faster pace. To further improve our agility, we're increasing our pace to migrate many of our client-facing digital platforms to the public cloud. Lastly, we're also making significant strides in removing friction from our middle and back office infrastructure to enhance our teammates' experience and improve efficiency. In addition to the strong revenue growth we delivered this quarter, it's important to recognize the significant progress we're making in improving the underlying financial performance of the company. Our net interest margin is up by 14 basis points year-over-year. A large part that's attributed to the improving rate environment, but we've also benefited from our improved loan mix and a higher risk-adjusted returns. Our tangible efficiency ratio improved by 190 basis points year-over-year as a result of our ongoing efficiency efforts, in addition to our strong revenue growth. Our tangible common equity was 17.7% this quarter. Some of this is clearly a reflection of a favorable operating environment, but it's also due to years of work on balance sheet optimization, improvements in efficiency and better asset quality. And ultimately, each of these components drove a 45% improvement in our bottom line results. Lastly, the strength of our capital position, our improved analytics and risk profile and growing earnings power allowed us to maximize the opportunity to repatriate capital to our owners in the recent CCAR cycle. Each owner not only gains incremental ownership in the company as a result of our 52% increase in share repurchases, they also benefit from a meaningful 25% increase in cash dividends, which keeps SunTrust with an above-average dividend payout ratio. Owners and prospective investors in SunTrust will benefit from a $2 per share in dividends, along with growth opportunities created from the investments we have made in key businesses, our attractive footprint and our focus on making further improvements in returns and efficiency across the organization. All of this collective progress is driven by our team. Across the company, I can sense a higher level of performance and engagement among teammates. It gives me great pride that our teammates take an active role in shaping our engaged, purpose-driven culture. So team, thank you. In summary, we had a strong quarter. We have good momentum building into the second half of the year. Our businesses have compelling competitive advantages and strong markets in which they operate. All of this is underpinned by a purpose-driven culture that emphasizes a one team and client-first mentality. So with that, let me turn it back over to Ankur, and we'll begin the Q&A portion.

Thanks, Bill. Julia, we're now ready to begin the Q&A portion of the call. [Operator Instructions]

[Operator Instructions] And our first question comes from the line of John McDonald of Bernstein. Please go ahead.

Hi. Good morning, guys Looked like you saw a nice pickup in loan growth this quarter. Bill, maybe you could give us a little bit of color in terms of what you saw there? Is it changes in production, you seeing better production or -- is also some better paydown? Maybe just a little bit of color there on both the commercial and consumer side? Thanks.

Yes, paydown has actually been fairly consistent. So this was a quarter in which we saw strong production. We talked about that sort of at the end of the first quarter and leading into the second quarter. We've talked, John, about the advent of when will we sort of see some of this benefit from tax stimulus, sort of what's the gestation period, and I think we're starting to see some of that. I mean, what was really encouraging is that it was very broad-based. It was more business investment and M&A, less refinance, so seems more sustainable. Consumer lending, continuing growth in the targeted areas, LightStream and the partnerships, credit card and all of those are accretive to our bottom line. We did see the benefit of some new lending capabilities in CRE that we introduced last year. This was part of our broader strategy and really a lot in conjunction with our Pillar acquisition. We're doing some more permanent financing. We're doing some agency bridge financing, all very conservatively underwritten as you would expect, but allows us to participate more in the full cycle with very, very strong partners. And then we've also seen some construction loan activity in the Southeast, in particular. We've seen a lot of build to suit for regional and national headquarters, which I think is a good evidence of just the strength in our markets. And then some revolver utilization improvement as well. So the answer is, it was -- a lot of places, it was broad-based, and it was accretive to what we saw, I mean, to our existing portfolios and the existing pipelines look good.

Great. And just a quick follow-up on the capital return. There's a nice step-up in the buybacks. Any expected cadence or timing around the buyback? Do you have any preset idea to front-load it or have it more evenly distributed? Any thoughts there?

Sure, John. This is Allison. We have more flexibility with our buybacks this year, but we haven't determined exactly how we're going to space that out yet.

Okay. Thanks, guys.

Thanks, John.

Thank you. And our next question comes from the line of Matt O'Connor of Deutsche Bank.

Good morning.

Hi, Matt.

I was just wondering if you could talk about the ability to continue to take out costs and essentially self-fund. Obviously, your comments on the efficiency ratio in the medium term are very positive, but we are seeing some expense pressure at some of your peers, with some inflationary pressures. Could you just talk about the ability to continue to take out costs and keep the expense growth minimal?

Yes, we tend to focus on the efficiency ratio rather than the expense number. But as I've said in my comments, I mean, I think over the medium term, Matt, I still see several hundred basis points of efficiency improvement. We don't want to get locked down to a quarter-by-quarter definition of what that might be, but we still see opportunities to improve, and they're in virtually every category. I mean, there are organizational issues. We've done a lot of things related to structure, span and layers. We did a voluntary retirement last year. We're down in roughly 4% total FTEs over the last 9 months. Lots of opportunities still in technology and the realization, quite frankly, of investments that we've already made. We've automated a lot of processes in the company. Private wealth has been a really good leader in that area as an example; the new loan and mortgage platforms; cloud migration, which I mentioned; a lot of end-to-end back office opportunities; we consolidated from 10 to 2 sites in mortgage and, again, we'll realize the benefits of that; supplier relationships continue to grind on those opportunities and optimizing and more opportunities to pay for what you use; and then our real estate footprint. Our branches are down 5% roughly year-over-year. Total combined real estate footprint is down 20% since 2011. We've done some major consolidations in some of our major markets, and we still have opportunities there. So all of those things, Matt, are what give me the optimism that we can continue to drive the efficiency ratio down and, as you said, create the additional runway to invest, which we've been doing all along. I mean, this structure of the declining efficiency ratio has been combined with significant investments in our business.

Okay, that’s helpful. Thank you.

Thank you.

Thank you. And our next question comes from the line of John Pancari of Evercore.

Morning.

Morning, John.

Also, on the efficiency ratio outlook, thanks for that color. Just in terms of the change in the guidance and the pull-forward or the expectation that you could hit that lower -- below 60% level sooner, how would you describe the main driver of that change? Is that more of where you're coming in on the revenue? Or would you say greater progress than you initially anticipated on the expense side in the Consumer and corporate business?

Yes, I'd say it's both. I mean, it's a good combination of both. The environment from a revenue standpoint is increasingly better and then all -- just realizing all the things we've done from an efficiency standpoint on the expense side and then conscious of the things that we're continuing to do. So remember, we've set the sub-60% a good while ago. So what we're just trying to do is give more updated guidance that we'll reach that earlier. But as I said before, that's not a way-station. I mean, we expect to just wave at that on the way past. We'll continue to have improvements as we go along.

Got it. Thanks, Bill. All right. And then my follow-up is on the capital markets side. On the expense side of things, it didn't seem like we saw an expense impact from the better capital markets revenue in the quarter. Was it there? Or is it something that could be coming in next quarter? And then separately, on the capital markets revenue, I just wanted to see if we could get a little bit of commentary on your outlook there?

Yes, on the expense side, it's never sort of a perfect quarter-to-quarter match. So it's more important to look at it sort of on a broader base and the opportunities. And it was broader-based. I mean, the capital markets increases came from a variety of different businesses. Our sort of core M&A and core investments that we've made in our equity capital markets business we saw good activity from. We saw a little more on the interest rate derivatives side, so clients starting some hedging activity, which I think we probably would have even anticipated that earlier, and I think is a good indicator of things to come. We mentioned before investment banking from non-CIB is up 30% year-to-date. So that's creating capacity. We're in new markets. I think it's just a combination of things, but what I think most importantly is that it was broad-based, and it's reflective of our advice-centered strategy.

Got it. Thanks, Bill.

And our next question comes from the line of Ryan Nash of Goldman Sachs.

Good morning, guys, Allison, you talked about the trajectory of the net interest margin up 0 to 2 basis points that you guys have continued to beat over the last few quarters. And I guess, a two-part question. Just first, what's assumed within that in terms of betas? And then second, can you just talk about what you're seeing on the deposit side? You mentioned migration into CDs. Has there been any movement in terms of retail pricing? And just given that your loan-to-deposit ratio is in the 80s, can you talk about the appetite to pay up for deposits versus potentially optimizing on the deposit side?

Sure. So let me take your first one. In terms of our NIM guidance of 0 to 2 basis points in the third quarter, our assumption there is about a 35% beta. So a modest pickup in betas relative to the second quarter, kind of consistent with some of the upward pressure, and I think we're seeing a pretty broad-based right now. And just keep in mind that third quarter has an extra day relative to second quarter, so there's a little bit of a headwind there, which is what gets us back to that 0 to 2 guidance as we think about it. You are correct on CDs. You certainly see a pickup in CDs on our balance sheet. That's, for us, a very attractive cost of funding. We've been using that very deliberately as a tool to manage our asset rate sensitivity and control the pressure on betas as well. And as we think about our loan-to-deposit ratio and where that heads. I mean, certainly, that's going to be loan growth, in particular, is going to be one of the biggest drivers on that upward pressure on betas. If you think about second quarter relative to first quarter, our loan growth was a little bit softer. We were able to maintain betas a little bit lower. We're very pleased with -- I'm sorry, that was first quarter relative to fourth quarter. If you think about second quarter loan growth, which was a nice pickup in activity and balances, and you see that upward pressure on deposit betas as well. So going forward, betas and our loan-to-deposit ratio are going to be pretty closely correlated.

Got it. And then, Bill, maybe a question on capital. I guess, with this year's plan, you're clearly starting to make some progress in bringing the capital levels down. Do you still feel that running the capital somewhere in the 8s is the right level for the organization? How do you think about the mix in terms of the use of capital? And then second, just as the efficiency continues to improve and the capital comes out, where do you think returns to the organization could ultimately get to?

Yes. So I do think we still have more opportunity on the capital side, and we've said if there were an optimal capital level, it would probably have an 8% handle on it in some way. So that indicates 75 to 100 basis points in terms of opportunity. When and how we get there is, obviously, has a lot of factors attached to it. And I think the language and the thought process around tailored regulation and around speed are -- we've got more tailwind than headwind there than has existed in the past. What was the second part of the question?

Where do you think the combination of lower capital and improving efficiency could get [indiscernible]

Oh, yes, sure. Yes. We're at a nice inflection point in terms of total return right now. We're at a nice inflection point because we've got a good operating environment and particularly strong operating environment from a credit standpoint. We've said 14% to 16%. We're, obviously, sort of exceeding that right now. I think as we think through what a more normalized environment looks like, so think about what more normalized looks like long -- medium term and long term from a credit performance standpoint as well as get some more light and some more clarity around when we can get to a lower capital ratio, I think, will clear that up better. But I feel more confident about operating at the high end of that range than I do about being at the low end of that range, if that will narrow it a bit.

And next we go to the line of Ken Usdin of Jefferies.

This is Amanda Larsen on for Ken. The fee performance this quarter was quite strong in wholesale, including the IB and trading as noted, and a bit weaker in mortgage from the lower gain on sale margins and elevated decay as you noted. Looking at 3Q, can you help us level set on some of those significant items that may or may not repeat?

Yes. I'd rather not sort of go Q-to-Q, but let me sort of talk more at a higher level around both of those. I think in mortgage, we're now entering into a normalized purchase market. And a normalized purchase market will have better second and third quarters on the production side, and will have more decay on the second and third quarters from the servicing side. So for mortgage, barring anything radically different, I think the second half might look a bit like the first half, and it'll be weighted a little differently with production and servicing. As it relates to the capital markets business, we feel good about the pipelines, we feel good about the business. Obviously, the first quarter was a bit slower. The second quarter was more reflective, I think, of the opportunity that we have within our business. So if we look there on a first half to second half, I would expect the second half, given economic opportunities and no major upsets in the market, would be better than the first half. Does that help?

Yes.

And next we'll go to the line of Erika Najarian of Bank of America.

I just wanted to ask a little bit more about your comments, Bill, earlier about waving at 60% or sub-60% efficiency ratio on your way past. As you think about the progress and the constant optimization the company has undergone and the revenue potential, I'm wondering where you think the tangible efficiency ratio potential is going to be from a range perspective over the medium term and how you define the medium term?

Yes. I mean, I've said, Erika, without wanting to sort of put up a final label because then that assumes that you're complete. So this -- in my mind, this process doesn't have a finality attached to it. So if you define the medium term as 2 to 4 years, I sort of -- I said we have -- I can see several hundred basis points of opportunity within that time line and range. I want to be careful about getting caught up to a quarter-by-quarter or a really specific guidance as it relates to that only because I don't want to limit the company in terms of our ability to invest and the opportunities that we may see. So I'm not trying to be clever, but just trying to say we do have more opportunity. We can see that over the medium term, but we don't want to put a final number in place because this isn't embedded. I mean, this is part of what we do. This is the culture of our organization. This is not a project. This is not a one-time thing. This is not something that's over. This is just now how we run our company.

Got it. And as a follow-up question to that, Allison, I just wanted to inquire about your comments on the net interest margin and wanted to make sure I didn't misunderstand it. So you've mentioned that each subsequent Fed rate hike would be less impactful positively for the margin, and you're guiding 0 to 2 basis points of margin expansion in the third quarter. Does that mean that for each subsequent rate hike beyond June that funding cost repricing will offset asset yield repricing? And as -- just really quickly on that, as we think about the balance between deposit pricing and alternate sources of funding, could you give us a sense of what the cost is of new alternate sources of funding if necessary?

So let me take the first one on NIM and the value of a Fed rate hike. As betas are around, let's call it, 30% or so where they've been today, then the value of a Fed rate hike is about 2 basis points of NIM for us. So as betas increase, the value of that Fed rate hike starts to come down. It starts to be neutral to NIM, somewhere around a 50% beta. So as you think about our guidance for the third quarter, and going forward, it's just -- it's really a function of how much pressure there is on betas. As we think about alternate funding sources and what that could look like, again, a lot of factors that go into that, but it could be anywhere from 0 to 50 basis points depending on what we use and some are just the rate curve and the market pressure at the time.

And next we'll go to the line of Saul Martinez of UBS.

A couple of questions. If I could just follow up on -- actually on Erika's question first. Can you just talk a little bit about the glide path on -- of the 35% beta? And when you see -- or if you see us getting to a 50% beta during this Fed fund cycle, assuming a terminal Fed fund around the 3%, which is sort of the market expectation? Just curious how you look at that and where you think betas go from here.

Sure. So hard to say exactly when betas get to any sort of range, in particular. I mean, it's a function of 3 things: one, the absolute level of rates; two, the pace of rate hikes; and three, the level of loan growth that we experience. And so not being able to predict some of those things, we think it will take a few more quarters, but again, any one of those factors could change that.

Okay. No, that's helpful. And if I could just ask a bit of a broader question. I think you guys have been pretty forward-thinking in terms of digital banking and just technology overall and, at the same time, you've been reducing your branch footprint for a while and continue to do so. So I'm curious what your view is on the national digital banking strategy that a lot of your peers have adopted. Do you think that's a -- how do you think about that in terms of your own strategy? Do you think it makes sense, for example, as a deposit gathering tool or client acquisition tool?

If we define the term of a national digital bank as something that's a national platform that creates new channels and creates new clients, we've had a digital bank for a while, called LightStream. We've been primarily focused on the asset side of that equation, and it has allowed us to do all of that. It's allowed us to diversify our mix, and it's allowed us to acquire new clients. It puts us in a lot of markets where we weren't before. We've got other national businesses as well that we expand relationships with from indirect auto to mortgage correspondent, whatever it may be, that we have an opportunity to leverage relationships on a more national basis. Now that being said, on the liabilities side, we're pursuing that. We're sort of looking at our options and really haven't declared our preferred approach. But the advent of being in the national digital market to acquire new clients, we sort of think we've been on that forefront for quite a while.

Okay. That's helpful. But it is something, Bill, that you're kind of considering in terms of whether you think it makes sense for you.

Oh, yes, absolutely. As I said, I think we're exploring a lot of different options. We have some unique advantages, we think, with branding and investments that we've already made, and we want to make sure that we leverage those to their best advantage.

I'm going to jump in and let me just clear up one thing on my answer to Erika's earlier question on alternative funding sources. I just want to make sure that the cost of that is 0 to 50 basis points over LIBOR.

And our next question comes from the line of Steve Moss from B. Riley FBR.

I wanted to follow up on funding sources here. You've spoken a lot about the liability side. Wondering what is your appetite for using investment securities to fund loan growth as the curve flattens here.

I think that we're going to remain focused on keeping our investment portfolio generally consistent with the overall size of our balance sheet. Our investment portfolio is really there to help us manage our interest rate sensitivity. So as we think about funding loan growth, we're really thinking about deposits and alternative funding sources.

Okay. Got you. And then appreciate the color on the efficiency ratio guidance. I guess, just wanted more -- a little bit more of a housekeeping item. With regard to outside software expense, is that a good run rate going forward? Or is that just a one-time?

Yes, it's going to -- it fluctuates quarter-to-quarter. So it's not something that you necessarily annualize. But it is a reflection of some of the investments that we've made and the relative amortization of those investments take different forms relative to what we've done and the shelf lives and those kinds of things. So again, not to annualize the number, but also look at it as a positive investment towards the revenue and client-facing part of what we do.

Our next question comes from the line of Gerard Cassidy of RBC Capital Markets.

Bill, can you give us your thoughts -- obviously, you guys have invested quite heavily in technology and have done a very good job with LightStream, as you know. Can you share with us, is the technology spend in the digitalization that you and your peers are doing, can you view that as table stakes, meaning, it just gets you into the ballpark, it doesn't give you the competitive advantage, and it really comes down to execution and delivering on the field? Or do you think, no, this is the competitive advantage that you have it and others don't?

The answer is yes. I mean, it's sort of both. It's both highly offensive and highly defensive in terms of how we think about it. We really approach the business very much as a digital first type of approach. I mean, that's been a fundamental change in our strategic thinking now for several years. And what you see from us is you see high adoption rates, really good increases in sign-ons. 28% or so of our sales in this quarter were digitally assisted. So I think there's a lot of meeting client expectations around the digital side. But then there are ways to use it and you mentioned LightStream as just one example. But just in expanding client relationships and managing data and analytics and leveraging AI to more fully light the way to financial well-being for our clients that we do think are competitive advantages. So I think it's a combination of both. And again, you've seen from us, I think, really good adoption from our clients and that's -- all of that's reflective in the results that we've been talking about.

Very good. And then as a follow-up, obviously, we've been through cycles, and we know what to expect in a credit cycle, and many banks, yours included, will underwrite loans maybe more conservatively or better after going through a tough credit cycle. With all the digitalization and the AI and all the technology you folks are using, how do you assure yourself that you're not over-reliant on this technology to protect yourself and it could, actually, lead you astray because you're not -- it's too much technology and it's not enough human common sense or human touch.

Yes. I'm staring at our Chief Risk Officer who is maybe offended by the lack of common sense...

No offense is intended.

No, I know, I know, I'm just teasing. I mean, I think, clearly, there is a lot of common sense embedded in the whole part of what we do. But I think the more sophisticated answer to your question is we stress it a lot. So we're constantly stressing the portfolio for virtually any way you can think about, stress it for rates, stress it for commodity prices, stress it for different economic environments. And I think that's sort of the litmus test is that we're constantly looking over the shoulder of our own decision-making to make sure that we're on the right track. And the most obvious public representation of that is CCAR. If you look at our portfolio under an adverse stressed conditions, we have continued now for several years to perform at a very low level, but most importantly, with a really low standard deviation. So this isn't something that's fluctuating CCAR-to- CCAR cycle. We've been very, very consistent in what we do. And as a total percentage of our automated underwriting, if you look at sort of our total portfolio, it's a pretty small percentage. I mean, at the end of the day, there is a lot of still human intervention supported and enhanced by digital capability.