First Horizon Corp (FHN) 2016 Q2 法說會逐字稿

Good morning.

And welcome to the First Horizon National Corp.

second-quarter 2016 earnings conference call.

(Operator Instructions)

Please note, this event is being recorded.

I would now like to turn the conference over to Aarti Bowman, Investor Relations.

Please go ahead.

Thank you, Bianca.

Please note that the earnings release, financial supplement and slide presentation we'll use in this call this morning are posted on the Investor Relations section of our website at www.firsthorizon.com.

In this call we will mention forward-looking and non-GAAP information.

Actual results may differ from the forward-looking information for a number of reasons outlined in our earnings announcement materials and our most recent annual and quarterly reports.

Our forward-looking statements reflect our views today and we are not obligated to update them.

The non-GAAP information is identified as such in our earnings announcement materials and in the slide presentation for this call and is reconciled to GAAP information in those materials.

Also, please remember that this Webcast on our website is the only authorized record of this call.

This morning's speakers include our CEO Bryan Jordan and our CFO BJ Losch.

Additionally, our Chief Credit Officer, Susan Springfield, will be available with Bryan and BJ for questions.

I'll now turn it over to Bryan.

Thank you, Aarti.

Good morning, everyone.

Thank you for joining us.

We're very pleased with the results of the quarter and the progress that we're making.

Although the economy continues to move forward at a very slow pace, we do see continued progress and growth in the economy, and we see no reason at this point to expect that to change over the course of the next several quarters.

We, I suppose, like the rest of the world, do expect that the Fed's unlikely to move rates up very much over the next couple of quarters, so we are expecting lower for longer, in the common vernacular.

But we've built our business model and you'll hear from BJ that we've made some adjustments in our interest rate sensitivity that we think should accommodate lower for longer in the Fed outlook.

We continue to see very good progress in our core businesses, very pleased with the high quality loan and deposit growth we saw across our banking franchise.

Our bankers are making very good calls.

We have very good pipelines as we end the quarter and we're very optimistic about our momentum for loan and deposit growth as we look at the second half of 2016 and into 2017.

We saw good revenue growth through controlling our margin, our fee income.

We saw good expense control in the Banking business.

If you exclude the legal matters charge that was recorded in the Banking business, we actually saw our overhead efficiency ratio drop into the high 50s, which we're pleased with.

Credit quality continues to be strong and you'll hear from BJ and then Susan later, we see very good trends in credit.

Non-performing assets are down, charge-offs are down, and our outlook is very optimistic as we look into the second half of this year.

FTN Financial had a very strong quarter.

Average daily revenue totaled $1.1 million.

There's a graph in our supplement that shows the number of days that we exceeded $1 million a day.

We're pleased with that.

It's the highest quarterly average daily revenue going back to the early part of 2013.

As we look into the second half of this year, particularly the third quarter, we expect seasonality to impact the third quarter.

Late July, August are historically slow because of vacation periods, et cetera.

But we're optimistic that average daily revenue in the second half of 2016 will be somewhat higher than it has been the last couple of years.

Not sure that it will exceed $1 million a day, but we're confident or have some hope that it will be significantly better than it has over the last couple of years.

So, we're optimistic about that business and the opportunity to continue to see strength as the markets are somewhat more stable around the Fed's expectations around interest rates.

With respect to capital deployment, we were able to repurchase some stock during the quarter.

And then there's a slide in the deck that also highlights our acquisition or proposed acquisition of the restaurant loan franchise portfolio from GE.

We're very pleased with that.

We see that as a great opportunity to, one, deploy capital; two, to add to a business that we understand and that we like, and expand our specialty lines of businesses, and do it in a way that drives enhanced profitability and improvement to our returns on our tangible common equity.

We're making good progress, in my view, in driving higher economic profits and hitting our bonefish targets.

I'm pleased with the momentum that we see in the financial results, but I'm also very pleased of with the conversation that we see and hear in the organization and people's focus on those metrics and how we as an organization continue to drive towards hitting those bonefish targets.

With that, I'll stop.

I'll let BJ take you through the details.

I have a couple of closing comments and then we'll all be happy to take some questions.

BJ?

Great.

Thanks, Bryan.

Good morning, everybody.

Thanks for joining us.

I'll start on slide 5.

For the first quarter we reported net income available to common shareholders of $57 million or $0.24 a share.

Linked quarter net income was up 18% and up 12% year over year.

Our preprovision net revenue grew 22% linked quarter and 21% year over year on strong operating leverage, with revenue growth well outpacing expense growth, both on a linked and prior-year quarter basis.

Our loan loss provision was $4 million in the second quarter, compared to $3 million in the first, as credit quality continues to remain healthy.

Our balance sheet growth continued to show strong momentum with overall loan growth of 3% linked quarter, 6% year over year, and deposit growth of 1% linked quarter and 9% year over year.

Revenues were up 5% linked quarter, largely driven by an increase in fixed income as well as higher net interest income on the solid loan and deposit growth, while expenses were flat linked quarter including a few notable expense items that in aggregate had only a slight impact on results.

First, we were able to settle certain mortgage repurchase claims that resulted in mortgage repurchase release of $31 million.

And we did have $26 million of contingent fees and litigation expense related to some existing legal matters, as well as a $2.5 million negative valuation adjustment for derivatives related to prior sales of [recent] shares.

Slide 6 shows an overview of our segment highlights and some variance analysis for each.

But let's go straight to more detail on our core businesses over the next few slides.

So, if you join me on slide 7, regional bank performance continues its positive momentum with very healthy core trends and balance sheet growth, operating leverage, PPNR and pretax income.

The balance sheet growth in the regional bank continued its momentum with overall loan growth of 4% linked quarter and 11% year over year, with deposit growth of 2% linked quarter and 7% year over year.

Net interest income was up 3% linked quarter and 7% year over year, largely driven by commercial loan growth.

And linked quarter fee income was up 3% due to increases in bank card income, trust, and brokerage fees.

Expenses in aggregate were up 13% linked quarter, primarily driven by $22 million of litigation expense.

But excluding that charge, as Bryan said, regional bank adjusted expenses declined 2% linked quarter and the efficiency ratio fell below 60%.

Loan loss provision in the Bank was $11 million in the second quarter, down from $15 million in the first, as the decrease reflects overall improvement in the loan portfolio.

Looking at the regional bank's balance sheet in a little bit more detail on slide 8, you'll see strong loan growth across our commercial portfolios, as I talked about.

Average loans were up 4% linked quarter and 11% from 2Q 2015.

And the linked quarter loan growth came from our economically profitable specialty lending areas such as loans to mortgage companies, commercial real estate, private client and healthcare.

Loans to mortgage companies continues to benefit from the low rate environment.

Commercial real estate growth largely reflects the funding up of commitments.

We're seeing solid commercial loan demand across our markets, particularly our middle Tennessee market is showing some strength.

And we're pleased with our progress in new markets such as Houston, where our experienced team of lenders is growing profitable relationships.

Our net interest spread in the Bank was up 2 basis points as deposit rates stayed flat, while our specialty lending areas drove the increase in loan yields.

And despite the competitive landscape, our bankers continue to show discipline on pricing and underwriting, which we're particularly pleased about.

Moving on to slide 9, we'll take a look at our pending acquisition of restaurant franchise loans from GE Capital.

As we announced in the quarter, we agreed to acquire $637 million of loans in the transaction.

This acquisition will create a strategically compelling specialty restaurant franchise lending area with roughly $800 million in loans outstanding.

As you can see, the portfolio's geographically diverse with established franchises.

Albeit a smaller portfolio that we have currently, we know the business and have some expertise in it already.

And this is the type of portfolio that aligns well with our economic profitability focus where we like businesses with larger average relationship sizes, efficient infrastructure, and a strong risk/return profile.

Importantly, the transaction makes strong financial sense as it is immediately accretive to earnings with no book value dilution, as well as being very attractive and complementary to us from a loan yield and fixed to floating rate mix perspective.

Moving on to fixed income on slide 10, FTN Financial showed strong results in the second quarter with average daily revenues at $1.1 million, up 15% linked quarter and up 48% year over year.

The average daily revenue growth was driven by rate and market volatility that we saw in the quarter as well as the decline in longer rates.

We saw increases across all our desks, with particular strength in agencies and corporates.

You can also see the positive operating leverage capabilities of the business model this quarter due to our flexible variable expense structure.

Additionally, the expansion of our sales force over the last few years with strategic hires has contributed positively to our growth.

Digging into net interest income and net interest margin a little further on slide 11, we see net interest income up 2% linked quarter and 6% year over year.

Net interest margin was steady from a year ago and up 4 basis points linked quarter.

As you can see in the bottom left, the linked quarter improvement was mostly driven by lower Fed balances.

We've been able to defend the margin with strong commercial loan growth and believe we can continue to do so in the second half of 2016.

While our balance sheet remains asset sensitive, as Bryan talked about we have begun to moderate that sensitivity based on our outlook for rates.

You can see in the bottom right how our sensitivity has changed over the past year from some of the actions we have taken.

And, in addition, the restaurant franchise loan portfolio acquisition with its heavier fixed rate loan component will be a further moderating factor.

Turning to slide 12, on asset quality, again, those trends are very solid.

Net charge-offs, nonperforming assets and delinquencies were down year over year as well as linked quarter.

Our reserves to loans stands at 107 basis points for the second quarter.

We've added to the reserve in the Bank and decreased it in the non-strategic portfolio as those consumer loans continue to run off.

The asset quality in our commercial loan portfolio in the Bank remains strong.

And in non-strategic credit metrics are stable to improving as balances continue to run off with period-end loans dropping to $1.8 billion.

Wrapping up on slides 13 and 14, We're pleased with both the strong quarter we had and the momentum we still see in the business.

From a bonefish perspective, we are pleased to see improved ROTC at 11%, improved ROA, NIM expansion, a reduction in net charge-offs, strong fee income generation from FTN and improved efficiency ratio, and an accretive capital deployment.

So with that I'll turn it back over to Bryan.

Thanks, BJ.

As I said earlier, we're pleased with the momentum that we see in our core businesses.

They're strong.

They're executing well in an operating environment that we think will be steady, not as strong as we'd like or not as much interest rate improvement as we would like, but overall very good execution in this environment and very pleased with the momentum that we see there.

We do continue to make progress in improving our profitability and movement towards hitting our bonefish targets.

We're pleased with the opportunities that we see to do that through customer activity.

And as BJ and I both mentioned, acquisition opportunities like the GE capital restaurant loan portfolio.

And we will continue to work to hit those targets, to deploy capital smartly, and to grow the business in a way that builds long-term, sustainable shareholder value.

Finally, I'll add my thanks to all the First Horizon, First Tennessee, FTN Financial teams -- awful lot of people doing a lot of great work to support our customers, to implement the processes and systems necessary to support those customers, and greatly appreciate their efforts.

With that, Bianca, we will stop and take questions.

(Operator Instructions)

The first question comes from Steven Alexopoulos with JPMorgan.

Please go ahead.

Hey, good morning, everybody.

Maybe I'll start on the margin.

Given what the curve has done recently ex-hikes, do you still see the NIM trajectory as flat to up from here?

Hey, Steve, good morning.

It's BJ.

I'd say flat.

I think, as we talked about a little bit, we think that we can defend the margin pretty well.

If you look over the last two years, what our margin has done -- and we actually have it mapped out on slide 11, it stayed pretty steady.

And that's a testament to our bankers with pricing discipline, us looking at the mix of our portfolio, and then most recently moderating our asset sensitivity as we've gotten less encouraged about rates going up anytime soon.

With all of that said, our current assumption is that we do get a rate increase in December.

So, obviously that doesn't do much for margin or income in the year of 2016, but we think we can defend the margin and keep it flat.

BJ, the NIM was helped in the second quarter from lower cash.

When we look at your average cash, you're running about half where you were last year.

Is there a need to build cash or are you about where you could run the Bank at this point?

We're about where we'd like to run it.

It was down about $0.5 billion in average balances, I believe.

And we were fortunate last quarter to have such an influx on deposits and so this quarter we were able to deploy that a little bit more.

But this kind of cash level is more appropriate from an operating perspective.

Okay.

And then just one question on the capital markets business.

For the 60% of days where you did see revenue over $1 million, was that essentially higher vol when you look at those days that drove that?

Higher volatility?

Yes.

Generally speaking, yes.

That business thrives whenever there's higher volatility, either positive volatility or negative.

And so there's a little bit sentiment, was more negative, clearly, in the second quarter, but we were able to take advantage of it.

And the great thing, as I said in some of the opening comments, is we've got a very strong depository institution focus that mostly buys agencies and MBS, and then we've got a total return focus that buys more corporates.

And as I talked about, agencies did well.

We were able to capture share and volume from depositories as well as having a really good quarter on the corporate desk, as well.

So, the model worked.

We captured both sides of the equation and we saw so much higher ADRs as a result.

And BJ, the efficiency ratio actually trended down pretty nicely in the fixed income business.

Did you structurally change anything there?

And do you see it sustainable around 77% here?

Thanks.

We didn't change anything.

It's really attributable to the variable model that we've got.

75% of the expense base at FTN is variable.

So, when we start to see lower ADRs, like we did last year in the 600, 700, 800 range, it compresses that variableness, if you will.

But when you start to see revenue expansion like we did this quarter, you can really see the differentiation between how we can drive higher revenues with making sure we pay our sales force and traders appropriately, but also capture a lot of the operating leverage that we need to as a firm.

It was all of that and, you also have to remember, in the first quarter of the year whether it's a fixed or a step wise or variable cost, there's FICA resets and payroll taxes and things like that that create a little bit of a bump in the first quarter that doesn't recur in the second.

Our next question comes from Ebrahim Poonawala with Merrill Lynch.

Please go ahead.

Good morning, guys.

I think if we can first us just start with, BJ, if you can help us think through in terms of future reserving and provisioning expense.

I'm looking at slide 12.

One, from a regional bank standpoint, is there more room for the reserve ratio to go lower from here?

And, also, I'd love your thoughts in terms of what's the macro outlook that's guiding your reserving methodology today as you look out over the next 6 to 12 months.

Sure.

I'll start and then Susan can add more color.

What we've talked about is that, as the regional bank is continuing to grow the balance sheet, we'll incrementally be adding to the provision appropriately in the regional bank.

The reason that this quarter you saw it decline from a percentage coverage perspective is we had such out-sized growth in loans to mortgage companies.

Loans to mortgage companies was 20% of our period end C&I loan portfolio this quarter.

It's usually in the 12% to 15% range.

That portfolio has really no credit related reserves for it.

That portfolio has more fraud risk than it does credit risk.

So when that is part of the denominator, it actually artificially lowers the reserve and how that looks.

But if you look at underlying what we've done, we actually increased the reserve in terms of dollar coverage in the Bank from last quarter.

And as it relates to the outlook for provision and coverage, we continue to see, if we continue to have runoffs in the non-strategic portfolio, which we would expect, we would continue to see decreases in that portfolio.

But as BJ mentioned, if we continue to have growth in the regional bank, we would expect to see provision grow with the growth in that portfolio, depending, as he said, on the makeup of the loan portfolio and the specific provisions that go with various portfolios.

At this time, as you can see, we had very strong asset quality.

Trends are very good.

And so we're pleased with where we are and feel like that we have the appropriate reserve level at this time.

Understood.

And just switching to capital deployment priorities, Bryan, if you could remind us in terms of, obviously the GE acquisition looks quite favorable in terms of the metrics and contribution going forward.

But as you look out in terms of as you look to more M&A versus buybacks, how are you thinking about that?

Ebrahim, nothing really, I would say, has changed.

We feel very strongly that we need to be smart about the way we deploy capital.

Organic growth -- which you saw in the quarter is first priority and in many ways is probably the most efficient way to deploy capital in the business.

Smart acquisition -- you referenced and we referenced a couple of times the GE capital restaurant portfolio -- we see that as a very attractive way to, one, round out the specialized businesses that we like and, two, to put capital to work in an effective and shareholder friendly way.

And then we would continue to deploy capital and buy back.

We bought back a significant block of stock in the first quarter when the price dislocation occurred.

We have bought back a little bit more in the second quarter and we'll continue to use all of those tools.

In terms of the use in M&A, we intend to be disciplined.

We still think that low-premium transactions are the right way to think about the growth through acquisition in this environment.

It enables you to do it in a shareholder friendly way.

Most of the upside, in our view, in M&A in this environment is going to be cost reduction, and it's going to be important that you price deals right on the front end.

So we continue to look at all of those options.

We see good momentum to continue to deploy.

And our organic growth in the core banking businesses, you see that growth better over the last several quarters, last year, because you don't have as much non-strategic portfolio rundown to offset that growth.

But you see our core banking business has really good asset generation capability.

And, as I said earlier, pipelines are strong.

So we're optimistic that we're going to have a lot of good opportunities to put capital to work.

The next question comes from Ken Zerbe with Morgan Stanley.

Please go ahead.

Great.

Thank you.

Just a little bit more on expenses.

If I look at last quarter's expenses, the $137 million, and then we back out, call it, roughly $4 million of FICA, I was expecting compensation expenses to be a little bit lower than where it t was.

And I totally get that the capital markets business had an extra -- I think it increased about $4 million sequentially.

But it still seems that there were other things in there in terms of variable comp side.

Can you just elaborate on what drove that?

Hey, Ken, it's BJ.

Nothing that jumps to mind.

What I see in our detailed financials is that the vast majority of that increase was related to FTN.

The other thing -- I'm not sure exactly how it rolls up in the line that Ken's looking at -- our healthcare costs have continued to go up a little bit.

We did have a little bit of lumpiness in the second quarter, in particular, because we've had some higher claims with some serious illnesses.

But I don't think that's a longer-term trend.

Overall, if you look at our growth in the employment base, FTEs, we see very steady trends across the business.

You see it's continued to gain efficiencies in certain areas, and offsetting that with revenue producing growth investments in people.

The big driver in this quarter was the impact of the increased or incremental revenue at FTN Financial.

Got it.

And, last, I recall you guys had an expense target for the year of around $860 million to $870 million.

Is there a way for you to break out FTN from that?

I understand the capital markets business is going to be very volatile in terms of the compensation line.

But just curious for the all other expenses outside of that, if that ends up being a more stable line, if that's something we should be thinking about.

Yes, I'm sure we could do that.

We break out the FTN segment in terms of expenses.

What I would tell you is that relative to that $860 million, $870 million, it's probably towards the higher end of the $870 million.

And what is driving the current expense quarterly run rate being higher than that is all FTN.

It's not anything that's in the business that we're seeing is an issue at all.

So, we'll try to figure out a way to help you see that a little bit more clearly.

Got it.

Understood.

Just one last question, the loans to mortgage companies, obviously incredibly strong end of period balances at the $2.2 billion, average of $1.6 billion.

Are those carrying over into third quarter such that third quarter may end up being a little bit stronger than where it seasonally would be otherwise?

I think last night we ended at $1.950 billion.

So through this part of the quarter it's still pretty strong.

Perfect.

Okay.

It's the lowest 10-year rate.

We would expect to see refinance activity in addition to the traditional purchase activity that carries into the third quarter because of the summer months.

And as we've talked in the past, as Susan has pointed out, we continue to look for opportunities to grow market share.

We think our team is doing a very good job of broadening and deepening our relationships with customers and the strategies that's they're employing.

We do think, though, while there's more volatility in those balances around the 10 year, with the lower 10 year and the work that they're doing, we think that there's an opportunity for those balances to remain fairly strong.

Perfect.

All right.

Thank you very much.

The next question comes from Kevin Fitzsimmons with Hovde Group.

Please go you ahead.

Good morning, everyone.

Just one quick follow-up question on M&A, Bryan.

I hear you about the low-premium cost-saving focus type of deals.

Previously you've characterized your interest as being more toward the larger end.

In other words, you would only be interested in large or MOE type deals.

And with the rate and yield curve environment we're having, I would have to think there's going to be some smaller players that may think about throwing in the towel or will look for a larger, stronger partner.

And coupled with your stronger currency today, would you be more open or consider smaller type deals than you would have a few quarters ago?

Kevin, I'd never say never.

And I'd say, though, that we still have a preference to do larger transactions, principally because it's a calendar challenge in terms of how long it takes to get through the approval process, the fact that it's important to get the integration done properly, and the amount of time it takes to do that.

And all of that results in gaining the efficiencies from the cost side and then any revenue synergies that exist.

I would suggest that if you're going to invest the time and the process requirements to do M&A, it's more efficient to do them on larger transactions for those reasons alone.

So, that would be the preference.

I never would say never.

We've had great opportunities.

We still think that the fill-in opportunity or the expansion opportunity that we had in Raleigh fill-in in our Mid-Atlantic franchise through Trust Atlantic was very attractive.

If the right thing comes along we will certainly look at it and I would say we'll be open minded.

But if you ask me what my guesses was, we'd still be more focused on doing something larger, MOE type transaction.

Okay.

Great.

And one quick follow-up -- you guys mentioned being pleased with what you're seeing in Houston.

Can you just give a little more color on what's going well down there and how you feel about energy, given where oil prices seem to be stabilizing here?

Is it any direct energy or is it all things unrelated to energy altogether?

Thanks.

I'll start.

This is Bryan.

We do feel good about the progress we're making in Houston.

We think we've got a very strong team, a great group of bankers on the ground.

We're seeing opportunities across the entire economic -- commercial, in particular economic spectrum.

We are making and evaluating opportunities in the energy space.

We think that with, one, the repositioning that has gone on with a number of competitor balance sheets, as well as the structural things that are working into the market through regulatory guidance and people repositioning their balance sheet, we're seeing very good opportunity to expand our energy business.

We're seeing opportunities in the broader economy, whether they be commercial real estate or C&I related activities.

So, coupled with a good team and a overall strong economy -- job growth in Houston is likely to be down this year but it's still going to be a positive number, and would be an envious number for the vast majorities of MSAs in the country -- we think that there's still very good opportunities there.

We've continued to see great opportunities for growth.

Our executive team spends a lot of time in Houston, working with the bankers that we've hired, meeting with prospects, meeting with customers.

And we do believe there continue to be great opportunities that are well structured.

There's a great opportunity to do very disciplined lending in energy as well as C&I and in commercial real estate.

So, we feel very good about the opportunities that we have in the future with our Houston bankers.

These are well established, long-term bankers, well connected in the Houston community.

Gary Olander has a 30-plus-year career in that marketplace.

I think we're making very good contacts and building very good relationships for being two, two and-a-half years into what we're trying to develop there.

Okay.

Thanks, guys.

The next question comes from Jefferson Harralson with KBW.

Please go ahead.

Thanks.

Good morning, guys.

I was going to ask you some details on the modeling of the restaurant franchise business.

I think you guys said you expect it to be $800 million of loans by the time it closes.

You've told us that it's 4.5%, I think, to 5% loan yields.

But can you talk about the efficiency ratio, any ongoing expense that should go with it, how we should think about funding it, and anything else that we should think about as we're trying to calculate how accretive this deal is?

Okay.

It's BJ, Jefferson.

Good morning.

So, a couple things.

When we say $800 million at close, that's combining our existing restaurant franchise lending loans with what we're purchasing.

So, putting the businesses together.

Today we do have some bankers that have portfolios of restaurant franchise lending in them, and so we're going to put it into another group.

I don't think I can give you specifics on exactly how many people we're going to have in this group.

We're still trying to evaluate what we need for that.

But what I would tell you is that it will be a handful to several people, not dozens of people, which, combined with our existing infrastructure and credit and loan operations and underwriting and servicing, buying a loan portfolio like this is going to be a highly efficient addition to our existing business.

All right.

And the funding, do you use liquidity?

Should we think about this conservatively use a 1% cost of funds or deposits?

Or how do you think about funding this additional $600 million-and-change?

Yes, so funding, we're going to use existing funding.

So, we didn't have to do anything in terms of issuing, obviously, any term funding for it.

It will be funds transfer priced on the fixed rate loans, will be, you can see, weighted average maturity of four years, and the floats will be funded shorter than that.

But I guess you're trying to get me to give you a margin.

It's probably, FTP is in the 1.25 range for cost of funds, let's call it.

Okay.

And then, lastly, on provisions, should we think about it as an average provision for the rest of your bank?

Should we put 1% on it?

Should we put 1.5%?

How do you think about the provision cost of this ongoing?

And I'll leave it there.

Jefferson, as we think about provision, obviously we don't set in advance any kind of coverage level.

We use our models as we look at portfolio shifts.

Not sure if you heard what BJ said earlier on the call, but when we have shifts in portfolios that really need invest reserves, like we did this quarter with loan to mortgage companies, grew and became a larger percent of the portfolio, that portfolio did not attract as many reserves as, say, the rest of the portfolio.

The coverage was down slightly.

So, we look at individual portfolios, loss rates, grade migration.

But I would expect in the non-strategic portfolio as it continues to run off, we've continued to see stable asset quality there.

With runoff you'll continue to see relief in consumer in non-strategic as we build our regional bank portfolio.

Asset quality being stable, economy being stable, I wouldn't expect a lot of changes at this point.

The next question comes from Emlen Harmon with Jefferies.

Please go ahead.

Good morning.

BJ, I was hoping you could clarify your comments on the expense target.

Even if you were at the high end, which would be $870 million, just given where expenses ran the first couple quarters this year, it would imply a pretty meaningful step back in the run rate.

What assumptions are underlying, or what are you thinking is going to keep you at $870 million for the year, and maybe how much of a stepback in capital markets are you baking in there?

Just trying to understand how you're getting to that number.

Let me be clear.

The delta, as I talked about earlier, is all capital markets right now.

So, if you took our -- what is it -- $227 million for the quarter and annualized that, you're a little bit over $900 million.

All of that is really related to FTN in terms of being above the $870 million type target.

So if FTN continues at this level, the quarterly run rate would stay here or maybe even go higher, because of that variable comp.

As Bryan talked about, I don't know if we'll see 1.1 next quarter or something a little bit less than that, but still pretty strong.

We don't know.

But that's going to be really the delta between the $870 million for the total expense base and whatever we come in at.

But we do, even with FTN performing well, we do believe that our expense base in the rest of the core franchise is very efficient and will continue to be more so.

Got it.

Perfect.

That's helpful.

Thank you.

And then while I'm on the topic of expenses, taken the repurchase pipeline down so meaningfully quarter over quarter, do you see any expense benefits from that?

And maybe the other question would be if you could actually just put that behind you completely, is there some expense that goes away related to that?

On non-strategic?

Yes.

So, outside of just the settlement cost.

Yes, there's certainly expenses that are related to non-strategic that we think will go away as the portfolio runs off.

In terms of the provision costs driving any expense reductions, probably not.

We have periodically and continue to do so look at whether or not there's an appropriate market for us to sell down further some of those loans.

We look at that, but if you look at the performance metrics of those, how quickly they're running off, what kind of yields they have, the lack of charge-offs that we see, it's a portfolio that we're fine keeping for right now.

This is Bryan.

If you look at that expense structure -- I'm doing this a little bit from memory, so BJ may have to correct me.

I think we're running about $16 million, $17 million or so a quarter in non-strategic expenses.

A lot of that is related to the loan portfolios that remain.

There's very little of that that is associated with the repurchase reserves.

That group of folks is doing a fantastic job of resolving these remaining pieces that are out there.

You can see we had fairly significant resolutions in the second quarter of this year.

And they've been very effective and efficient.

If all of that went away tomorrow, it wouldn't have that much expense impact.

Where the real expense benefit is going to come from is the final resolution of the longer term loan portfolios.

Great.

Thanks for taking my questions, guys.

The next question comes from Geoffrey Elliott with Autonomous Research.

Please go ahead.

Good morning.

Thank you for taking the question.

Looking at the number of financial center locations, that's down quite a bit over the quarter from 174 to 162.

I wondered if you could remind us what you've been doing there.

Sure.

It's BJ.

You may recall in the first quarter that we recorded a $3.7 million branch impairment charge, and that was in anticipation of consolidating and closing branches.

We're expecting to maybe close upwards of 15 branches or so this year and that reflects the first half reduction that we saw.

We're trying to be as efficient as we can following our customers' needs and wants.

And I think you could expect us to continue to look closely at our branch network and probably over the long term see more reductions there as we invest more in digital offerings, online, et cetera, where we certainly see more of the volume going over time.

And then what do the economics of those closures look like and how quickly do they feed through into the expense numbers?

I think last quarter we talked about that $4 million to $6 million annualized run rate positive benefit from closing these branches is expected.

So it's a little bit of an upfront charge, it's a little bit of a change for our customers, but long term we find meaningful expense reduction opportunity in there.

And, by the way, that $4 million to $6 million a year includes any assumption that we would have for revenue attrition.

Our retail people are extremely thorough and smart about how we communicate with customers, how we understand what attrition might be, and try to head that off at the pass.

And they've been highly successful at minimizing our revenue attrition from that to make closures pretty compelling.

Geoffrey, good morning.

This is Bryan.

I want to reiterate what BJ said.

Our folks that are in the financial centers, the people that are executing on this, are doing a really good job of making sure we work with customers and we introduce them to the new financial centers and the new financial center staff.

We're working to make this as seamless a transition of customer activity as we possibly can.

And it's all against a context or a backdrop where customer visits to the branch continue to decline.

The numbers have dropped significantly, 3% to 5% or so a year for the last several years, and we expect that to continue to decline.

And it's being evidenced by the continued utilization and pickup in customer transactions through mobile and online channels.

And to acknowledge a lot of hard work, we've got a great group of people who are working really hard to implement a new online banking, mobile banking platform over the course of this summer, which is going very well.

So, while we're saving money in branch closures, we're investing in our online and our mobile banking and alternative channels.

And as we have highlighted a couple of times, we're doing it with an overall expense discipline.

And we're trying to help customers bank the way they want to bank in the most convenient fashion, and do it in a way that meets their needs in the short and the long term.

Great.

Thank you.

The last question comes from Christopher Marinac with FIG Partners.

Please go ahead.

Thanks.

Bryan, I wanted to go back to the Houston topic.

Can you or Susan give us a delineation for how much lending on the new production is coming in energy as well as out of energy?

Sure, Chris.

This is Bryan.

I'll let Susan do the specifics.

She'll be better at it than I will.

As we said, we've had some good growth across really three key portfolios -- CNS, commercial real estate, and energy.

If you look year over year, our energy balances have roughly doubled.

We're in the $124 million range.

Commercial real estate is just under $50 million.

And we've talked about this before.

Our commercial real estate in Houston, we've got a very experienced commercial real estate manager, and he works with developers both in Houston and in other areas of Texas.

So, some of the exposure is in Houston and some is in some other areas of Texas.

And then our C&I portfolio is in the $45 million range.

I will say we've got excellent pipelines in all three businesses.

We see opportunities.

And as I mentioned before, these are opportunities where we can make well-structured loans to long-term business owners who have weathered cycles in Houston before.

So, we do believe these will continue to be opportunities where we can grow the portfolio in a very good way.

We're very optimistic with some of the things we think will close in the third quarter that we'll continue to see very good, high quality growth there.

Thanks.

And just to follow-up separately for either of you about the market in Nashville, is Nashville just as strong for you as it has been?

Do you see any changes, positive or negative there?

I'll start, Chris.

This is Bryan again.

The middle Tennessee market continues to be very strong.

We are very optimistic about it.

We've got very good pipelines there going into the third quarter.

We've got some significant transactions that's we think are pretty certain to close here in the near term.

We think that the customer opportunities that we are getting there are very strong opportunities.

I'm in middle Tennessee fairly often, meeting with customers.

I see very good business activity in middle Tennessee.

I see very good calling efforts by our team.

I see us building deeper, broader, stronger relationships.

So we're very optimistic about it.

Middle Tennessee, like any other big, growing economy, is going to have some areas where we will continue to focus.

There's a lot of growth in multifamily.

There's a lot of growth in hotel/motel.

So, those are some areas that we're paying a little more attention to.

But overall we're very optimistic about the opportunities we see for growth there.

And as Bryan mentioned, the growth in middle Tennessee is really across all of our lines of business.

We don't have one line of business responsible for all the growth.

We've got growth in C&I, private client wealth, healthcare lending.

In addition to that, we have hired some excellent relationship managers who have long and deep experience in middle Tennessee, who have come from other very good institutions.

So, they bring discipline.

They bring great relationships, family-owned, long-time businesses where we can get full relationships, not just loan only.

So, we feel like middle Tennessee continues to be a very good market for us.

Sounds great.

Thanks for the additional color.

This concludes our question-and-answer session.

I would like to turn the conference back over to Bryan Jordan for closing remarks.

Thank you, Bianca.

Thank you all for joining us this morning.

We appreciate your time and your interest in our Company.

If you have any questions for any of us in follow-up, please feel free to reach out to any of us.

Aarti will be available throughout the course of the day.

I hope you all have a great weekend and look forward to speaking with you in the future.

Thank you.

The conference has now concluded.

Thank you for attending today's presentation.

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