WesBanco Inc (WSBCP) 2017 Q4 法說會逐字稿

Good morning, and welcome to the WesBanco Fourth Quarter 2017 Earnings Conference Call. (Operator Instructions) Please note, this event is being recorded.

I would now like to turn the conference over to John Iannone, Vice President, Investor Relations. Please go ahead.

Thank you, Cary. Good morning, and welcome to WesBanco, Inc.'s Fourth Quarter and Full Year 2017 Earnings Conference Call. Our fourth quarter 2017 earnings release, which contains consolidated financial highlights and reconciliations of non-GAAP financial measures, was issued yesterday afternoon and is available on our website, www.wesbanco.com.

Leading the call today are Todd Clossin, President and Chief Executive Officer; and Bob Young, Executive Vice President and Chief Financial Officer.

Following opening remarks, we will begin a question-and-answer session. An archive of this call will be available on our website for 1 year.

Forward-looking statements in this report relating to WesBanco's plans, strategies, objectives, expectations, intentions and adequacy of resources are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The information contained in this report should be read in conjunction with WesBanco's Form 10-K for the year ended December 31, 2016, and Forms 10-Q for the quarters ended March 31, June 30 and September 30, 2017, as well as documents subsequently filed by WesBanco with the Securities and Exchange Commission, which are available on the SEC and WesBanco websites.

Investors are cautioned that forward-looking statements, which are not historical fact, involve risks and uncertainties, including those detailed in WesBanco's most recent annual report on Form 10-K filed with the SEC under Risk Factors in Part 1, Item 1A. Such statements are subject to important factors that could cause actual results to differ materially from those contemplated by such statements. WesBanco does not assume any duty to update forward-looking statements. Todd?

Thank you, John. Good morning, everyone. On today's call, we'll be reviewing our results for the fourth quarter of 2017. Key takeaways from the call today are: 2017 was another successful year for WesBanco as we executed upon our long-term operation and growth plans; we have demonstrated continued strength in credit quality, profitability measures and expense management; and we remain focused on long-term success of our company and our shareholders. As I mentioned, we had another successful year in 2017 as we reported record earnings surpassing $107 million for the year after adjusting for the deferred tax asset revaluation and merger cost or $2.45 per fully diluted share. These record earnings generated solid profitability ratios for 2017 with return on average assets of 1.09% and return on average tangible equity of 13.90%.

For the 3 months ended December 31, we earned fully diluted earnings per share of $0.66 on net income of $29 million, when excluding the impacts of the revaluation of deferred tax assets and merger cost, which was an increase of 11.6% from the fourth quarter of 2016. And we generated strong fourth quarter profitability ratios with return on average assets of 1.16% and return on average tangible equity of 14.36% when excluding the same items.

As our various metrics demonstrate, we remain committed to maintaining a strong financial institution for our shareholders and continue to be well positioned for the future. In addition to our strong profitability ratios, our consolidated and bank level regulatory capital ratios are well above the applicable well-capitalized standards promulgated by bank regulators and the Basel III capital standards. We continue to demonstrate strength across our credit quality measures as well as adhere to our strong legacy of credit and risk management.

As I mentioned, we reported record annual earnings as we surpass $107 million. Consistent with our stated strategy, we announced the merger agreement with First Sentry Bancshares, which allows us to cross the $10 billion asset threshold during the first half of 2018. We have maintained strong market positions across our legacy and major metropolitan markets and have continued to benefit from our core funding advantage from shale energy-related deposits in our legacy markets.

Our wealth management business is on the cusp for crossing $4 billion in assets under management for the first time. We continue to be nationally recognized for our performance, strength and community focus, including for the eighth year since the list Inception in 2010, we were named one of America's best banks by a leading financial magazine, recently making the list at #17. We were named to Money Magazine's 2017-2018 list of the Best Bank in Every State, as we were one of the few institutions recognized in multiple states, receiving the designations for the States of Kentucky and West Virginia. We earned our sixth consecutive outstanding Community Reinvestment Act rating from the FDIC, and we remain committed to returning value to our shareholders as demonstrated by increasing our dividend by 86% since 2010, including the 8.3% annualized dividend increase announced earlier last year 2017. And we increased our tangible book value per share by 52% since 2010 to $18.42. We're executing well upon our well-defined, long-term operational and growth plans that we've implemented over the last few years.

Our long-term growth remains focused on 5 key strategies. Growing our loan portfolio with an emphasis on C&I and home equity lending, while maintaining our high credit standards, increasing fee income as a percentage of total net revenues over time, providing high-quality retail banking services and generating positive operating leverage and franchise enhancing expansion. We've been successful in our balance sheet remix strategy as we encouraged loan growth while reducing lower-yielding securities, which meshed perfectly with our $10 billion asset threshold plans. The combination of these strategies provided sufficient time for us to prepare and position WesBanco for crossing the threshold, while finding appropriate franchise enhancing opportunities, such as First Sentry Bancshares. While providing the opportunity to make a high-quality commercial bank part of our organization, First Sentry will solidify our position in the Huntington, Charleston, West Virginia corridor, as it bridges our existing market gap between Charleston, West Virginia and Southeast Ohio. The merger continues to progress well, and we remain on schedule. And we continue to see opportunities for our wealth management capabilities in this market. Over the next few years, we will continue to target additional franchise-enhancing acquisitions within a 6-hour drive of our Wheeling headquarters.

Total year-over-year loan growth for the quarter continue to reflect the impact of our stated strategies related to our residential mortgage and consumer loan portfolios. We see good residential mortgage loan origination volumes, which is bolstered by the continued traction of our expanded team in Kentucky and Southern Indiana. Moreover, our strategy to sell more of these originations on the secondary market is providing a nice lift to fee income. Our consumer portfolio, which now represents approximately 5% of total loans, reflects our decision to reduce the risk profile through targeted reductions as it declined 14% year-over-year.

Our strategic focus on growing our commercial lending and home equity loan portfolios continues to be positive and more than offset the targeted reductions I just mentioned. In fact, our year-over-year total loan growth and commercial loan growth are relatively consistent with national trends. While we continue to see higher multifamily commercial real estate pay downs during the fourth quarter, we realized mid-single-digit growth over the last 12 months and our focus categories as both total commercial loans and home equity loans grew 4.4%. It's important to view our loan growth over a rolling 4-quarter period as opposed to simply annualizing sequential quarter performance in order to mitigate the impact from quarterly fluctuations in the construction portfolio due to repayments. While recent national loan trends have shown a slight pickup in year-over-year lending activity as compared to the declining trends last quarter, the trends remained muted as customers reviewed the recently enacted tax law reform and contemplated the impact of potential fed rate increases during 2018. We believe, in theory, that once this new information is digested, the pace of lending should begin to pick up throughout 2018 as customers make their decisions regarding capital investments. We are not seeing any credit deterioration in our markets, and we continue to have no concentration issues or concerns across our portfolios.

Furthermore, we remain optimistic on the opportunities as we continue to diversify and strengthen the quality of our overall loan portfolio. We have balanced loan and deposit distribution across our diverse regional footprint, which is supported by positive demographic trends. We've maintained strong market positions across our legacy and major metropolitan markets with substantial market share in West Virginia and the Columbus, Louisville and Pittsburgh MSAs, with a continued benefit from our core funding advantage related to shale energy-related deposits in our legacy markets. We have an average loan-to-deposit ratio around 90%, providing ample support for loan growth.

As we invest to become a larger organization, we remain focused on enhancing shareholder value and returns. We carefully manage expenses in order to improve operating efficiencies and produce positive operating leverage.

During 2017, we delivered on the expected cost savings from the YCB acquisition as well as diligently managed overall discretionary expenses. The solid expense management was demonstrated by fourth quarter noninterest expenses, excluding merger-related costs, decreasing both sequentially and year-over-year, helping to drive the improvement in the efficiency ratio to 55.08%. We will continue to control discretionary expenses as we make revenue-producing hires in our markets.

Finally, we remain focused on the long-term success of our diversified business model. WesBanco remains well positioned for success in any type of operating environment as we have the right teams and products in place across our franchise, our legacy of strong credit quality and risk management and the demonstrated ability to manage discretionary expenses. We are strengthening our loan portfolio and see opportunities for expanded wealth management revenues.

I would now like to turn the call over to Bob Young, our Chief Financial Officer, for an update on our fourth quarter's financial results. Bob?

Thanks, Todd, and good morning. We generated mid-single-digit loan growth in our strategic-focused categories and continue to exhibit strong expense control as we lowered discretionary cost, both quarter-over-quarter as well as year-over-year. For the 12 months ending December 31, 2017, we reported net income of $94.5 million and earnings per diluted share of $2.14, reflecting a $12.8 million net deferred tax asset revaluation, as a result of recently enacted federal tax reform legislation and $0.6 million in merger-related expenses. Excluding these expenses, net income would have increased 13.3% to $107.9 million from $95.3 million, with earnings per diluted share increasing 3.4% to $2.45. In addition, the year-to-date return on average assets was 1.09% and return on average tangible equity was 13.90%, when excluding the items mentioned.

For the 3 months ending December 31, 2017, we reported net income of $15.9 million and earnings per diluted share of $0.36 as compared to $24.2 million and $0.55, respectively, in the prior year period. When excluding net deferred tax asset revaluation and merger-related expenses, net income would have increased 11.6% to $29.0 million and earnings per diluted share would have increased 11.9% to $0.66.

For the fourth quarter, excluding the items mentioned, return on average assets and return on average tangible equity were 1.16% and 14.36%, respectively.

Unless otherwise stated, my remaining earnings-related comments will focus on the fourth quarter's results and exclude the impact of the net deferred tax asset revaluation in the current period and restructuring and merger-related expenses in both periods. As a reminder, financial results for the former Your Community Bankshares have been included in WesBanco's financial results since the merger date of September 9, 2016.

Let's turn to the balance sheet. Total assets as of December 31, 2017, remained at $9.8 billion year-over-year, with total portfolio loans increasing 1.5% to $6.3 billion. Year-over-year, total loan growth continues to reflect our efforts to prudently manage our loan portfolios to encourage growth without sacrificing credit standards as we realized growth in our strategic-focused categories of C&I and home equity lending and continue to executing upon our targeted strategies in our retail portfolios.

Mid-single-digit loan growth of 4% from both total commercial loans and home equity loans more than offset the targeted reductions in the consumer portfolio as we reduced its risk profile and increased secondary market loan sales as a percentage of residential mortgage loans originated, causing a reduction in the amount of 1 to 4 family mortgage loans held in our balance sheet.

Regarding residential real estate, year-to-date mortgage originations increased 2% year-over-year, while the percentage sold in the secondary market increased to approximately 54% during 2017 as compared to 42% during 2016.

Lastly, the current size of the securities portfolio remains at 23.6% of total assets, similar to the 23.8% at year-end 2016. And the portfolio provides us the near-term flexibility to continue to manage the size of our balance sheet, provide liquidity and support loan growth.

Total deposits were $7.0 billion at December 31, 2017, as growth in all other deposit categories offset the continued targeted reductions in certificates of deposit. When excluding CDs, total deposits increased 4% as total demand deposits now represent 49.3% of total deposits as compared to 47.4% a year ago.

Now turning to the income statement, net interest income and the margin. Net interest income for the fourth quarter increased 2.1% year-over-year to $73.2 million due to a similar percentage increase in average loan balances, which reflects the targeted lending strategies I mentioned previously.

The net interest margin, which has remained at relatively consistent throughout 2017, continues to reflect the benefit from the increases in the Federal Reserve Board's targeted federal funds rate over the past year and the higher margin on the acquired YCB net assets, but it was partially offset by higher funding costs as well as a flattening of the yield curve. The increase in the cost of interest-bearing liabilities is primarily due to higher rates for interest-bearing demand deposits, which includes public funds and certain Federal Home Loan Bank and other borrowers.

As I mentioned last quarter, acquisition-related accretion of 12 basis points during the third quarter reflected an approximate $1.1 million benefit from the payoff of an acquired YCB loan with a specific loan mark assigned. And that we anticipated acquisition-related accretion to return to a level more consistent with prior quarter's performance.

During the fourth quarter, accretion from prior acquisitions benefited the net interest margin by approximately 6 basis points as compared to 8 basis points during the first and second quarters of 2017 and 10 basis points in the year-ago quarter. We currently anticipate acquisition-related accretion to be between 4 to 6 basis points per quarter during 2018.

Lastly, with acquisition-related accretion consistent in both years, our net interest margin during 2017 increased 12 basis points year-over-year as yields on earning assets improved 20 basis points, more than offsetting an 11 basis point increase on interest-bearing liabilities. We believe that our core deposit funding advantage, combined with the continued increase in noninterest-bearing deposits to 26% of total deposits, is helping to contain our overall interest-bearing deposit funding costs, which were up only 6 basis points year-over-year for 2017 despite three 25 basis point federal funds rate increases. That said, we do expect deposit betas to increase during 2018 as rates continue to increase, as we are currently modeling two 25 basis point increases in the fed funds rate for the year.

Let's turn to fee revenue now. For the quarter ended December 31, 2017, noninterest income increased 7.1% from the prior year to $22.9 million, primarily driven by higher mortgage banking income and higher electronic banking fees.

As I mentioned, our strategy to sell a higher percentage of residential mortgage originations in the secondary market resulted in a $1.1 million increase in mortgage banking income to $1.5 million and higher electronic banking fees reflect a larger average customer base.

In addition, during the 12 months of 2017, we have seen the benefits of our strategies of increasing the secondary market sales of our residential mortgage portfolio, increasing customer fee income and expanding our wealth management business organically as all of these fee income items grew nicely year-over-year.

Turning to operating expenses. We remain focused on discretionary costs and delivering positive operating leverage as we make the appropriate investments for long-term growth. During the fourth quarter of 2017, total operating expenses continue to be well controlled as most categories decreased, both year-over-year and sequentially, as the post-YCB cost savings were achieved and through strong discretionary expense control.

As of December 31, 2017, we reported 3- and 12-month efficiency ratios of 55.08% and 56.44%, respectively. Noninterest expense during the fourth quarter of 2017 decreased $1.4 million or 2.5% versus the third quarter and $1.2 million or 2.2% compared to the prior year period. The decrease from the prior year quarter was primarily due to lower other operating expenses, resulting from cost control across supplies, travel and entertainment and telecommunications, as well as low income housing amortization expense moving to tax expense during 2017.

Our focus on discretionary expenses as well as lower medical benefit and pension costs more than offset the $1.6 million year-over-year increase in salaries and wages that resulted from higher-average staff levels in the Kentucky and Indiana markets, the impact of the annual merit adjustments to compensation and higher-incentive accruals.

Now turning to the income tax provision. On December 22, 2017, the Tax Cuts and Jobs Act was signed in the law, which among other things, permanently lowers the corporate tax rate to 21% from the existing maximum rate of 35% effective January 1, 2018. As a result of this tax rate reduction, companies were required to revalue their deferred tax assets and liabilities as of the date of enactment. Consistent with our December 29 announcement of an estimated impact of $12 million to $15 million, the resulting tax effect of the revaluation increased our fourth quarter income taxes by $12.8 million, causing the effective income tax rate to be 59.14%. Excluding the impact of the revaluation, our effective tax rate for the fourth quarter and full year 2017 would have been 26.29% and 27.67%, respectively, as compared to 25.90% and 26.28% for the fourth quarter and full year 2016.

Some thoughts now on asset quality and capital. Overall, our credit quality continues to be strong and is reflective of our legacy of credit and risk management. As of December 31, 2017, both nonperforming assets as a percentage of total assets of 0.50% and nonperforming loans as a percentage of total portfolio loans of 0.68% remained consistent with recent trends.

Net charge-offs as a percentage of average portfolio loans on an annualized basis were 13 basis points for 2017 compared to 12 basis points in 2016. The allowance for loan losses of $45.3 million represented 0.71% of total portfolio loans at December 31, 2017, compared to 0.70% in the year-ago period. It was important to mention that our credit quality measures have been at or near historic lows over the last several periods and as such, certain changes from quarter-to-quarter might stand out in comparison to one another, but given the historic lows, they do not represent a material change in the direction of our overall credit quality.

Lastly, our fourth quarter capital ratios, while slightly negatively impact by the deferred tax revaluation, were strong, showing improvement, both sequentially and year-over-year. If adjusted for this onetime charge, all ratios would have been 14 to 19 basis points higher than the reported figures.

Before opening the call for your questions, I would like to provide some current thoughts on our outlook for 2018. It is important to remember that the yield curve experienced over the past few months has continued to flatten with a 2- to 10-year treasury spread roughly around 55 basis points at year-end as compared to 80 basis points at September 30 and 125 basis points at year-end 2016. Lower spreads generally result in lower margins for the industry. And despite our general asset sensitivity, we are not immune from such factors. We do not anticipate much overall change in our margin during 2018, considering the lower purchase accounting accretion and higher anticipated deposit betas as rates increase. However, we do expect 6 to 8 basis points of decrease during the first quarter related to the lower tax equivalency of the state and local municipal tax-exempt income securities portfolio.

As Todd mentioned, we anticipate the merger with First Sentry Bancshares to close during the first half of 2018 and expect cost savings of approximately 38% with about 75% phased in during the last half of 2018 and the remainder obtained during 2019. We will continue to execute on our stated growth strategies, strengthen our loan portfolio via our strategic-focused categories and organically grow wealth management. We will continue to focus on expense trends to ensure positive operating leverage while positioning the company for long-term growth. We are planning our typical merit increases to occur as usual during late second quarter and early third quarter during 2018 and expect marketing expense to be consistent with the overall level during 2017, but spread more evenly throughout the year 2018.

At this time, we anticipate our effective full year tax rate post tax reform to be between 18% and 20%, subject to changes in certain taxable income strategies that may be implemented in future periods. This tax change will have a positive impact on our budgeted earnings and key operating metrics, such as return on average assets, return on average equity and return on tangible common equity during 2018. And as I mentioned earlier, a slightly negative impact on the net interest margin. However, we currently anticipate that, over time, some portion of this tax benefit may result in lower-than-normal loan yields and higher deposit costs as such benefits are competed away by our industry.

We are now ready to take your questions. Operator, would you please review the instructions?

(Operator Instructions) The first question will come from Catherine Mealor of KBW.

I want to start with just the balance sheet, first. First on the securities portfolio. You all have continued to manage the securities portfolio down as a low percentage of average earning assets. You said you managed under $10 billion. So can you talk a little bit about now that we're going to be crossing $10 billion next year, what your strategy is for that remix? And then also, how the lower tax rate may play into that strategy as well?

Yes, I'll let Bob talk about the tax aspect of it, but the thought is that the portfolio as a percentage of the balance sheet would stay relatively consistent with where it is today as we cross $10 billion and just continue as the bank grows to continue to represent around 23%-or-so of it. So the plan wouldn't be to continue to shrink it to make room for loan growth, the thought would be loan growth and securities portfolio would both lift us, now that we're going to be past $10 billion.

And Catherine, on the tax-exempt side, I had a caveat in my discussion about the range that we expect for the effective tax rate in 2018. And it's really -- that wide range is really -- we're taking into account that we could have some tax strategies relative to low-income housing tax credits, relative to the portion of the portfolio associated with tax-exempt income, relative to bank-owned life insurance. Some of these things will play out over time, but indeed, they're worth less as pretax income strategy than in the old days of 35% statutory tax rates. So our guidance right now, if you will, not knowing how those issues might develop over the next few months is that the muni bond portfolio, which is 38% of that total $2.3 million, might gradually come down as a percentage of the total portfolio and thus impact both the margin calculation as well as the tax -- or the effective tax rate for the year. But I don't expect any big moves early on. And in fact, most of our municipal bonds are in the held-to-maturity portion of the portfolio.

Okay. That's helpful. And then also, thinking about loan growth, you touched this a little bit in your remarks, Todd. But how can we think about how much loan growth could improve going into this year, now that you are not managing under $10 billion? Is that -- is it really just -- is it more of a function of the status of the balance sheet from how you manage the securities or do you also see some upside in your loan growth next year?

I'm glad -- yes, I'm glad you asked the question. Yes, we never sent the message to our lenders to slow down at all. So the plan was always to grow the balance sheet the loan side and shrink the securities portfolio to stay under $10 billion. But there was never a plan in place to slow that down with commercial lenders. Now some of the things we did do over the last couple of years from more of a risk management perspective was start to reduce the portfolio on a multifamily side as well as the hotel side a couple of years ago. And on the indirect auto, we raised credit qualities' underwriting couple of years ago and raised rates. So we had some strategies in place that obviously, the consumer portfolio now being 5% of the total portfolio, that was very strategic to try to reduce that down. But with the commercial group, we continue to let them run strong. When we look at 2018, I think an important thing, and I mentioned a little bit in my comments, was the quarter-to-quarter fluctuation in the commercial real estate portfolio due to loans going to the secondary market, which is part of that business. We would expect that to happen. We typically average a little bit below $50 million a quarter in those type of loans going to the secondary market. And in the fourth quarter, that number was close to $120 million. So it was a $70 million delta, just in the fourth quarter by just a couple of loans that happened to go to the secondary market. So production in the fourth quarter was actually our second-highest production quarter of the year. So it's not a production issue, it was all really around just the timing of the payoffs. And our first quarter or 2 of this year looks to be more normalized, back to more traditional amounts going into the secondary market. But 1 quarter can have a big fluctuation, $70 million in a quarter. If the fourth quarter had been a more traditional quarter for us, that would have added a full percentage point of loan growth in the fourth quarter. So pretty much business as usual going forward here. We still want to continue to focus and emphasize the home equity product, which we think, in our portfolio and our markets, its tax effects of that with the customer is not going to be that big of an impact. We still feel good about that business. C&I business is going to continue to be a focus for us as well too in that area. And we'll continue to look at the consumer portfolio in the indirect portfolio. Just -- you are in the ninth year of an economic recovery here, and it's the second-longest economic recovery since 1857. So I don't think it's a time to be piling into a lot of indirect auto business right now or other type of consumer businesses. But those are important businesses to us. And we're going to continue to be in those businesses. But we're not trying to grow those businesses 8% to 10% like some are. We're not doing that on the consumer side, and we're not doing that on a multifamily side either. So that's impacting loan growth a little bit, but that's very much by design.

The next question will come from Austin Nicholas of Stephens.

Maybe just on the shale-related deposit flows. I know just looking at natural gas prices year-to-date, we've seen a pretty big move up in the 30% to 40% range. Have you seen that, I guess, move up in prices, reflected in any higher, call it share-related royalty payments? And I guess, ultimately, on the -- the deposits coming in, have they picked up or is there a lag there? Just any color there would be helpful.

It has. It's picked up. We're back into the 8-figure amount every month. Now we were there 2 years ago. We dropped down into the mid-70s and low 7-figure range for a few different quarters. But now we are back up into the 8-figure again. So it's nice to see that back. And we are seeing a little more activity in the marketplace as well too related to that with regard to oil and gas activities.

Understood. And then maybe just on that, is there any, I guess, economic development or large projects that are anticipated to come online. I know that there was maybe a secondary ethane cracker that was maybe going to be built around WesBanco or around Wheeling, I should say. Is there any kind of, I guess, tangible evidence that there is kind of increased activity given the rise of prices?

Yes, I would tell you that if you remember back with the cracker plant, the shale cracker plant up in the Beaver County area, it's where ESB, our acquisition from 3 years ago, was headquartered. And that cracker plant is obviously well underway, and we're starting to see some benefits from that. There is another cracker plant planned just a little bit south to where we're sitting right now in Wheeling, just a few miles down the road. That's not been approved yet. But a lot of positive indications around that. Things continue to move forward positively with that. If that occurs, then that would have a significant impact -- significant enhancement, I think, to the local economy as well. And there's some other ancillary things. China has agreed to put $87 billion into the state. And that's going to help. Don't know exactly where that's going to go yet. But liquid natural gas storage facilities, things like that will be probably in parts of our footprint. So there are a lot of positive signs on the energy front to support the growth. But again, we're not -- as we talked before, we're not landing into that industry directly. We're not taking big exposures in commodity type of products.

Great. And maybe just last one with tax rates lower and more accretion to capital, can you maybe just give us some update on how that augments your capital planning? And then within that, what's the outlook for M&A, once your most recent transaction is integrated?

I'll try to tackle the first part and make sure to answer your question in the right way with regard to the capital. Yes, obviously, it has an impact on our return on equity that we look at by loan actually, our larger loan relationships that come into loan committees. We have a return on equity calculation that's going to be impacted a little bit, obviously, by some of the tax changes. So that talk about part of the benefit of tax is being competed away. If you start to see some of that, it will probably happen in some of those areas from a return perspective. But from M&A, we continue to state our stated strategy. And I think the impact of some of the tax changes really doesn't have an impact on that from our perspective. It might on the perspective of potential sellers. But our approach is still to stay within that 6-hour range and try to find opportunities that will get us a little farther north of $10 billion that are accretive with appropriate earn back. And we don't think that tax changes are going to have a material impact on our strategies going forward with regard to M&A.

The comment I would make on the tangible common equity. You talked about the impact on capital ratios. And I had mentioned during my scripted remarks that there was a 14 to 19 basis point change in the year-end capital ratios from the DTA charge moving those down. But we will earn that back -- capital back very quickly. And in fact, the lower income tax expense in 2018 will earn back that onetime charge in less than a year. But the impact just on tangible common equity in 2018 as the tax change itself is 14 to 16 basis points positive. So that's why I say, you're going to earn that back pretty quickly. And it will obviously, as Todd hinted at, have a positive impact on our other operating ratios as well.

The next question will come from Steve Moss of B. Riley FBR.

Just with regard to the margin outlook and the relatively stable outlook, Bob, I'm wondering what you are assuming for deposit betas here?

Yes, we haven't -- Steve, we haven't in the past disclosed our deposit betas. We've made comments around some of the larger banks and what they disclosed. And we hinted at numbers that are higher in our modeling than what we are experiencing. But we haven't said it's 20%, 30%, any particular number. Obviously, with 6 basis points of increase -- 6 or 7 basis points of increase over the past 12 months in interest-bearing deposit costs, dividing that by 75 basis points of increase, if you ignore the most recent one at the end of December, middle of December, that's right around 10%. And I think it's fair for you all to dial-in a higher percentage, that's what we're basically suggesting going forward. And as you pile on increases time after time after time, there is some sort of catch-up that occurs, such that, as a percentage of each 25 basis point increase, you can expect that to be higher. But up until now what we have included in our modeling relative to deposit betas, has not been realized from a customer perspective other than, as I said, the interest-bearing demand deposit category, which is heavily influenced by public funds. Our public funds are over $800 million. So there's a significant amount of that in that category.

That's helpful. And then for this quarter here, it looked like a pretty good quarter for mortgage banking again. Wondering if you can give us some of the details underlying production and gain on sale margin?

Yes, it's a real bright spot for us in terms of what that business has turned into over the last couple of years. Part of it you can see, obviously, through the fee income from the sales in the secondary. But this business looks a lot different for us than it did just a couple of years ago. We brought new leadership into that area. We really advanced the business along pretty significantly. We're doing some hedging now and generating some revenue off of the hedging, which we didn't before. We get other investments around disclosure desks, things like that, that we're looking at as well. So not only is the business performing well for us and we're attracting talent to the business, but it's running much more efficiently and it's much more scalable now than it was before. And it's a pretty buttoned-up business for us. And as a result, the turn times have come down significantly in terms of the ability to turn around a loan and that helps us in the marketplace to be competitive and get additional business and attract additional lenders. The last thing I probably mentioned on that is the KSI market, Kentucky, Southern Indiana, which is the former Your Community Bank franchise, we're seeing some really nice growth there in terms of talent and business in the Louisville-Lexington, Elizabethtown, all those areas, New Albany, Indiana. And that was something we didn't have, obviously, a couple of years ago. So we think this business is pretty well positioned for the future, and we're expecting a lot out of it.

That's helpful. And in terms of just -- in terms of hiring more talent, should we expect a significant increase in 2018? And kind of what your thoughts on production?

Yes, I think it's always -- we'll take the talent where that's available. And mortgage loan originators are one of those areas where there's really no budget or limitation to how many you bring on. You find good ones and you're going to bring them on because there is a low cost associated with them and the variable cost associated with them bringing business in and getting paid. So given the commission-type structure of that business, the doors are open to hire additional mortgage loan originators. And we're actively talking in a lot of different markets with those individuals. And obviously, with First Sentry, as that would come on during the first half of this year, they have a few mortgage loan originators down there. But we think that would be another additive opportunity for us as well as to make that a bigger business in that marketplace. So in some of the markets we're in now like Pittsburgh, Columbus, Cincinnati, those are really good robust markets, where we had mortgage loan operations and mortgage loan originators for a number of years. We're expanding that base in those markets. But now we're adding the new markets in as well too to the recent acquisitions and that should only help. But I would expect us to have more mortgage loan originators a year from now than we have today. It's hard to put a number on it because a lot of it is dependent upon available talent. But I think our incentive plans are competitive, and it also is a business that kind of weeds itself out as well too. So you want to be bringing in producers, but people that don't produce wouldn't have a home in the organization. So you got that plus and minus, but on a net basis, it ought to be increasing.

(Operator Instructions) The next question will come from Russell Gunther of D.A. Davidson.

Bob, just wanted to follow up on your margin commentary. The -- I think you're communicating an expectation for a nice tight range for the year. But should we think about that after the 6 to 8 basis point negative impact in the first quarter or is that something that could be recouped throughout the...

It's the former part of your comment, not the latter. So if one were to take a look at our fourth quarter margin of 3.43%, you'd back that down 6 to 7 basis points just on January 1 because you're using 21% instead of 35%, the tax-exempt portfolio. And I think the reason we mentioned that is because it's probably a little bit higher impact for our bank than for some others because of the large percentage of our investment portfolio that is in tax-exempt securities, as I said earlier, munis are 38% of the portfolio. We still find value there. And I'm not suggesting that, that strategy is going to materially change over time. But it does have that kind of an impact when it's as material as it is, more than 1/3 of the portfolio. So it's -- if you thought it was in the similar range to the low 3.40s, then you would back that down by that 6 to 7, 6 to 8 basis points that we mentioned just on day 1. And no, I don't expect to earn that back over the course of the next year.

Okay. Appreciate the color there, Bob. I just have a couple kind of ticky-tacky items left. Most of my other questions were asked and answered. But on the other income line, it was a good quarter, I think that includes the insurance services. Just give a little bit color on what the driver was this quarter and what you would expect going forward?

Yes, and if you look at the last 5 quarters, as we give you in our earnings release and the statistics, you can see that bouncing around. The primary reason why that bounces around is because of the swap fees. So in any particular quarter, you can have a more material number in swap fees than in other quarters. So third quarter, we didn't have a lot of those. In the fourth quarter, we had a significant increase, and in fact, most of the increase between the third and the fourth quarter is related to swap fees. In the past, there were some joint venture income that we don't have anymore, those have been dissolved. I think we talked about those in prior periods. And then there's deferred comp and depending upon how that's mark-to-market, that could influence that line item. But the offset to that is in salaries. So hopefully, that's a little bit of color. You're right, the insurance services is in there. We do have some good expectations for that in 2018, particularly in the title business.

Okay. Very helpful. And then just switching gears to the expense side, you guys talked a little bit about this earlier, the employee benefits line trended down nicely throughout the year, similar result in other expenses. I know you talked about managing both, but is there an ability for these to continue to drift lower? Or are we going to be running to kind of keep them flattish going forward?

Yes, I'd say, our focus is, obviously, on positive operating leverage, right? So we're going to continue to make investments in the company. I think with -- particularly with regard to some of the tax relief that's coming as well, make some -- a few investments, nothing significant, but some investments in technology, more from a customer service standpoint, product enhancements, those types of things that we'll be looking to do. But as you can talk from the numbers, we got the expenses dialed down really, really well. And we spent a lot of time on that. We'll review expense reports, T&E reports, nobody gets on an airplane without my approval. I mean, we -- for a company our size to do the things that we do on expenses, but it's important, and it's always been part of the DNA of our company. And as we grow, we don't want to lose that. So I think expenses will always be an important part of it. But as we grow as an organization, obviously, we're going to have a bigger expense base associated with that. Looking though for where do we get the best return, where are we getting $2 of return for every $1 of expense that we put out there, which is kind of the criteria that we have. An example would be the marketing expense, which you saw in the first half of last year was pretty high. Second half of last year, little bit lower, kind of averaged out. We're going to be this year, we're not looking to raise that number much, but we're going to spread it out more evenly, and we're looking for a bigger return from the marketing dollars that we spent. If I get that return, then in future years, we'll spend more on marketing. If I don't get that return, then we're going to be more limited in marketing. So a lot of it has to do with the return that we're going to get on the investments we make. Last comment I would make on that is, there are not a lot of significant investments left that we need to do to cross $10 billion in size. That is, I think, story is pretty well behind us. And I think as we've messaged the last couple of years, we wouldn't expect to have a bad quarter or a bad year in expenses, resulting from trying to get ready to cross $10 billion. We were going to blend that into our business and our run rate and take other expenses out, while we added those on. And we've added a couple of million dollars' worth of expenses to our run rate based upon getting ready to cross $10 billion over the last few years, but it didn't show up materially in the numbers because we took other expenses out. And that will continue to be the focus, just try to keep the efficiency ratio strong. But discretionary expenses, we want to keep down. But we have to make investments in the business in order for us to be competitive on a long-term basis and attract the customer base and retain the customer base we wanted to be successful. So those investments will continue.

I think his comments are probably more important than mine and mine tend to be focused around line items. And in the fourth quarter, we did experience higher incentives as we trued those up for our performance for the year. And so on the salary line item, you see a little bit higher number there, I believe, a couple of you commented on that last evening. The offset to that was, as Todd and you mentioned, Russell, the employee benefit line. So the employee benefits did have a couple of items associated with it that were onetime in the fourth quarter, truing-up accruals for our self-funded health insurance plans and that will be back to kind of a normalized level that you saw in some of the other quarters, here in the first quarter of 2018. Although I do expend -- I do expect continuing savings on the pension plan in 2018 due to very good performance in 2017. Marketing, I think we talked about that, that it would be spread more evenly throughout the year, but relatively the same in terms of the total year spend, assuming we're getting an adequate return on our spend. And then some of those other categories that we implemented cost saving strategies on -- in the third and the fourth quarter, most of those should continue here into the New Year. We did have a couple of onetime things that benefited us in the fourth quarter, some vendor incentive payments, lower ROE costs, for instance, and I already mentioned the lower health care. So given that in the first quarter, payroll costs increase as some of those payroll taxes kick back in and some of the other expense lines related to weather, for instance, in the first quarter are typically higher, we would suggest to you that the numbers in the first half of the year would be before First Sentry, at least, would be slightly higher, would be a little bit higher than the fourth quarter run rate, more like the third quarter.

The next question will come from Daniel Cardenas of Raymond James.

Just one quick question here. Given a pretty well-behaved credit quality environment, I think, manageable credit metrics at your company, how are you thinking about credit expenses in 2018 and beyond?

A lot of that has to do with how the economy is going to perform, right? So you'd hope with the recent tax reform changes or tax reduction changes that you just got another couple of years before the next recession hits. So we would expect similar trends to what we've had in the last year or so. I mentioned in my comments that we don't have any material concerns about concentrations or any geographic areas. So we would expect this year to be similar to previous years at this point.

And this concludes our question-and-answer session. I would now like to turn the conference back over to Todd Clossin for any closing remarks.

Thank you. We are successfully executing upon our well-defined strategies as hopefully we displayed through our discussion today. Our long-term operational growth plans are in place and we really remain focused on long-term success of our company and our organization. We think we're well positioned for success in any type of environment. We work hard to try to make sure that we stay that way. We're excited about the opportunities for the upcoming year, and we look forward to providing additional value to our customers and our shareholders. And just want to thank you all for joining us today and continuing to follow our story. Have a good day.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines. Have a great day.