FNB Corp (FNB) 2016 Q3 法說會逐字稿

Good morning and welcome to the F.N.B. Corporation third-quarter 2016 quarterly earnings conference call. All participants will be in listen-only mode.

(Operator Instructions)

After today's presentation there will be an opportunity to ask questions.

(Operator Instructions)

Please note this event is being recorded. I would now like to turn the conference over to Matt Lazzaro, Investor Relations. Mr. Lazzaro, please go ahead.

Thank you. Good morning, everyone, and welcome to our earnings call.

This conference call of FNB Corporation and the reports it files with the Securities and Exchange Commission often contain forward-looking statements. Please refer to the forward-looking statement disclosure contained in our Earnings Release, related presentation materials and our reports and registration statements filed with the Securities and Exchange Commission, and available on our corporate website. A replay of this call will be available until October 27, and a transcript and the webcast link we posted to the About Us, Investor Relations and Shareholder Services section of our corporate website.

I will now turn the call over to Vince Delie, President and Chief Executive Officer.

Welcome to our conference call to discuss our third-quarter results.

Joining me today is Vince Calabrese, our Chief Financial Officer; and Gary Guerrieri, our Chief Credit Officer. We are very pleased to share the results of another record-setting quarter for FNB, as EPS grew 9% to $0.24 per share and net income exceeded $50 million for the first time, driven largely by record revenue of $213 million.

We also continued our streak of 29 consecutive quarters of organic loan growth and 15 quarters of total revenue growth. Third-quarter revenue was supported by continued growth in our key-based businesses, notably capital markets, mortgage banking, wealth management, and insurance.

The quarter's efficiency ratio of 54% reflects the benefit of increased revenue, continued diligent expense management, and the full realization of the targeted cost savings from the Metro and Fifth Third branch acquisition. Return on average tangible common equity and return on average tangible assets on an operating basis also improved from the prior quarter to 15% and 1.1%, respectively.

Looking at the income statement, non-interest income was a record high at $53 million, representing a 29% increase from the year-ago quarter. This success is largely attributable to the performance of our fee-based business units.

Our bankers engage in a planning process that involves identifying products that fulfill a client's needs and are committed to providing high-value fee income services with the best interests of our clients in mind. This approach enables our customers to most effectively manage their banking relationships and fully utilize our diverse products set, as specific needs arise. I'll note that in regard to the expected Yadkin acquisition, we conservatively modeled limited revenue synergies and utilized the current interest rate environment for five years, thus providing FNB with an opportunity to outperform the financial model and drive additional shareholder value creation.

Looking at the balance sheet on an organic linked-quarter basis, annualized average total loan growth was 8%, driven primarily by the consumer segment. Organic growth in the consumer loan portfolio was a combined 13% annualized, led by strong origination volume in mortgage, indirect, and home equity-related loans.

Commercial loan growth of 4% annualized was impacted by our continued efforts to reduce risk in our loan portfolio, as we were able to exit some underperforming credits. We were also impacted by planned takeouts in our performing investment real estate portfolio.

Commercial growth in the metropolitan markets of Pittsburgh, Baltimore, and Cleveland, continued at good levels. At the end of September, our commercial pipelines are healthy and are approaching $2 billion. The strong performance in the quarter fully demonstrates our continued ability to execute our acquisition strategy by achieving revenue growth and stated cost savings targets.

The Metro acquisition was our largest acquisition to date and marked the sixth whole bank acquisition since the beginning of 2012. In addition to achieving our expense target, the number of referrals to our high-value, fee-based product areas has exceeded our original expectations and are tracking well across the Company. As you recall from the announcement of the Metro merger last August, we also expected to benefit from additional commercial and consumer opportunities, and our current pipelines are at healthy levels.

We have had early success due to our disciplined relationship planning process, coupled with our expanded product line, which enables our bankers to deepen existing relationships and create win-win outcomes for our clients and the bank. The Metro transaction provides further evidence of our ability to enter new markets, achieve model financial assumptions, and create shareholder value. Our acquisition strategy will serve us well in what continues to be a challenging operating environment due to escalating regulatory requirements, as well as an extended low interest rate.

As part of our ongoing clicks to bridge strategy centered on bringing the e-delivery and branch channels together, we have made significant investments in technology. We have successfully rolled out our digital kiosks in all of our branches, and earlier this month, we became one of the first banks in the country to fully integrate debit control into our mobile banking app. This service provides an invaluable security tool that gives FNB customers real-time control over how their debit card is used.

It provides enhanced protection against fraud, allows for easier account control and better management of service charges. This service will be accompanied by the rollout of a touch ID feature in the fourth quarter, further enhancing security. In total, FNB has significantly enhanced its mobile banking capabilities, which include leading-edge technologies such as Popmoney payments, instant balance, mobile alerts, and other valuable mobile capabilities.

I would now like to provide an update for the pending Yadkin acquisition. Shortly after we announced a definitive merger agreement in late July, we were able to retain and secure the key local leadership in the North Carolina markets and we expect to retain employees serving on the front line in Yadkin's branch locations, as well as the vast majority of commercial and mortgage banking professionals. At this stage, we have retained nearly all customer-facing personnel.

I should also note that we are very impressed by the caliber of the Yadkin team and the similarity of the culture between the two organizations. We continue to pursue opportunities to reduce our one-time expenses and at this early stage, our credit mark is tracking in line with our original assumptions.

In regard to achieving the modeled standalone cost savings, we have a clear path to our 25% target and are focused on achieving our goal. It should be noted that our cost savings target is after the full effect of the Yadkin and NewBridge conversions.

Yadkin's third-quarter performance was slightly better than our modeled expectations and consensus estimates. Their organization displayed solid performance across multiple business segments, demonstrating that Yadkin continues to be a top performer in the Southeast. Yadkin group tangible book value per share $0.19 compared to the prior quarter, which is before the full realization of NewBridge cost saves. Together with FNB, our capacity to continue to grow tangible book value will be significant.

I want to thank our employees for their extraordinary efforts and commend them for our performance through the first nine months of 2016. We continue to be recognized as a top workplace, as First National Bank was once again named a best place to work in Pittsburgh, PA, our headquarters city.

This was the sixth consecutive year we have received this award. We are honored that FNB ranked as an employer of choice in the large company category and humbled to have been recognized with a special award for confidence in leadership by our own employees. This award is further evidence of the power of a positive, collaborative workplace and the unwavering confidence our employees have in our management team's expertise and direction as we continue to navigate mergers, a complex regulatory environment, and other challenges facing a growing financial services organization.

Looking back, FNB's performance since the financial crisis has been remarkable. We have maintained one of the highest dividend yields among the 100 largest US banks and returned over a $0.5 billion to shareholders since 2009. During that same period, we grew tangible book value at nearly 7% per year, grew earnings per share to our current run rate of $0.24 and completed nine acquisitions.

FNB was also consistently an upper-decile performer, relative to return on average tangible common equity. We achieved all of this despite the challenges presented by crossing the $10 billion threshold and the current interest rate and regulatory environments. On an annual basis, FNB faces more than $0.10 in lost earnings per share, due solely to lost revenue and added costs related to the Durbin amendment, higher FDIC insurance premiums, reduced dividends received on FRB stock due to the highway spending bill, and the cost of capital actions taken to replace trust-preferred securities.

All of this is fully reflected in our run rate and the largest impact to our Company began in 2013. These items have led us to think strategically about the best ways to overcome all of these challenges, and to create a company that will not only thrive in the near-term but excel in the long term.

We have invested heavily in leading-edge technology to provide our customers with the best experience. We have invested in high-value, fee income business lines to diversify our revenue sources and overcome low interest rates. Additionally, we have expanded into new geographies through acquisition to support our growth objectives while maintaining a well-established credit culture and a lower-risk profile.

This quarter's strong performance was additional evidence of these strategies paying off and I am confident that they will continue to benefit the Company. As I look forward, I feel that we are positioned extremely well to take advantage of additional opportunities to grow and to continue to increase shareholder value.

With that, I will turn the call over to Gary Guerrieri, our Chief Credit Officer.

Think you, Vince, and good morning, everyone.

The third quarter of 2016 reflects another successful quarter with our credit portfolio favorably positioned as we approach the end of the year.

We ended September with total delinquency at 1.33%, reflecting a 13 basis-point improvement over June, while NPLs and OREO at 92 basis points also moved favorably over the prior quarter's results. GAAP net charge-offs for the quarter totaled 33 basis points annualized, and on a year-to-date basis were 27 basis points, both satisfactory levels.

Let's now take a closer look at the results for the quarter. Turning first to our originated portfolio, the level of delinquency at the end of September improved slightly from the prior quarter to stand at a very good level at 1%. NPLs and OREO also improved, down 7 basis points on a linked-quarter basis at 1.08%, which was driven by strong commercial OREO sales activity.

Net charge-offs for the third quarter were elevated at $12.3 million, or 41 basis points annualized, as we were able to move some rated credits off the books at slightly better than positioned levels. The total originated provision was $14.1 million, which covered charge-off activity in the quarter and organic loan growth, resulting in an ending originated reserve position that is down slightly from the prior quarter at 1.23%.

Let's now move to our acquired portfolio, which at the end of September totaled $2.6 billion outstanding marks to fair value. We saw some very positive activity during the quarter, as evidenced by an $18 million linked-quarter reduction in contractual delinquency, bringing the level of past-due accounts to $75 million at quarter end.

The acquired reserve was up slightly, ending September at $6.4 million. Inclusive of the credit mark, the total loan portfolio remained well covered at 1.79% at the end of the quarter.

I'd like to switch gears now and talk briefly about our approach to managing the portfolio as we work toward the pending close of the Yadkin acquisition. The acquired credit integration process is a core competency and plays a key role in our overall credit management framework, just as it has for all prior acquisitions.

Shortly following announcement, our credit teams began work on identifying, quantifying, and monitoring risk within the target portfolio. These reviews are tailored to the unique characteristics of each portfolio in regional market, which produce results that are used to run extensive, ongoing, pro forma scenarios of consolidated credit quality, acquired loan valuations, and concentrations of credit. This continuous review process provides timely insight into the performance of the standalone acquired portfolio, as well as the expected impact to our credit results on a consolidated basis.

As Vince mentioned earlier, we are presently tracking in line with our original credit mark determined at the time of due diligence. Barring any unforeseen events during the credit integration process, we anticipate future economic benefit through our normal practice of actively managing risk in the portfolio. A proof point of this is the recent Metro acquisition, whereby we successfully reduced problem asset levels by nearly $150 million in the first six months following its close.

In closing, the third quarter of 2016 was marked by continued satisfactory results in our credit portfolio and we are pleased with its position as we enter the final quarter of the year. With the close of the Yadkin acquisition approaching, our focus remains on continuing to manage our portfolio in the same consistent manner that we always have, driven by sound underwriting, attentive management of risk, diligent work out of problem loans, and maintaining a well-diversified book.

These core credit philosophies have served us well through periods of strong organic growth, M&A activity, and various economic cycles. We expect that this rigorous and focused approach will continue to serve us well in the future.

I will now turn the call over to Vince Calabrese, our Chief Financial Officer for his remarks.

Thanks, Gary. Good morning, everyone.

Today I will discuss our financial performance for the third quarter, and comment on our guidance for the fourth quarter. Looking at the balance sheet, organic total average loans grew 7.6% annualized, a solid overall result with growth in both commercial and consumer lending.

Organic growth in the consumer loan portfolio of 13% annualized was seasonally strong, led by increased origination volume in both residential mortgage and indirect auto lending. Organic growth in non-interest-bearing deposits of 6.9% annualized was offset by a planned decline in time deposits.

In total, average deposits declined 1.4% annualized in the third quarter, given our desire to strategically exit certain higher costs and unprofitable acquired depositor relationships. On an organic spot basis, total deposits grew in the mid-single digits. From a total funding perspective, our relationship of loans to deposits was 92% at the end of September.

Turning now to the income statement, net interest income grew $3.1 million, or 2%, benefiting from the quarter's solid organic growth in total average loans of 8%, which was partially offset by expected margin compression given the continued low-rate environment. Out net interest market on a reported-basis equaled 336 compared to 341 in the second quarter, while our coordinated interest margin narrowed three basis points to 332, in line with our previous guidance.

Let's look now at non-interest income and expense. Non-interest income in the third quarter was a record high for FNB, increasing $1.8 million, or 3.6% as insurance, capital markets, and mortgage banking performed especially well. Investments made in these businesses continue to pay off, with significant upside opportunity available in the newer Metro markets, given the absence of these high-value businesses in the banks we acquired in Maryland and Cleveland. Commercial interest rate products experience increased demand, with broad-based contributions and increased referral activity across the footprint.

As Vince mentioned, our success in deepening relationships is a direct result of our team's ability to bring high-value services and enhance product offerings to our customers. Mortgage banking had a very strong quarter with record production levels leading to a 29% increase in mortgage banking income to $3.6 million. Increase in insurance commissions during the quarter reflected the impact of new-client acquisition, as well as seasonal increases in premiums.

Non-interest expense, excluding merger-related costs, increased $1.7 million, or 1.4%, even with a full quarter of expenses related to the Fifth Third branches acquired on April 22. Our efficiency ratio was 54.4%, which was another improvement over the prior quarter level and reflects the successful realization of cost savings from the Metro acquisition, as well as continued disciplined throughout the company in effectively managing expenses even while we continue to invest in our infrastructure to support future growth.

We continue to expect the Metro acquisition to be accretive to earnings in the first full year of operation, which will be 2017. Regarding income taxes, our overall effective tax rate for the quarter was 31%, in line with previous guidance. On the subject of net interest margin, we expect to continue to see some modest margin compression in the fourth quarter of 2016 in the 2 to 3 basis point range, from third-quarter core margin of 332.

Regarding the other elements of guidance provided in July, we are reaffirming the year-over-year projection shared as follows. Organic loan growth in the high-single digits, organic deposit and customer repo growth in the mid-single digits, core non-interest income growth in the $30 million to $40 million range, core non-interest expense increase in the $80 million to $90 million range, effective tax rate in the 31% to 32% range.

Regarding guidance for the provision for loan losses, we continue to look for a range of $12 million to $13 million on an originated basis in support of planned organic loan growth, commensurate with the increased size of our organization. For the acquired provision, we forecast a range of $0 million to $1 million, depending on reestimation results.

As it relates to the pending Yadkin acquisition, as Vince mentioned earlier, we're tracking well toward a first-quarter 2017 conversion. I would like to point out that with the fully phased-in cost savings from both the NewBridge and Yadkin conversions, the combined franchise is expected to add an incremental $30 million to our quarterly run rate expense base, beginning in the latter half of 2017. With a better-than-forecasted building of tangible book value per share, that Vince discussed earlier, it improves the tangible book value dilution that will occur at closing in the first quarter.

Combined with conservative assumptions incorporated into our merger model, the undervalued positioning of our common stock is even more evident, especially when viewing the discounted price to tangible book value and priced earnings, in light of our top-decile financial performance, top-decile dividend yields and strong growth prospects for the future. This should all translate into boosting shareholder value in the coming quarters and years.

In summary, the third quarter of 2016 was solid for FNB, as recent acquisitions began to demonstrate their value and several business lines turned in excellent performances. Loans continued to grow organically while our deposit mix improved and non-interest income contributed meaningfully to our earnings and another improvement in our efficiency ratio.

In a very challenging banking environment, we continue to be very pleased with our team's performance in executing our business strategies. I want to thank them for their significant efforts to make FNB a top performing regional bank.

Now I will turn the call to the operator for questions.

Thank you.

We will now begin the question-and-answer session.

(Operator Instructions)

The first question comes from Bob Ramsey with FBR.

Hey. Good morning, guys. I guess first of all on Yadkin, just wondering if you could provide any update on the deal timing. I know you said first quarter. Are you shooting for the start of the quarter, the end of the quarter? And how is the regulatory approval process progressing?

I will take that answer; it's Vince Delie.

I think things are progressing well. We are not changing what we have initially told you. We are still targeting the first quarter. And as I said on the call in the prepared scripts, I am very pleased with the culture of that organization, the quality of the individuals that work there. Their commitment to the overall organization performing at a high level is evident when you meet them.

I think that the leadership positions that we've announced really clarifies, truthfully clarifies who they are going to be reporting to in the field. And we have lost very, very few producers; so we're very pleased with how that's going.

On the integration front, if you look at the organizational structure and our ability to craft a clear path to the cost takeouts, we're there. We have our organizational structure in place. We have a firm grasp on run rate salary expense moving forward. We've identified people to step up into the product roles that we will be embedding in those units in North Carolina. So everything seems to be going very, very well.

From a conversion standpoint, we are well down the path with mapping, product mapping. And our IT systems operations areas have done a terrific job of laying out, again, a clear path to conversions. So we're moving forward as normal in a transaction.

Okay. Shifting to net interest margin. I know you guys said you expect two or three bits of compression in the fourth quarter. Is that sort of the pace that we can think about on a go-forward basis until rates move? And if the Fed does raise rates by 25 basis points in December, how does that impact the outlook?

I would say with rates where they are and without any Fed move, the 2 to 3 basis points is right where we are tracking. The differences between rates paid for loans that are maturing and new rates is narrowing, but it is still a 25- or 30-basis-point difference there. And in our investment portfolio, there's still a 20-basis-point or so difference between the stuff that's rolling off.

We have about $1 billion a year rolling off in a 12-month period versus the purchase activities. There's 20 basis points there. So when you kind of roll it all together, the 2 to 3 basis points is kind of what is baked in right now.

If the Fed moves in December, you can get a little benefit for the core. But really that benefit, as you see from our core margin slide, we picked up a few basis points from fourth quarter to first quarter with the Fed move last December. So there's some benefit there, but that would really show up in the first quarter. And we'll give full guidance come January for next year.

Okay. Great, so maybe it's fair then to think that if the Fed moves this year like they did last, you would see a similar lift. But that all else equal, 2 or 3 basis points per quarter would continue through next year if rates don't move.

Plus, remember too in the first quarter, you'll have Yadkin become some of our numbers. So Yadkin's margin is a bit higher than ours, and that would add a few basis points to the overall margin of the Company. So you will kind of have both things showing up in the first quarter.

Then shifting to the loan growth, you guys obviously had really good consumer loan growth this quarter. Just wondering if you could elaborate any on what were really the drivers behind that. Was there any increased marketing or promotion?

Were certain geographies stronger than others? Is there something you're seeing from consumers that is sort of driving this? I would just love any qualitative comments.

I just think the overall, we've seen lift across the board, truthfully. And I think consumers, for whatever reason, have become a little more active in terms of the desired borrow. And given the broad geographic area that we cover and the number of branches that we have, it's logical when that occurs to see an increase in lending activity in those categories.

I wouldn't say it is in a specific area, truthfully; it seems to be pretty steady across the board. And I think it's largely driven, as far as we can tell, from consumer demand. We don't run special campaigns or promotions in the retail bank.

We set our goals at the beginning of the year. We give our salespeople 12 full months to achieve their sales objectives so that they could plan with their clients. Any increase, truthfully, would be more driven by consumer demand than anything else.

Okay. Great. Thank you.

Thank you.

Thank you.

The next question comes from Jason Ong with JPMorgan.

Good morning, everybody.

Good morning.

I would like to stay on the topic of loan growth real quick. On the organic commercial side, the last few quarters we have seen loan sales. Can you just quantify maybe how much that was and thoughts on sales going forward?

Yes. In the last couple of quarters, you're looking at about $60 million, where we were able to move some of the rated assets that I mentioned earlier, Jason, off the books at economically positive results. So it was a win-win for the Company from both angles, taking risk off of the balance sheet as well as being positive from a performance standpoint. We look at those as no-brainers.

That was a strategic focus of ours coming out of the Metro acquisition. And we're very pleased with our ability to execute on that plan.

And the majority of those assets were in the acquired book. They were not originated assets, so it was a planned item.

Right, so should we expect that to be done with or tapered off now, then?

At this point, we don't have any plans for anything on a go-forward basis.

Okay. Great. That's helpful.

Shifting gears to non-interest income, mortgage banking was pretty strong in the quarter. I'm just curious if you could give us some color on what the volumes were and maybe your gain on sale margins?

Well, our volume year to date as of 9-30, was approaching $1 billion; so production volume was up fairly significantly, $417 million for the quarter.

(Multiple speakers)

So we mentioned, god, it has to be at least two years ago, that because of the sustained low-rate environment, we were investing in our mortgage operation. We felt that there would be an opportunity to kind of hedge an extended low-rate period with enhanced mortgage banking activities. So we did that and we've grown production there.

Our annual production in the past was very small, about $350 million; so that particular investment has paid off for us. The production is up considerably, and the gain on sale that you are seeing in servicing the income is also up significantly over that period. That's helped us.

Okay. And with respect to all the investments that you've made, if volumes continue to trend up in this --

We invested in our syndications platform. We are approaching, I think, $1 billion in left-lead syndications in total. We also have built out the international area. International banking was an area of focus for us. We outsourced a lot of that activity in the past.

We brought quite a bit of it in-house. And that's provided us with a fairly significant benefit relative to zero, which is what we got, or very little, in the past. So that's taking off and continuing to grow.

We've invested in our derivatives sales team and in our capabilities there. That has continued to contribute very nicely to the fee income line. And then a number of products that we rolled out in the consumer bank, many of the products that I mentioned from a mobile perspective, we are trying to keep pace with J.P. Morgan and Bank of America and others.

I think we have a great product offering. That's led to customers expanding their relationships with us, truthfully. So while there is an initial investment in that technology, it starts to pay off over time. So the consumer segment, in terms of interchange fees and other areas, ATM fees that we obtain, has gone up as well.

Okay. Thanks for taking my questions.

No problem.

Thank you.

Thank you.

Thank you.

The next question comes from Brian Martin.

Hey, guys. Just wondering a couple of things. On the loan growth, we think that with some other banks maybe there is a little bit of like a slowdown in some of the C&I lendings.

Just wondering your take on that. If you can talk about that, if you guys are seeing any of that, or if it's kind of pretty normal based on the flows you're seeing. It sounds like the pipelines are strong at $2 billion heading into the quarter. Just curious if you are seeing any of that within your footprint.

I would say C&I demand has tapered off, to be truthful. Earlier in the year, there was more robust activity. I don't know if it is uncertainty around the election or concerns about the economy, who knows. But it seems as though demand has begun to taper.

And we're still, because of our strategy, our strategy was to not rely on one particular geography to drive growth for us. That is part of what led our acquisition strategy and took us into Baltimore and Cleveland and now into Charlotte and Winston-Salem and other areas. It is the desire to not be reliant on one particular asset class or one particular geography from an economic standpoint to drive loan growth for the Company.

That strategy has paid off for us because it has enabled us, given our relative low share in the commercial segment in those cities. And even today in Pittsburgh we have a much larger share, but there is a long way to go. It provides us with the ability to focus on growing those portfolios at a rate that you would see probably beyond some of the larger banks that have heavy concentrations of share. Our relative share from a deposit share standpoint relative to the commercial loan share provides us with the ability to grow that loan share at a more rapid rate.

That's really the thesis behind our M&A strategy. We've mentioned that to a number of people, and it seems to be paying off. I don't know, Gary, if you want to comment on it.

We are seeing and we have talked about this a little in the past. We are seeing significant increases in credit opportunities due to the investments in these newer markets that Vince has mentioned.

The other thing that it is allowing us to do is to maintain our very consistent underwriting and credit decisioning practices and process because we're seeing so many new opportunities out of these newer markets. And the investments that we've made in Cleveland, Baltimore, and soon-to-be in North Carolina. It's really panned out very well for us from a credit opportunities standpoint.

And while C&I demand seems to be down ever so slightly, our portfolio and our pipeline continues to be very robust.

And I would say, based upon the Greenwich survey results, that is the consulting firm that surveys the markets that we compete in, we received I think a total of nine awards. So our commercial bank is perceived in those markets as a player. We are first in thought. So we get to look at many of the transactions that go on in all of those cities, just like some of the other large competitors.

So I wouldn't discount the fact that we have very good people in the field, that we have a very deep product set, and very high customer satisfaction scores across the board. That helps us.

Okay. Thanks for the color.

And then maybe just one other question, just going back to mortgage for a minute. Obviously, the environment has been helpful this year on the mortgage side Certainly the investments you guys have made have also contributed.

But just thinking about next year, just in general, does it seem reasonable that you guys can kind of sustain the type of mortgage gains you're seeing this year? Maybe not grow it next year, but maintain based on current trends and pipelines you're seeing? Or does that seem out of the question?

I think, given the expansion that we're embarking upon, that gives us tremendous opportunity to continue to grow that business. In addition to that, the majority of our originations have been purchase money originations. So we're really a little more dependent on the housing market than others. We are not simply refinancing all of our customers. So a very high percentage, proportionately 2/3.

So I think that the model we have works. Given our deposit share in those markets, that leads to opportunities from a mortgage perspective. And we were, truthfully, underserving the markets we were in, given the size of our mortgage operation prior to the investment. So we are simply benefiting from right-sizing that organization. So clearly, I believe it is sustainable.

And I actually feel that moving into markets that have a higher growth trajectory in terms of -- and remember our existing footprint doesn't grow population wise. Moving into the Southeast gives us tremendous tailwinds, so we can --

I was looking more on a core legacy basis as opposed to -- certainly --

On a legacy basis, I think we are getting our fair share based upon our deposit share in the markets that we compete in; and I still think there is some upside. I think our people have done a great job building market share in those markets and really making it equal to our deposit share, as you look at what we should have in terms of our piece of the total pie.

Okay. Perfect. And maybe just the last one for me.

Can you just talk about, I mean, obviously the efficiency ratios track nicely based on leveraging the investments you've already made. But as you think about it, as you integrate Yadkin, just how you're thinking about it, bigger picture, how that's going to trend over the next four to six quarters.

I would just make a few comments on efficiency ratio. I think 54.4% is a very strong performance this quarter. I think a combination of the Metro cost savings that we talked about earlier, as well as the contributions from the fee-based businesses in a flat-rate environment, really were key to that movement in the efficiency ratio from the second quarter to the third quarter.

As we've talked about in the past, the acquisitions have clearly created scale, which enhances the positive operating leverage we were already generating on an organic basis. And allows us to continue to see the improvement in efficiency ratio, but also in our bottom-line earnings and our returns. The new markets we continue to have significant revenue growth prospects.

Remember in Cleveland and Maryland when we entered those markets, they didn't have much in the way of the banks that we bought, the fee-based businesses. So we've been starting to build there, but there is still a lot of upside there.

And while we're doing this, we're investing in the franchise. So we continue to invest in our people. We're investing in infrastructure so that to support not just where we are but kind of the growth of the Company.

I think there's still opportunities. Obviously, when margins start to expand a little bit, there's opportunity in the efficiency ratio. And on top of all of those things, we focus a lot on renegotiating contracts. As we have gotten a lot larger, we have more leverage than we had before. That is a continuous focus.

There's a lot of things we're focusing on. Process improvements is something we've been --

Branch optimization.

Branch optimization is a continued program we have, so there is still opportunity there to continue to improve it.

Okay, in the first clean quarter with the expense savings from Yadkin, what would you guys be targeting for that to be the first clean quarter? Would that be the third quarter of 2017, assuming the transaction is completed as you are targeting now?

Yes. Third quarter would be a good, clean quarter.

Okay. That's it for me. Thanks.

Thank you.

Thank you. Appreciate it.

Thank you.

The next question comes from Casey Haire with Jefferies.

Hey. Good morning, guys.

Good morning.

Vince Calabrese, a question for you on the Yadkin quarterly expense rate. If I heard you correctly, you said $30 million? That's decently better than what I was expecting.

Has there been any change? I think you had said 25% cost save number with a ramp in the 2017. It sounds like third quarter 2017 will be full recognition. But at $30 million, that seems better than that 25% cost save. Also, is that a cash number, given that there will be intangible amortization expense with this deal?

I would just say there hasn't been a change. That number is kind of all in with the 25%.

Remember, part of the noise in Yadkin's numbers in the first quarter, they did the NewBridge transaction. So you have not seen all those cost saves. Even today, their expenses are still elevated, including the NewBridge costs. So the $30 million is a GAAP number, kind of where we would be after the 25%. And as Vince commented on earlier, we have a very clear path to that 25%. We've already identified how that will be accomplished and kind of plans are in place.

So it is not a change; it is what was baked into the model from the beginning. But you just have a couple of steps to get there, Casey, given the timing of the NewBridge acquisition.

Remember, Casey, as we mentioned, we built the model from the ground up. So we essentially reconstructed the organizational structure and built the salary expense from the ground up, by person, because of the noise with NewBridge. So we have a very firm grasp on where we're going to be. And the biggest component here is salary expense.

We have a very, very good grasp on where we are. And I think Vince's number is solid, and it ties right into what we had in our initial modeling. I think there was a lot of noise, as I mentioned on the call last quarter, because of the phase-in and the cost takeouts for NewBridge, as Vince Calabrese mentioned, which is why we are telling you what that number is here.

(Multiple speakers)

We think people were confused, and I think it will help clear things up for them.

The expense run rate for Yadkin in the second quarter was 43.6%. It sounds like the right number, the starting point is around 36%, to get to this $30 million run rate addition in the back half of 2017.

If you analyze their press release, you will be able to figure that out, I think, because they illustrate what the operating run rate is from a net income standpoint. And they also obviously breakout their expenses.

Okay. Switching to credit, apologies if I missed this; I jumped on a little late. But I appreciate the provision guide going forward on the fourth quarter. Can you just talk to what is the outlook for net charge-offs? Because that did tick up a little bit, and non-accruals did go down. So the quarter just seemed a little bit mixed on credit quality. Just a little color on how you guys are feeling about asset quality.

In reference to the charge-offs, Casey, as I mentioned in my remarks, they were slightly elevated due to us exiting that pool of loans. We took advantage of an opportunity to exit a small pool of loans, about $30 million, which we had reserved for naturally. And that reserve was flushed through the charge-off line.

We were able to exit that pool at better-than-reserved-for levels. So it was really a no-brainer to de-risk the balance sheet and to generate positive economic benefit. That number was right at about $3.2 million for that one transaction. So you can see that's what elevated that a little bit.

As far as charge-offs, if you look at our annual averages that I referenced earlier in the call comments, I would expect that performance will continue to show very nicely, as it does, from a year-to-date basis.

Okay. Great. And just last one on capital.

I get a lot of questions about your capital adequacy. I know you have always run very capital efficient. Are you still feeling good about capital? Not just with the TC in the mid-6% level, but also total capital getting close to that 12%, which is a threshold for others. Just some overall thoughts on capital adequacy going forward.

I will tell you we still feel very good about capital. The investment pieces that we reaffirm regularly are still intact. We are going to manage capital efficiently.

Under Basel III, under DEFAS, we just filed our stress test results. And they show the strength of running a lower-risk model with the quality of the underwriting that we have underneath. Our worst ratios in the nine quarter are not only comfortably above minimums, they are above well-capitalized levels.

So that is a key part of why we manage capital the way we do, because of the strength of the risk management. Not just underwriting, but the enterprise-wide risk management infrastructure throughout the Company. So we feel very good about capital, the levels that when we do our model, any M&A actions, the ranges that we use were right within that. And with Yadkin onboard, we are right within those ranges still. We are still very comfortable with it, given the overall strength of the risk management in the Company.

Okay. Great. Thank you.

Thank you.

The next question comes from Collyn Gilbert with KBW.

Thanks. Good morning, guys. Just a quick followup on the capital question.

It sounds like you are comfortable as the profile of the bank stands today. Is there a trigger as you guys look out at the lifecycle and you get Yadkin under the hood? Is there a trigger or a catalyst that you would see yourselves raising some form of capital, either common equity or sub debt?

I would say that we've talked about the ranges in the past, and that's what we manage to. TC, 6.5% to 7%; leverage, 7.5% to 8%; total risk-based capital in that 11.5% to 12.5% range; tier one common, 9% to 9.5%. Those are the operating ranges we've used to manage the Company, and we use it when we model M&A.

If something fell significantly below that, we would raise capital. When we did Parkvale, we raised capital for that. We have not had to raise common equity since then. And as you know, the regulators have approved every transaction we've done. We are comfortable with it; they have been comfortable with it. So those are really the operating ranges, Collyn, that we use when we model M&A.

We are not actively pursuing M&A. We have a transaction in front of us here that we want to integrate and really benefit from the investments we've made. I don't see us changing our stance on capital here.

(Multiple speakers)

To Vince's point, we are all focusing on the Yadkin integration. That plus the organic growth in the rest of the Company are really the key focuses, And Yadkin at closing we would expect, based on their current ratios, their capital ratios are higher than ours. So that we'll get some build from that actually as opposed to detracting. I think that is an important point, too.

And as Gary mentioned in his prepared comments, our goal here is to drive accretion through exits of distressed credits and prepayments in the portfolio, which I think we do a good job of. We assess the risk appropriately upfront to take it off the table. And then we work the portfolio to ensure that we get the appropriate benefit down the road. That helps as well.

Okay. That's helpful.

Gary, I know you've gone through this a couple of times; I just want to make sure I understand. The rationale for exiting some of these credits, I understand that you were able to exit them at values better than what you anticipated. I am trying to reconcile that yet with the increase in the net charge-offs. Because it would suggest maybe that you did have to exit them at levels lower than where you maybe were carrying them. I just want to try to understand that a little bit better.

In terms of the rated portfolios, Collyn, any rated credit is going to carry a higher level of reserve, based on an increased level of risk within that particular transaction. So as you move through various stages of risk in a credit, we build reserves against it in the normal course of business. We were able have a small pool of loans here; again, $30 million. Some of these were originated as a smaller piece of the pool. The majority of them were originated loans that have reserve and marks against them.

When you add that pool together, you've got a credit mark, i.e., against the total. We were able to liquidate that portfolio, take that risk off the table. And we generated cash payments against it that were better than those previously reserved and marked positions. We essentially freed up reserve levels in that transaction.

It was an economic benefit to the Company. We reduced criticized asset levels with it. And as my earlier comment, it is a win-win for us. We also stopped spending money on it to collect it going forward. So it was a very, very simple trade from a decision standpoint to move those assets off of the books.

Just to clarify, Collyn, even on a loan that you have perfectly reserved for, you are still going to see run through charge-offs. Just counting the way it runs through, it is going to come through charge-offs even if it is zero --

(Multiple speakers)

Okay. That makes sense.

And then, Gary, and I know you're at the tail end of this exercise, so this is maybe a moot point, but just to understand how you think about it. Was there anything in particular about these credits that caused you to put them out of the bank? I know you had indicated they were acquired credits. But was it just the overall profitability of them? If it was something you saw from a sector perspective or an individual borrower perspective? Just want to understand what the impetus was on these specific credits.

I will walk you through that, Collyn.

In terms of pools of credits that we have moved off the balance sheet, let's go back to the due diligence done from the Metro transaction. During our due diligence process, whereby we re-underwrite anywhere from 70% to 80%-plus, 85%, 90% in some instances, of the entire commercial credit book, where we do a full re-underwriting. During that process, each of the credits that becomes a rated credit in our analysis, and based on our underwriting, gets thrown into a pool.

Our team goes through that pool. And at the end of the day, they make a recommendation that I sit down with them with and go through each individual credit. At the end of the day, we will look at those credits and put them in an exit pool. That is done at the time of due diligence. Going back to the March timeframe, we acquired Metro in early March, I believe.

We sold $100 million portfolio before the end of the first quarter. So you can see the work that was done during that process. We'll go through that. We'll list them based on individual credit risk and credits that do not fit our profile that we want to move off of the books.

Collyn, what you're weighing on an individual credit-by-credit basis is your ability to recover versus the reserve that you placed on the credit and the economic environment that you are in or the particular industry. So it is all over the board.

But when you're selling these loans, Gary's objective is to take the risk off the table. And he does not feel that it makes economic sense for us to hold and work through them over a long period of time.

One final comment, Collyn, for this piece of the discussion.

During the Metro due diligence process, we identified $160 million worth of loans that we wanted to exit. We were able to exit a few of those just organically. We moved them off the balance sheet without having to liquidate them.

We sold approximately just shy of $150 million. And the important thing to understand here is in terms of that transaction, if you grouped them all up, we were within a few hundred thousand dollars of the original credit mark over that whole group of loans. Reflecting the importance of the due diligence and the understanding of what these assets are worth through that period. We essentially hit that nail right on the head from a credit mark perspective.

That is super color. Thank you very much.

Thank you.

As there are no more questions at the present time, I would like to return the call over to management for any closing comments.

Thank you.

This is Vince Delie again. I appreciate everybody participating in the call. And again, I would like to congratulate our entire team for the effort that they have put forth through the first nine months of this year.

This is a very challenging environment in the industry, and our people step up at every turn. And the culture and the attitude of our organization is very positive. I think it is reflected in the awards that we've won.

And again, I'm looking forward to bringing the Yadkin employees on. And we are very excited about their high spirit as well. So looking forward for good things down the road.

Thank you again for participating and take care.

Thank you. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.