First Horizon Corp (FHN) 2016 Q4 法說會逐字稿

Good morning and welcome to the First Horizon National Corporation fourth-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, Gary.

Please note that the earnings release, financial supplement, and slide presentation we will use in this call are posted on the investor relations section of our website at www.firsthorizon.com.

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

Actual results may differ from the forward-looking information for a number of reasons outlined in our earnings announcements 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 announcements materials and in the slide presentations 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 will now turn it over to Bryan.

Thank you, Aarti.

Good morning, everyone, and thank you for joining us.

I'm really pleased with the progress we saw in 2016 and the fourth quarter.

We saw very good customer acquisition; we saw good trends and loan and deposit growth.

Overall, our fixed income business was strong.

We saw good opportunities to invest in the business in 2016.

We invested in a number of our specialty businesses.

We have announced the acquisition merger with Coastal Securities, which will occur in 2017.

Throughout our banking business, we were able to put in place an additional 50 front-line bankers, which is a substantial increase.

And when you look at period-end headcount, we were essentially flat on our headcount.

So we are very pleased with the investments we were able to make in our businesses.

And what we think that leads to in 2017 and beyond in terms of revenue and profitability growth, allowing us to leverage our capital and drive higher returns.

I mentioned FTN having a stronger 2016.

Obviously, the fourth quarter of 2016 was a little bit softer.

October and November were pretty much in line with our expectations.

December became very soft.

BJ will talk more about it, but the markets got very volatile, rates backed up substantially, and volumes really fell off.

Whether that was the effects of the election, whether that was the effects of the Fed meeting that occurred in mid-December, or even the effect of the holidays in December, but revenue was -- average daily revenue was very soft in the month of December.

Expense control continues to be a primary focus for us.

We saw a number of parts.

There's some one-times that BJ will talk about in the quarter.

We also saw a little bit of what I would call a year-end cleanup in the fourth quarter.

We think we've got the processes in place to have very good expense control as we look into 2017.

One area of note that came in a little bit higher than we expected would have been our legal costs.

We continue to wrestle with two or three matters which we are wrapping up related to the mortgage business in particular.

In fact, one of the matters that we spent some money on in the fourth quarter actually is related to a significant recovery opportunity we are pursuing.

So we are very focused on expenses and we think we have the right controls in place and that will continue to be a lever for us in 2017.

We continue to be focused very much on how we deploy capital.

We will continue to deploy it strategically, whether it be through our dividend policy, stock buybacks, and/or further acquisitions of portfolios, or further acquisition opportunities.

We continue to be thoughtful about how we deploy that capital in an effort to drive higher returns, which we experienced in 2016.

So we are focused on hitting the bonefish metrics.

We're making good progress in that regard.

Very, very happy with the results.

I am optimistic that the operating environment in 2017 will continue to improve.

Clearly there's more optimism in the marketplace.

Customers are generally more optimistic as a lot of it is dependent on what may or may not happen in Washington, what may happen in terms of interest rates.

But as we look into 2017, we are reasonably optimistic about the operating environment and see a pretty good playing field for us as the coming year unfolds.

So with that, I will stop and turn it over to BJ.

Thanks, Bryan.

Good morning, everybody.

I will start on slide 5 of the earnings deck.

For 4Q 2016, we reported net income available to common of $53 million or $0.23 a share.

And for the full year, net income to common was $221 million or $0.94 of earnings per share.

Relative to both prior-year quarter and full-year 2016, the momentum of the franchise is evident.

We were pleased with the double-digit loan and deposit growth, strong revenue growth, good expense discipline, and excellent credit quality.

Linked quarter, we are pleased with the continued strength and momentum in the regional bank from a balance sheet and net interest income growth perspective, though lower fixed income activity, as Bryan talked about, as well as some legal settlement accruals did moderate our overall earnings in the quarter.

Slide 6 provides what we think is a helpful view of the net income and per-share impact of our business segments versus both prior-year quarter and linked quarter.

Versus 4Q 2015, you can see significant growth, 24% in fact, in regional banking earnings, driven by double-digit revenue growth leading to positive operating leverage, even with continued investment in new specialty areas and growth markets.

Versus linked quarter, you can see regional banking maintained its strong earnings levels, while fixed income results were softer.

Turning to slide 7, as we finish up 2016, it's probably a good time to take you through a view of our progress on driving positive operating leverage.

For us, that means more than just revenues growing faster than expenses; that's obviously important and the ultimate goal.

It also means maintaining a strong discipline on expenses, as Bryan talked about, by minimizing or eliminating what we call bad costs, which are nonrevenue supporting.

And investing in good costs that do support revenue both now and in the future.

For full-year 2016, revenue increased 9%, while reported expense decreased 12% and was up 6% on an adjusted basis, resulting in solid positive operating leverage.

As you can see on the graph, while expenses are up, the majority of the increases are largely related to revenue-supported activities, such as higher fixed income revenues, strategic hires in new specialty businesses, and expanding our growth markets.

The expenses in the corporate support segment and our nonstrategic segment were well contained, even with elevated legal costs and settlement accruals.

We believe that investing in these high potential businesses and markets now while still maintaining positive operating leverage overall will allow us to continue building momentum towards bonefish-level profitability and returns.

Let's turn to net interest income and net interest margin trends on slide 8. As you can see in the upper right-hand chart, over the last two years, we have significantly improved the revenue trajectory and earnings power of the balance sheet.

Full-year 2016 verses 2015 saw a 12% or $75 million increase in NII through a combination of strong performance from our collective Tennessee markets, expansion of our higher-return specialty businesses, and the early results of our investment in new markets and businesses.

The majority of the roughly $30 million per-quarter increase in NII from 4Q 2015 levels is from strong relationship growth and pricing discipline with some help from the one rate increase that occurred in late 2015.

With continued momentum, as evidenced by our pipelines, the continuing ramp-up of our newer businesses in expansion markets, as well as anticipated future rate increases, we are bullish about our prospects.

Linked quarter, consolidated net interest income was up a strong 6%, driven by higher commercial loan balances and an increase in short-term rates.

Net interest margin expanded 4 basis points linked quarter due to the December rate move, demonstrating the benefits of our asset sensitivity position, despite a modest headwind of higher cash balances.

The duration in the securities portfolio lengthened from 2.5 years in the third quarter to 4.8 in 4Q 2016, primarily due to the significant rate moves on the longer end of the curve postelection as well as some prudent bond swaps we executed in the quarter.

Overall, however, our asset sensitivity was unchanged, as the securities portfolio duration extension was offset by strong deposit growth.

As we usually do, from fourth to first quarter, we do expect some pressure on the NIM and NII due to several factors: seasonal lower loans to mortgage company balances, which is one of our higher-yielding portfolios; higher commercial and public fund deposit inflows; and higher cash levels in anticipation of the closing of the Coastal Securities acquisition.

Full-year outlook, however, remains bright.

We expect continued solid loan growth from our existing markets in specialty businesses, incremental balances from our newer specialty businesses and markets, and more optimized cash levels.

We are now also assuming two rate increases over the course of 2017, which will be accretive as well.

On slide 9, you can see the positive momentum being generated by our regional banking franchise.

Linked-quarter revenue was up 3%, driven by a 5% net interest income increase from the strong balance sheet growth across multiple specialty areas and markets.

PPNR and pre-tax income remained strong while we continue to invest in our future profitability and growth.

Looking at regional banking balance sheet trends on slide 10, you can see that average loans were up 5% linked quarter and 20% year over year.

The growth was primarily driven by an increase in commercial loans from our specialty areas, such as private client wealth management, correspondent banking, commercial real estate, and franchise finance.

We saw good momentum in our growth markets as well, with Middle Tennessee average loans up 8% year over year and Mid-Atlantic average loans up 14%.

We saw steady growth in customer deposits while maintaining pricing discipline.

Average core deposits in the Bank were up 2% linked quarter and 6% year over year.

Deposit costs in the Bank were only up 1 basis point linked quarter and up 4 basis points year over year.

We benefited from the rate increase with loan yields in the Bank increasing 7 basis points linked quarter and up 20 basis points year over year.

Turning to slide 11, pre-tax income for FTN Financial, our fixed income segment, was $6 million in the fourth quarter compared to $15 million in the third.

Lower earnings in the quarter reflected a decrease in fixed income average daily revenues to $718,000 compared with $922,000 in the third quarter.

As Bryan talked about a little bit, challenging market conditions began in the latter part of the third quarter with increased expectations of a Fed rate increase and general pre-election market uncertainties leading to muted customer activity levels.

This sentiment continued into the fourth quarter and was exacerbated by the sharp increases in rates and overall market dynamics following the November elections.

Although performance softened in the fourth quarter, FTN finished full-year 2016 with a strong increase in average daily revenue to $919,000 for the full year compared to $780,000 in 2015.

And total fee income for FTN at $269 million for the year was the best performance we've seen from the business since 2012.

FTN also maintained its position in 2016 as number one underwriter globally of callable GSE debt, with increases in both number of issues and par volume underwritten.

And we finished in the top 10 for competitive municipal underwriting as well.

As we announced in October, FTN has entered into an agreement to acquire Coastal Securities, a Houston, Texas, based broker-dealer that specializes in government guaranteed loan products, principally SBA and USDA loans and securities.

Planning activities are progressing well and the acquisition is targeted to close at the beginning of second quarter.

Turning to asset quality on slide 12, consolidated loan-loss provision was zero in the fourth quarter, reflecting stable asset quality trends and continued runoff for the nonstrategic loan balances.

We actually had a net recovery of $500,000 in the quarter compared to net charge-offs of $2 million in the third quarter.

And the reserve to loan ratio remained steady at 103 basis points.

So obviously our credit quality remains strong and our outlook remains bright.

Wrapping up on slides 13 and 14, we made good progress towards our bonefish targets in 2016.

Our balance sheet trends were strong, with loan and deposit growth evident.

Our asset sensitivity paid off with increased net interest income and margin expansion.

We improved returns with ROTCE at 10.6% for the full year.

We deployed capital with the acquisition of the franchise finance portfolio, share repurchases, dividend payouts, and we entered into the agreement to acquire Coastal Securities, which will further leverage our capital base.

We will continue to control what we can control by investing in our revenue-supporting activities while being disciplined with our overall expense base to drive positive operating leverage.

We will continue to have a sharp focus on improving economic profit across all of our businesses through optimized use of our capital and maintaining strong pricing, fee, and credit discipline.

We remain somewhat optimistic in regards to the positive sentiment post elections for us and the banking industry overall and look forward to continuing our strong momentum into 2017.

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

Thank you, BJ.

Well, to summarize, we are really optimistic about 2017.

We think we are positioned very well.

Our loan pipelines as we turn into the year are very, very strong.

Again, we are very optimistic about the trends we see in the business.

Fixed income business has begun to stabilize some here in the first quarter, so we're optimistic as we look at the year.

I'm very proud of the hard work that our folks have done to build these two fine franchises in the business that we have an opportunity to continue to build on in 2017.

Thank you to all of our colleagues for all the hard work that you do.

And we will continue to stay focused, as BJ said, on deploying capital in ways that drive higher returns, managing our customer acquisition, our expense control, our credit quality.

Doing all the blocking and tackling things that we have been about doing for the last eight, nine years.

So thank you, all.

With that, operator, we will take any questions.

(Operator Instructions) Steven Alexopoulos, JPMorgan.

To start, I had two questions on loan growth.

First, you guys had good growth in C&I, X mortgage warehouse.

Could you give some additional color on the pipeline?

I know Bryan, you had some preliminary comments there.

And did you see a shift in the commercial pipeline at all post the election?

We are seeing additional optimism from customers postelection, feeling like things around regulation, which would affect multiple industries, including things like trucking and obviously our industry.

So we are seeing some lift from that.

And the other thing that we are seeing is as we've added bankers, and Bryan talked about this earlier, these bankers are bringing opportunities for relationships that they've had for a long time into the pipeline as well.

So those pipelines have really benefited from both of those things.

There's generally more optimism about should I build another plant?

The economy seems to be getting better.

In some sense, when the stock markets go up, people feel better about things.

So we see more optimism in general and pipelines are looking pretty strong.

Okay.

And then on the mortgage warehouse, what was the split this quarter of refi and purchase?

And where do you see the balances overall migrating to?

We did see toward the end of the quarter a shift more towards purchase than refinance.

Earlier in the year, obviously, we had a slightly higher percentage of refinance.

We are -- we also brought in a number of new-to-bank clients during 2016, knowing that as interest rates at some point did go up, which they did later in the year, that continuing to build the number of clients that we have would be a good way to continue to sustain that business.

But we would expect -- one, you would expect during the fourth quarter and the first quarter seasonally, you always see some downturn in that business.

As well as long-term rates went up, you are seeing some pullback in terms of refinance.

But the home purchase and home buying is also seeing a lift -- early signs of lift from this consumer optimism that seems to be in the market.

Steve, this is Bryan.

We have always acknowledged that the mortgage warehouse lending business will ebb or flow.

And we've talked a lot about the last couple of years all the work that our team has done to expand and broaden and deepen relationships and bring on new-to-bank clients.

And we're seeing good traction there.

And at least in 2017, while interest rates, particularly 10-year treasury, has backed up some 75 basis points to 100 basis points depending on your starting point will drive lower refinance activity.

As Susan said, we think the market for purchase activity can continue to be strong because the economy seems to be strengthening.

As I mentioned earlier with commercial borrowers, consumers, confidence is up, home buying trends seem to be pretty positive.

So we can't forecast with a high degree of precision what might happen over the next year or two.

We are reasonably optimistic on that business as we turn into 2017.

Okay, that's helpful.

Thank you, Bryan.

And just for my final question, if we assume that interest rates follow the forward curve, what would your expectations be for average daily revenue in capital markets over the next few quarters?

Thanks.

I'm going to let BJ take that one.

Yes, Steve, that's a good question.

I think we would expect it to potentially be at least at these levels and maybe higher.

I think one of the things that we've talked about before is volatility being good in this business.

The interesting thing is there was plenty of volatility post elections, but that wasn't necessarily very good to us.

And part of the reason was is that all the volatility was one way.

And when that happened and rates backed up so much so fast, everybody kind of froze.

And that kind of muted our activity pretty significantly in the latter part of the quarter.

But, if the expectations are that there's going to be some rate increases but they are not going to be nearly as sharp, there's going to be some more orderly trading, there's going to be repositioning of portfolios, then we do think that that is going to be good for our activity levels and our fixed income revenues could be higher.

So we're optimistic that they are at least at the levels that we saw this quarter, but probably trending towards being higher throughout the course of 2017.

Steve, this is Bryan.

Listen, I'm going to take the risk of overanswering the question.

We can't really forecast it very precisely and so I'm not issuing a forecast, but we have to put together a plan for 2017.

And I would say we are probably looking in our plan at something in 800s at this point.

We think it will be a little bit better than the fourth quarter ended up.

It may not be as strong as some parts of 2007 -- 2016, but we think overall, we will have a pretty good year in the fixed income business in 2017.

One more thing I will add, Steve, to what Bryan just said is that is for our base business, our existing business.

Obviously when we layer in Coastal Securities, Coastal we think adds $200,000 to $300,000 a quarter -- excuse me, a day in average daily revenues, which will be helpful.

So we believe that that will help get us hopefully over the $1-million-day level and beyond.

Great, I appreciate all the color.

John Pancari, Evercore.

First, on the expense side, I know you have your long-term efficiency target in the 60% to 65% range and then for 2016 full year, came in around 72%.

Could you talk about 2017?

How much closer to the long-term target do you think you can get, just given the amount of Fed hikes you think and some of this strengthening of balance sheet growth you could see in the expense and payment efforts?

What type of ratio could we be looking at for full-year 2017?

Yes.

John, it's BJ, good morning.

We fully expect to continue to make progress on that.

Over the last several years, a lot of our progress, or at least in the 2011, 2012, 2013, 2014 time frame, was more on the numerator side of the efficiency ratio taking cost out.

2015 and 2016 has been driven by much stronger revenue growth.

I think 2017 is going to be a combination of both.

As Bryan and I both talked about, we're very focused on expense discipline on things that don't support revenue.

But we are fully willing to pay for things that do support revenue.

And so we do expect that we will continue to try to flatten out the expense levels that we have while continuing to expand the revenue line and drive positive operating leverage, which is clearly going to drive a better efficiency ratio.

So I see it continuing to come down from this level hopefully into the 71%, 70%, even high 60s% levels.

John, this is Bryan.

I will add to BJ's comments.

I've been in the expense watching battling business in banking for 25 years now.

And while fourth quarter -- third and fourth quarter had some higher expense trends, some of it is related to legal, for example.

You can look at our nonstrategic segment and expenses are up year over year.

Most of that, if not all -- more than 100% is driven by higher legal costs on some of those matters that I mentioned earlier.

Fourth-quarter T&E expense was a little bit higher.

Some of that is just timing in the year.

Some of it is fourth-quarter cleanup.

I'm not particularly concerned at this point about our ability to continue to drive the efficiencies that BJ described.

The management team in our organization has been working on cost control for eight, nine years.

We have achieved significant progress in that regard, and we're very focused on it.

It is built into our plans for 2017, so I'm -- I know that might -- got some attention in the third quarter, it might get attention this quarter.

I'm not particularly concerned about it at this point.

I've got a tremendous amount of confidence in our ability to continue to drive efficiency in parts of the business that allow us to invest in other parts of the business like we've done in 2016 and be smart about building this business for the long term.

All right, Bryan, that's helpful.

Thank you.

And then if I could just jump to capital, mainly around M&A.

Just want to get your thoughts, your updated thoughts, on M&A, particularly post the election and post this rally in valuations.

You have a currency now to a degree and -- but at the same time, sellers may be feeling a little bit better about remaining independent, given the economic outlook and what could be coming.

So I just would love to get your thoughts on how you think about it.

Yes.

I think -- of your points there, I think everybody is feeling better about the environment in the banking space.

I ran into a banker earlier this week who said it's fun again.

And I think as you point out, our currency has moved up, but in some sense, everybody else's has.

And so I'm not sure on a relative basis a whole lot has particularly changed.

My expectation is that 2017 is likely to start off pretty slow from an M&A perspective.

I guess if you had a glass-is-half-full view of the world -- glass-half-full view of the world, you might say sellers can get prices that they would only dreamed about two years ago.

And this might be a good time in the next year or two.

On the other side, it may be regulation, taxes, everything is about to change.

It is fun again, so why now.

I just don't think much will happen personally in the first part of the year.

I think fundamentally, the same major challenges that existed three or four months ago are still there, and that's the cost of technology, the cost of compliance, and all the things that are necessary to be cost-effective long term.

So I think the fundamentals are that the industry will move back into further consolidation.

I'm not sure whether it will be in the first half of 2017 or not.

I sort of don't expect it.

But I think by a year from now, you'll start to see more activity.

Ebrahim Poonawala, Bank of America Merrill Lynch.

I just had one follow-up question first on expenses.

Just wanted to make sure I heard you correctly.

Should we -- I get that you are being disciplined on expenses and cutting where you can while reinvesting in the franchise.

Should we take that to assume that core expenses outside of conflated costs tied to capital markets should be in this 920-ish kind of range as a base case for 2017?

Ebrahim, good morning, it's BJ.

I think we're going to stay away from creating absolute levels of expense guidance because we want to be flexible to take it lower or incrementally invest where we need to.

But yes, we're going to be very disciplined on our expense levels, trying to flatten them out going forward.

And driving more positive operating leverage than we have already.

So we're going to be very disciplined looking for costs to take out of the organization and leverage in the investments that we've already made.

This is Bryan, Ebrahim.

I would add that as we planned for 2017 starting three months ago, everybody went into it with the idea that expenses need to be flat to down in 2017.

So part of the problem is if you pick a number, you stipulated 920 and then said except capital markets, and that is so hard to reconcile back to -- particularly with all the ins and outs of one-time stuff.

That's why BJ is reluctant, but in terms of what we are managing for, we're managing for flat to down expenses.

That's extremely helpful, thank you.

And another follow-up question just in terms of capital deployment, one, is it safe to assume that if the stock stays where it is, you are unlikely to buy back any shares?

And secondly Bryan, you have talked on and off about MOEs.

Do you think it makes sense to wait to see if we get any move on the SIFI legislation before you think about M&A from -- as an acquirer?

Yes, I will start with the capital question first.

We will continue to look at all of the levers, and -- as we've done in the past, when we see dislocations in the valuation of our stock vis-a-vis the market or historical norms, we are willing to take advantage of those.

And so we will continue to use the buyback, and I think we have $185 million, $187 million of capacity remaining on that.

Now we will continue to look at our dividend policy.

This is the time of year that our Board looks at that in our January meeting.

And then we will continue to look for opportunities like our restaurant franchise finance business, the ability to expand through our specialized healthcare lending business where we can put capital to work in an organic or semi-acquisition fashion, and then we will look more broadly at the M&A market.

I would say that in my view, the industrial logic for merger of equals is equally relevant today as it was six months ago.

I think to your point that the trends, particularly even with the existing bright line on the SIFI designation are that CCAR and those elements are going to see more flexibility.

Clearly I think it is a much better thing to see that threshold raise.

I think there's a good likelihood that that will happen.

You have heard even the Federal Reserve, Governor Tarullo in some public speeches acknowledge that that ought to be raised.

And so I think Congress will at some point act on that.

So I have always viewed that as important to stay below that bright light.

I think that will move up.

I think the industrial logic of MOEs are still important, and we will continue to look for opportunities to deploy capital smartly in lower or no premium mergers.

But at this point, it takes I think a little more activity in the market to see anything really starting to spin out of that.

Understood.

Thanks for taking my questions.

Jennifer Demba, SunTrust.

I was just wondering if you could talk about the provisioning outlook over the next several quarters.

The trends continue to be really good.

Any areas you are particularly concerned about right now about getting overheated?

Jennifer, we -- credit quality remains very strong.

Obviously each quarter, we assess what the provision would be in models, looking at economic indicators.

But we continue to have very, very [short low] charge-offs, reductions in nonperforming loans, reductions in non-pass loans.

That being said, we are very intentional around making sure that we are looking for any weaknesses in the economy or certain segments of the portfolio, training front-line bankers, portfolio managers on what to look for.

We're doing higher scrutiny on certain type loans just to make sure we are ahead of that curve.

At this point, all things being equal, I think you would continue to see -- even though we don't manage to coverage, all things being equal, I can't see that we would be increasing at this point.

However, again, we are watching all the time for certain segments.

I've said on previous calls, commercial real estate, and I know other bankers do this as well, watching certain product types in certain markets is just part of everyday prudent portfolio management, and we remain disciplined around that.

So all that being said, I do at this point would say that the provision outlook would be stable to where it's been during 2016.

Thanks so much.

Kevin Fitzsimmons, Hovde Group.

Could -- BJ, can you talk a little bit about the NIM trajectory going forward?

On one hand, I think you guys have had three consecutive quarters of the NIM going up about 4 basis points a quarter.

But now, it seems like there's a more accommodative rate environment going forward.

But you have also talked about peeling back the asset sensitivity.

And there's also the element of the warehouse lending coming in, or falling in pace and that -- you made the point of that being one of your higher-yielding loan segments.

So I know that bunch of variables, but if you can just guide us or help us in how to think about the movement of the margin going forward.

Yes, absolutely.

Clearly, we are very pleased with the trajectory of what we have seen.

We have bucked a lot of trends being able to improve the NIM steadily as we have.

Shorter term for the first quarter, in my opening comments, I did kind of want to make sure people understood that seasonally we usually do see a downtick from fourth to first because we have stronger deposit inflows, loans to mortgage companies are seasonally down.

We have higher cash balances at the Fed, etc.

So to not be surprised if you see backup in the first quarter.

But if you step back from that and look across 2017, we are very encouraged by the outlook that we have.

We see continued strong loan growth coupled with deposit growth.

We now have layered in what the futures market is calling for, which is roughly two rate increases for 2017.

Based on our asset sensitivity, that will help us as well.

So overall, we continue to believe that the NIM trajectory will be higher.

It may fluctuate quarter to quarter, but the trend will continue to get stronger and strengthen.

And NII will have the same type of trajectory over the course of 2017 as well.

Okay, BJ.

Just on the topic of moderating asset sensitivity, is that more a move that -- you guys have talked about that in prior quarters.

Is that more a move that was part of that plan?

And going forward, would you still be peeling it back or would you not -- would you be holding back on that now with this new outlook on rate increases going forward?

Yes, so by nature, we are always going to tend, at least in this environment, to be more asset sensitivity -- asset sensitive because of the loan book and what we are putting on, which is mostly floating-rate.

But we did in the fourth quarter execute some pretty attractive bond swaps.

About $400 million of notional swaps that were at about four-year durations that we swapped to six.

So that would add a couple million dollars over the course of the year to NII.

So short term and has a positive benefit.

It is attractive from yield perspective, but the interesting thing is I talked about as well was that theoretically dampens sensitivity.

But because of the strong deposit growth we had, our overall position didn't change.

So we are able to incrementally take advantage of certain dislocations in the market to improve our NII as well as our balance sheet positioning.

So you will see us do a few more things like that, though overall, we are clearly -- with what sentiment looks like, what futures are saying, and what is coming out of Washington, we are more optimistic now that we could see more rate hikes as opposed to less.

So that also -- that is also something we talk about in ALCO.

Kevin, this is Bryan.

One thing to keep in mind is that we are very asset sensitive today.

And 100 basis points is just under, call it, 5% up 100 basis points.

And if it were up 200 basis points, it would be close to 10%.

We are able to maintain that because the risk of rates going down is very low.

As rates move up, you have to -- you start deal with the risk that rates can move back down.

So naturally, that asset sensitivity has to be narrowed in a little bit, depending on what rates do in the future.

So as BJ said, we're doing some tactical things that we think will help the margin.

But over time, if rates move up 200 basis points from here, then we're going to look to bring that asset sensitivity down some simply because at some point, you have the risk of recession and rates moving back down, and you've got to narrow that range in a little bit as well.

So it's hard to answer the question in a long-term basis with a high degree of precision other than say yes, we'd bring it down.

In the short term, though, we continue to look for rates moving up and we expect to benefit from them.

Ken Zerbe, Morgan Stanley.

I heard your comments -- obviously the fourth -- or next quarter is going to be -- have a little pressure on the margin.

But just in terms of this quarter, I'm looking at slide 8 that you guys have, higher rates drove 6 basis points of NIM expansion, right.

Or at least the 6-basis-point piece of it.

Was there anything else in there beside high rates?

Because I guess I was just -- I know you guys are asset sensitive.

I guess I was a little surprised of the magnitude this particular quarter of the NIM expansion, given rates didn't go up until -- you have literally two weeks' worth of high rates in the entire quarter.

Just want to make sure I fully get the magnitude there.

Yes, good question.

So actually, it's not necessarily the Fed rate increase that drives it, it's LIBOR.

And what we typically see, and what we saw this time for sure because the December rate hike was so telegraphed, was that LIBOR started to tick up well before the actual rate increase in December.

So we saw much more of a full-quarter impact than we normally would from that rate increase because LIBOR started to creep up much sooner.

So that's why you saw a pretty outsized impact in the fourth quarter.

And so that will obviously continue into the first.

And the other thing that helped was the franchise finance acquisition.

So that was closed in the third quarter; in the fourth quarter, that was fully layered in.

And as we talked about when we made that acquisition, it had much higher rates on the aggregate portfolio than many of our existing portfolios.

And that certainly helped as well.

Got it, understood.

Okay.

And then just really quick on the franchise piece.

How much -- if you look at the 4% average loan growth in the quarter, how much of the average loan growth came from the incremental or the full-quarter impact of franchise versus organic growth?

On the NII side or the NIM side?

Actually, the average balance side.

Oh, okay.

Let's see here.

In terms of average to average on balance sheet growth, if you look at franchise finance, it was about $450 million of the increase quarter over quarter for average to average.

Got it, just from franchise fees, okay.

Yes.

Perfect.

All right, thank you very much.

Jefferson Harralson, KBW.

I wanted to ask you guys about Coastal.

In your press release, where you talk about it, you say there is $16 million in trailing 12-month earnings.

But is the reason that that should go up a decent amount as you guys put it onto your platform.

It seems like you could use your balance sheet more, perhaps cross-sell between the -- between Coastal and your legacy bond guys.

And can you talk about if that run rate has actually increased already since the election.

Good question, Jefferson.

Yes, we really like this business; we like the mix of the business.

We have already given you some statistics on what we think the business will do.

We do think that there's synergies across our existing platform, so we're bullish about that.

We do think that there's some funding opportunities.

I talked about why first quarter might be -- there might be a little bit of pressure on the NIM because of higher cash balances related to Coastal.

So clearly, we're trying to reposition their balance sheet to take advantage of some funding opportunities that we think we have.

So I think I'll stick with what we and Aarti gave you on the outlook for that business and hopefully it can be stronger.

And you think -- have you changed on how much you think the balance sheet can be bigger?

What kind of book do you need to run?

You've been carrying -- before, you were saying $500 million to $700 million of inventories on the balance sheet.

So when this deal is closed sometime I guess this quarter, should we expect for the full quarter of Q2 the balance sheet to be $500 million to $750 million larger?

Or is that a good starting guess or do you think that's -- or would you like to lead us in a higher or lower size?

No, that's about right.

We don't necessarily plan at this point at least initially to make any fundamental changes to how they do business.

We really like how they do it.

And it's very complementary to what we do.

So we think their inventory needs will be largely the same.

And if they have to expand, it will be for a good reason.

So we will stick to that kind of guidance for it.

And that in total is margin dilutive, too, right?

We should put -- that will have a heavy impact on the margin, I suppose, all things equal.

The trading inventory there?

I don't think so.

Our trading inventory is a little bit different from their trading inventory.

So there's a little bit more carry, i.e., NII, that is available in that type of business and trading environment versus ours, which is virtually fully hedged out.

So no, we don't think it will be nearly as dilutive as maybe our trading inventory is.

Okay.

Because they are trading inventory is mostly SBA loans at 4.25 or 4.5 or something?

Is that how to think about?

Yes, they are mostly in SBA and USDA lenders, so that's right.

All right.

Thanks, guys.

Jefferson, this is Bryan.

I will add I was there in really late -- mid-to-late December.

Had a chance to meet with not only the management team, but also with a great cross-section of the organization.

We are really excited about the opportunity, and as BJ said, I think it's fair to stick with what we've got.

But because there's some onboarding costs and things like that that need to be dealt with.

But we are optimistic that this is going to be a great partnership.

It's got a great group, a great business model, and we're very optimistic that in the outyears, we will see significant upside in this business.

Okay.

I will leave it there.

Thanks, guys.

Jared Shaw, Wells Fargo Securities.

Just a follow-up question on the securities purchases.

When did you do the swap in the quarter?

Is that the beginning of the quarter or is that after the election?

We actually executed two in the quarter.

So they weren't actually together.

So they were across the quarter.

Okay.

And then when you look at the incremental purchases [and it's in the part] from that swap, are you taking on more duration in your standard purchases at this point?

Or is that basically the duration extension really limited to whether or not you did do the swaps?

Yes, so what we did is we had about a four-year duration on what we had and we swapped into about a six-year duration.

So we sold CMOs, reinvested in a 30-year MBS.

Okay, okay.

Thank you.

And then finally, just on the credit side, how long can we expect, do you think, continued credit recoveries at this point?

Are you pretty much through what you expect is the -- are the ETA recoveries or actually that you see these have (inaudible) written on the few quarters?

Jared, obviously forecasting credit recoveries is a difficult proposition.

But we continue to -- we will have some opportunities in any given quarter for some recoveries on both the consumer side and the commercial side.

On the consumer side, we have benefited from home price appreciation, optimism in the marketplace.

But over time, we would expect some moderation in that.

So we have benefited from that.

But we've also had -- and it's in the presentation.

We have actually had very low gross charge-offs as well.

So while we have benefited from recovery, we have also had historically low gross charge-offs in the portfolio, too.

That's great.

Thank you.

Casey Haire, Jefferies.

Wanted to circle back on the M&A.

I know you guys -- we have touched on it a bunch, and you're not expecting much in the first half of the year.

But when activity does pick up, what is sort of your sweet spot in terms of size?

I know you guys have been looking for the MOE.

That is been tough, and I know you guys want to be -- you don't want to be as small as that TrustAtlantic deal, so what is the sweet spot?

And then geographically speaking, what would be of interest to you?

Well -- Casey, this is Bryan.

I would say in some ways you have to think about it on a continuum.

If we had another opportunity like TrustAtlantic in a Raleigh or a Nashville, we certainly would consider it.

And as we said, it was a long and in some ways drawn-out process.

But we would still consider it.

But on an absolute basis, we would prefer to do something with more significant size.

If I had to pick a number, I would say something between $5 billion and $10 billion would be more in the ideal sweet spot.

But I wouldn't foreclose that we're going to be opportunistic and think about M&A in a broader sense.

For example, the acquisition of the franchise finance business was basically a $600 million portfolio acquisition with a lot of really good talent that came along with it we were able to hire.

So we will think about it in sort of a moving way.

We will look at what markets does it fill in, what market opportunities does it open up for us.

And with that, how do we build the franchise for the long term.

And again, back to our bonefish and what does it drive in terms of improving our ROE in making a decision.

So clearly, bigger is better than small, but we have to look at a lot of factors, and that's what we do.

Okay, understood.

And on the bonefish topic, so the efficiency ratio target longer term, that obviously is a pretty big bogie between where we are today and what you guys are aspiring to.

What sort of -- what kind of Fed funds policy makes that a more achievable metric?

Hi, Casey.

Probably at least 100 basis points higher.

Okay, great.

And just last one for me, the tax rate came in a little light versus May.

It looks like there's some permanent benefits there.

Is 30% a good number to use going forward?

Yes, I think that's --

After tax reform, of course.

Okay.

30% to 32% is probably a good number.

Okay, thank you.

Chris Marinac, FIG Partners.

BJ, I guess I will pick up where Casey left off on tax reform.

If something were to happen this year, what does that mean for your tax strategy?

And would there be any one-time adjustments you would have to implement, even if it's just uncertain at this point?

Yes, so we don't necessarily foresee any meaningful impact like to our DTA or DTL or anything like that.

We clearly think that tax reform and what is being talked about, a lower tax rate is going to be significantly beneficial to us.

It is unclear.

We certainly have permanent and discrete tax credits that help lower our effective tax rate that may be impacted by corporate tax reform.

But net net, we certainly see it as one of the biggest positives that could happen to us in terms of EPS.

Okay, great.

And then I guess a question for Susan.

What is happening with CECL this year?

Is there anything that we would see here formally as all of the CECL work is kind of happening behind the scenes?

Yes, we have -- probably like many other banks, we are -- we've got teams examining CECL, working with accounting -- our accounting partners.

And at this point, there is a number of different scenarios that show it could have an impact from 0% to 30% on average, depending on the bank.

And so we're just -- and in some cases even could be a positive benefit where you could actually have a release.

So we've got teams working in credit and accounting and finance.

We're looking at the potential impact for us, but at this point, I don't have a specific amount.

Susan, is that something that you would talk about later this year, or probably push that into the future?

Just curious when that comes to be a front-burner issue?

I think we will have more information and analysis completed later in the year.

Okay.

That's great.

Thank you very much, guys.

Appreciate it.

This concludes our question-and-answer session.

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

Thank you.

Thank you, all, for taking time to join us this morning.

Please feel free to reach out to Aarti, BJ, me, Susan, anybody that can help you with any follow-up questions that you may have.

We appreciate your interest in the Company.

Thanks again to the First Horizon, First Tennessee, First -- FTN Financial folks for all that you are doing.

Hope you all have a great weekend and look forward to speaking with you soon.

Thank you.

The conference has now concluded.

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