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BB&T Corporation (NYSE:BBT)

Q2 2013 Earnings Call

July 18, 2013 8:00 am ET

Executives

Alan W. Greer - Executive Vice President of Investor Relations and Capital Planning & Investor Relations Manager

Kelly S. King - Chairman, Chief Executive Officer, President, Member of Executive Committee, Member of Risk Committee, Chief Executive Officer of Branch Banking & Trust Company and Chairman of Branch Banking & Trust Company

Daryl N. Bible - Chief Financial Officer and Senior Executive Vice President

Christopher L. Henson - Chief Operating Officer

Clarke R. Starnes - Chief Risk Officer and Senior Executive Vice President

Ricky K. Brown - Senior Executive Vice President and President of Community Banking

Analysts

Paul J. Miller - FBR Capital Markets & Co., Research Division

Erika Penala - BofA Merrill Lynch, Research Division

Matthew D. O'Connor - Deutsche Bank AG, Research Division

Kenneth M. Usdin - Jefferies & Company, Inc., Research Division

Kevin Fitzsimmons - Sandler O'Neill + Partners, L.P., Research Division

Todd L. Hagerman - Sterne Agee & Leach Inc., Research Division

Betsy Graseck - Morgan Stanley, Research Division

Matthew H. Burnell - Wells Fargo Securities, LLC, Research Division

John G. Pancari - Evercore Partners Inc., Research Division

Michael Rose - Raymond James & Associates, Inc., Research Division

Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division

Christopher W. Marinac - FIG Partners, LLC, Research Division

Operator

Greetings, ladies and gentlemen, and welcome to the BB&T Corporation Second Quarter 2013 Earnings Conference Call on July 18, 2013. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Alan Greer with Investor Relations for BB&T Corporation. Thank you. You may begin, sir.

Alan W. Greer

Thank you, and good morning, everyone. Thanks to all of our listeners for joining us today. We have with us today, Kelly King, our Chairman and Chief Executive Officer; and Daryl Bible, our Chief Financial Officer, who will review the results for the second quarter, as well as provide a look ahead. We also have other members of our Executive Management team who are with us today to participate in the Q&A session: Chris Henson, our Chief Operating Officer; Ricky Brown, the President of Community Banking; and Clarke Starnes, our Chief Risk Officer.

We will be referencing a slide presentation during our remarks today. A copy of the presentation, as well as our earnings release and supplemental financial information, are available on the BB&T website.

Before we begin, let me remind you that BB&T does not provide public earnings predictions or forecasts. However, there may be statements made during the course of this call that express management's intent, beliefs or expectations. BB&T's actual results may differ materially from those contemplated by these forward-looking statements. Please refer to the forward-looking statement warnings in our presentation and our SEC filings.

Our presentation also includes certain non-GAAP disclosures. Please refer to Page 2 and the appendix of our presentation for the appropriate reconciliations to GAAP.

And now, I'll turn it over to Kelly.

Kelly S. King

Thank you, Alan, and good morning, everybody, and thanks very much for joining our call.

So I'd say, overall, it was a very solid quarter, especially given the kind of sluggish economy we have. Basically, frankly, everything looks good except expenses. There was some noise there which we'll explain to you. But fundamentally, the high level was driven by some non-run rate issues, and we'll give you some color on that.

We did have record net income of $547 million, which was up $37 million or 7.3% versus second quarter of last year. Diluted EPS was $0.77, up 6.9%. Revenue was $2.5 billion, up 1.3% versus second quarter of '12 and 6.2% annualized versus first quarter of this year. That was driven by record insurance, investment banking and brokerage and trust investment advisory revenues. Fee income ratio increased to a very strong 44.6% versus 42.4%, so we feel really, really good about the continued positive progress in that.

In the Lending area, average loans helped investment increase 3.8% versus first quarter. That was on the high end of our guidance range so we felt good about that. That was including certain areas. Sales Finance was up about 35% versus first quarter. C&I was up strong for the market 4.7%. Other lending subsidiaries grew 16.8%. Obviously, as we've mentioned there's some seasonal positive influence with regard to that. Direct retail lending is coming back, it was up 4.6%. And some of that was offset by lower mortgage and ADC runoff.

In the deposit area, deposits did decrease 1.4%, which is kind of our plan as we continue to manage our margin and reduce certain CD categories. Non-interest-bearing deposits increased a very strong 13.2%, which continues to be a really good robust performance in that area. We continued to improve our deposit mix as we run down the CDs and so, our total costs declined to 32 basis points, consistent with the general guidance we've given you.

Our credit improvement is a really big story for us this quarter. Charge-offs declined to 0.75%, frankly, more than we had expected so we're very pleased about that. The lowest level in 5 years. NPA decreased another $137 million or 9.7%, lowest level in 5 years. Allowance coverage ratio improved to 1.55x NPLs from 1.43x at the first quarter.

In the expense area, we were up materially on our annualized run rate versus the first quarter, but much of this was $27 million of merger and restructuring charges that we took following our community bank reorganization. We did have other expense areas related to higher production-related personnel cost. Our volumes were up so we get some clear correlated increase in cost there. And we had a meaningful amount of expenses related to systems and process-related enhancements. These expenses included $35 million in systems and process-related cost, composed of temporary consulting and similar costs which are not a part of our long-term run rate. We are doing exactly what we have said to you over the last 1.5 years and that is, we are in the process of reconceptualizing and looking at every part of our business. I know it may seem like that isn't consistent with an increase in expenses, but again we want you to understand these are non-run rate expenses.

To give you a perspective on that, in our community bank, Ricky Brown did a really good job of reorganizing our regions, which we believe make us more efficient, and at the same time, more effective. And the numbers on that gives you a good perspective on the kinds of things we're doing. So the onetime charges related to that community bank reorganization was $16 million and the run rate savings on that is $26 million, so a substantial run rate payback versus the onetime charge. So we will continue to report to you from time to time those types of changes as we put them into effect.

As I've said before, I'm not going to announce some big robust plan like is often done but we will continue to report to you what's happening along the way as it's materializing.

If you'll turn to Slide 4, much better loan growth than last quarter which we're very pleased about. C&I was up 4.7%, retail 4.6%. Sales Finance is very strong. Some seasonality there but really, really moving market share there, up 34.9%. Other Lending Subsidiaries were up 16.8%, so if you minus out the negative impact of covered loans, that gets us to the positive 3.8% growth.

In the Other Lending Subsidiary areas, very strong results in our Sheffield small ticket finance area. It was up 41%. AFCO/CAFO which we've called [ph] our insurance premium finance business always has a big seasonal kick here, and it was up 22.7%. We were pleased that end of period loans held for investment were approximately $1.5 billion, higher than the second quarter average and it was our highest production quarter ever. Now remember that a lot of the production is mortgage and we sell most of our mortgage, but still it produces revenue so it's really, really good.

So we expect for the third quarter loans to grow in the 2% to 4% range. It's still frankly difficult to project lending volumes in this kind of market, but what we do have some visibility on that, we expect other demand to remain strong, growing double-digit in the third. Other Lending Subsidiaries will also be double-digit in the third, we believe. Commercial loans and Direct Retails will be kind of similar to what we saw in the second quarter. On the other hand, mortgage will be likely down, and that'll have some impact with regard to our loan growth for next quarter.

If you turn to Slide 5, another great quarter for deposits as we improved our deposit mix and cost. As I've said, DDA was up 13.2%. We allowed CDs to run down. These are non-client relationship-sensitive CDs, they are more price-sensitive CDs, so we're not concerned about that from a long-term franchise point of view. We did grow net new retail accounts in the second quarter, which is always something we look at. Deposit cost, as I indicated, came down to 32, so we're heading towards what we've said, which is pushing slightly below 30 by the end of the year. So we expect to have strong growth in non-interest-bearing deposits in the third quarter, and with probably similar activity with regard to the CD area.

If you look with me on Slide 6, I just want to give you a little update on some of our revenue initiatives. Recall that we said in the beginning of the year that we felt this was going to be a sluggish growth economy, that's proving to be true. We thought that there were going to be upward pressure in certain cost areas, including technological and regulatory, which has proven to be true. And so we decided that we needed to focus very seriously on revenue initiatives, and we've been doing that.

So just a quick update. Continuing to have excellent results in expanding our Corporate Banking national market. I want to be very clear to everybody, we have -- we do have a national Corporate Banking strategy now. So while our Community Banking is basically mid-Atlantic Southeast swinging around the Texas strategy, we're very national in many other categories, certainly, including Corporate Banking. We did add Corporate Banking teams in some of the larger markets in the country, including Dallas, Chicago, Cincinnati, San Francisco. To give you a perspective, common quarter loan growth in the Corporate Banking area is at 31%, so it's working. Continued to invest in the wealth management area and making targeted investments in certain key markets. We opened a Dallas wealth management office. We've added multiple invest -- advisors in Texas, Florida and North Carolina. Added other offices in some of our key states like North Carolina, South Carolina and Virginia. And we did open new broker dealer offices in Maryland and Florida, so nice investment there. Wealth income is up 19% and outstanding loans are up 20% versus common quarter, so that's working well.

Continued to execute on our Crump life insurance opportunities, real pleased with the way the Institutional sales effort is going. For example, Crump added a major account, MetLife, in the second quarter, which is the largest new client in Crump's history, and obviously, that's a major, major account. We're very appreciative of that partnership. But it just gives you an example of the opportunity there, quarterly revenue growth in the Crump life area is up 11% versus common quarter, so that's working.

In the mortgage area, we're continuing to expand our correspondent lending network. Obviously, organic mortgage volumes are under pressure because of refis, net purchases are doing really well. So we're looking for other ways to continue to mitigate that. So year-to-date production was up 14% over last year. We do expect production to fall some this next couple of quarters because of rates, mostly because of refis. Margins will be under some slight pressure there. So by focusing on our correspondent delivery strategy, in particular, our mandatory delivery expansion, that will offset meaningfully some of those negative impacts.

In the retail mortgage lending area, we continue to expand in some of our newer markets like Texas, Florida, Alabama. And so our mortgage area, while under pressure because of rates, is doing relatively very well.

I feel really good about what's going on in Texas, Rick and his team are doing a great job down there. Recall that we said we would execute on 30 new commercial branches this year. We've already opened 25 of those, the other 5 will open very soon. We are seeing nice increase, for example, checking deposits in Texas are up 45%. Loans are up 45% compared to second quarter of last year. Revenue is up 38%. And on a very current perspective, business credit pipeline is up 132% versus January. So obviously, we're starting from a small base, but Texas is a really big opportunity for us. We love Texas and it's got a huge amount of opportunity for us.

We also continued to execute on our revenue opportunities into legacy Colonial markets. Just to give you a perspective, common quarter loan growth in Texas, Alabama and Florida, which is primarily where we picked up Colonial presence, is up 27% and revenues are up 9% compared to common quarter.

We continued to expand our wholesale Sales Finance area. Committed lines are up 61% on a linked-quarter basis to approximately $850 million, Outstandings were up 75%. So you could see that all of these 2013 initiatives are working and will be somewhat uneven as we go forward, but the general trajectory of all those initiatives is very, very positive and offsetting to the downward pressure from a sluggish economy and margin pressure.

So let me turn now to Daryl to give you some more color with regard to a number of these areas. Daryl?

Daryl N. Bible

Yes. Thank you, Kelly, and good morning, everyone. I'm going to talk about credit quality, net interest margin, fee income, noninterest expense, capital and segment reporting.

Continuing on Slide 7. Our improvement in credit metrics really accelerated versus last quarter. These are our best credit numbers in 5 years. Charge-offs declined to 75 basis points during the second quarter. That's down from 98 basis points last quarter. The improvement was driven by a significant drop in commercial inflows. This equates to a 22% drop in loan losses during the quarter. We have reached the top end of our normal charge-off range of 55 to 75 basis points, and we are ahead of our projections from last quarter.

The primary drivers for the improved charge-offs were old vintage loans have mostly run their course, improvement in recoveries and improvement in real estate values. Going forward, we expect modest steady improvement in net charge-offs.

Nonperforming assets declined 10% during the second quarter and are down 33% since last year. Commercial nonperforming loans decreased 14% versus last quarter. We expect modest improvement in both nonperforming loans and nonperforming assets during the third quarter.

Turning to Slide 8. You can see a 28% drop in commercial nonperforming asset inflows that led to the overall credit improvement this quarter. While delinquencies can fluctuate due to seasonality, the 30 to 89 and 90 days past due both improved this quarter. The allowance to nonperforming loans increased from 1.43x to 1.55x, reflecting a continued strong coverage. We had $36 million in reserve release this quarter. Excluding the impact of covered charge-offs and the recovery in the covered provision, this reserve release is similar to most recent periods.

Continuing on Slide 9. Net interest margin came in at 3.70%, down 6 basis points from last quarter and somewhat better than our initial guidance. Core margin fell 3 basis points to 3.40%. The decrease was the result in several factors: the runoff of our covered assets, lower yields on earning assets and tighter credit spreads on retail production. These were offset by a decrease in interest-bearing deposit cost and mix changes. I'd like to point out that the steeper yield curve is positive for us. Obviously, this will reduce pressure on our core margin over time.

Looking at the second quarter, we expect to be down 5 to 10 basis points. We anticipate third quarter core margin to decline modestly due to tighter credit spreads resulting from competition. As you can see in the lower graph, we are asset-sensitive and are positioned for rising rates.

Turning to Slide 10. Our fee income ratio in the second quarter increased to 44.6% compared to 42.9% in the first quarter, and up from 42.4% from second quarter last year. This is one of our highest fee income ratios in recent history. We had record results in insurance, investment banking and brokerage, and trust and investment advisory services.

Insurance produced record revenue up 67% from first quarter, driven by firming market conditions and a $13 million premium refund.

Mortgage Banking produced record originations in the second quarter. Mortgage Banking income declined due to lower gain on sale margins, driven by lower spreads in the retail channel.

Investment banking and brokerage income increased due to strong commission income in BB&T securities and improved Investment Services income.

FDIC loss share was up mostly due to a $29 million swing in the provision for covered loans.

Looking at Slide 11. Total noninterest expense was up $82 million linked-quarter. This was driven by 2 things: first, $27 million in restructuring and merger-related costs; second, there was also $35 million in systems and special project costs. As these expenses subside over the next several quarters, so will total noninterest expense.

Personnel expense increased versus first quarter, due mainly to higher production-related incentives and commissions, partially offset by lower Social Security and unemployment costs.

As you know, we recently announced the restructuring of our Community Bank where we trimmed back from 37 regions to 23. We will also be closing about 40 branches. With this decrease in personnel costs, we expect to see lower expenses for the next couple of quarters.

FTEs were down slightly compared with last quarter. Loan-related expense increased $5 million compared to first quarter due to higher pre-foreclosure expenses and mortgage repurchase expense.

Foreclosure costs continued to decline, down $6 million. Professional services increased $11 million, driven by systems and special project costs. We expect these costs to decline over the next few quarters.

Merger-related and restructuring charges increased $22 million, primarily due to the Community Bank reorganization I mentioned earlier. The good news is we expect to offset that with a similar amount of annual cost savings going forward.

Other expenses increased $24 million due to higher project-related expenses and operating charge-offs. Despite the increase in this expense this quarter, we continue to focus on positive operating leverage which will, overtime, drive the efficiency ratio down.

Finally, the effective tax rate for the quarter was 27.7%. We expect a similar rate for the third quarter.

Turning to Slide 12. Capital levels were up from last quarter with Tier 1 common at 9.4%. Under the final [ph] rules, our estimated Basel III Tier 1 common is about 9%. We successfully issued preferred stock in the second quarter, and we also synced up our preferred stock dividend schedule. This resulted in a subdividend payment in the second quarter. We expect the Board to authorize next week a full preferred dividend payment for next quarter of approximately $37 million.

We completed our CCAR resubmission on June 11. As Kelly mentioned earlier this quarter, we have taken a very conservative approach to our resubmission in terms of capital deployment for the rest of 2013. As a reminder, we increased our dividend 15% in the first quarter. And when we resubmitted, the final capital rules had not been announced, and at that time, the industry expected higher capital requirements.

Now, here are a few highlights from our segments.

Turning to Slide 13. Community Bank net income totaled $209 million showing strong growth versus common quarter and down from a very good first quarter. Average dealer floor plan loans grew $133 million or 116% compared to -- with first quarter.

Turning to Slide 14. Residential Mortgage net income was down $25 million linked-quarter and up modestly compared to second quarter last year. Increased interest rates and changes in channel mix pressured gain on sale margins. They came in at 1.31%, down 34 basis points from last quarter.

We had record loan production of $9.3 billion, up 7% versus last quarter. Purchase mortgages made up 44% of production versus 32% last quarter.

Looking at Dealer Financial Services on Slide 15. You will see net income totaled $59 million. That's up $19 million off a strong first quarter, and down slightly compared to a common quarter. We continue to see strong demand and had record loan production in both recreational and retail auto lending.

On Slide 16, you will see Specialized Lending experienced a solid quarter, with net income of $68 million. Average loans grew 9% versus second quarter last year, with the strongest performance in Sheffield, Commercial Finance and Premium Finance businesses.

Moving on to Slide 17. Insurance Services generated $66 million in net income, up significantly compared to linked-quarter, and flat compared to common quarter. Wholesale revenues increased 11% and retail increased 5%. We continue to focus on business opportunities presented by our acquisition of Crump Insurance through Institutional sales and cross-selling with our Wealth team.

Turning to Slide 18. Financial Services generated $71 million in net income, mostly driven by Corporate and Wealth. These businesses had loan growth of 31% and 20%, respectively.

And with that, let me turn it back over to Kelly for closing remarks and Q&A.

Kelly S. King

Thank you, Daryl. So as you can see, it was a very solid quarter relative to the economy. We think most all parts of the business did really well. Credit was a really big story. Expenses were noisy but the real trends are very positive, so we're very optimistic about our relative performance going forward and we look forward to entertaining your questions. Alan?

Alan W. Greer

Okay. Thank you, Kelly. We will now ask the operator to come back on the line and explain how the Q&A session operates. [Operator Instructions] Thank you.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Paul Miller with FBR.

Paul J. Miller - FBR Capital Markets & Co., Research Division

On the insurance line item which you guys did very -- it was very strong this quarter, is there seasonality in that? How should we model that going forward?

Christopher L. Henson

Yes, Paul, this is Chris Henson. There clearly is going from first to second. In fact, it's our largest seasonality hit of the year. Second quarter is typically our strongest and third quarter is typically our weakest. So we -- I think, we estimated last time, we'd be up in the 15% range. We actually beat that. Third quarter, you could see a drop off to 17%, 18% or so.

Paul J. Miller - FBR Capital Markets & Co., Research Division

And then, real quick on a follow-up. On your allowance for loan losses, you released some revisions which, of course, that's understandable given the improvement in credit. But how far down do you think you can take your allowance for loan losses to total loans or do you hit targeted number?

Clarke R. Starnes

Paul, this is Clarke Starnes. Certainly, we think as we're reaching normalized level of credit cost on the charge-off side and the NPAs are normalizing, we would expect the allowance releases to start subsiding. So while it's not clear exactly what a floor might be, certainly have to look at our models and make sure we feel good about the incurred loss in the portfolio. I would just -- I wouldn't expect continued sustained releases as we move forward, and look more toward flattening out as we reach the normalized levels on the credit cost.

Operator

And we'll go next to Erika Penala with Bank of America Merrill Lynch.

Erika Penala - BofA Merrill Lynch, Research Division

My first question is on the margin. Daryl, you mentioned that a steeper yield curve will be beneficial to BB&T eventually, and I noticed that your agency MBS book, the yields were up 5 basis points quarter-over-quarter. And at 1.97%, it seems to be below some of the reinvestment rates that we've heard from other banks. I guess, as we think through your margin guidance of 5 to 10 basis points, could you give us a sense of how you're thinking about your reinvestment strategy in your bond book within that guidance?

Daryl N. Bible

Yes, Erika. If you look at the securities that we've been purchasing for the last couple of years, if you take that same mix of securities, we're up about 60 basis points. I'd say the average purchases used to be around 1.60%. At same mix of securities, it's around 2.20% now as we do our new investments. So we definitely are benefiting from the higher yield curve. The other thing that you notice is that increase in yields on agencies. A lot of that is driven by, as rates go up, prepayments slow down. As prepayments slow down, the amortization of your premiums also slow, but you kind of boost the yields of those portfolios. So if you have bonded premiums with slower prepayments, you have actually an uptick in some of the yields.

Erika Penala - BofA Merrill Lynch, Research Division

Okay, got it. And my follow-up question is on the expense line. I appreciate the color on total expenses, but if we think about -- I think, I heard you mention $62 million in non-run rate expenses in this quarter which gets to me about $1.4 billion in core expenses. How quickly can that $62 million run off over the next few quarters? And what should we expect for the core run rate?

Kelly S. King

Erika, this is Kelly. I think the non-run rate expenses will be over the next 2, 3 quarters. Some of that is in new systems that we are initiating. For example, we're putting up a new GL system. We're in the very early stages of putting up a new commercial loan front-end system. So as you know, you incur a lot of upfront expenses with regard to that, and so I expect that will begin to subside over the next few quarters. We'll continue to do the reconceptualization focuses that will be mitigating other increases in expenses that are more permanent in nature, like we are seeing some permanent increases in expenses in technology -- technological and regulatory area. So we're going to continue to push toward focusing on the efficiency [ph] ratio, which I think is the best way to kind of think about it. Obviously, there's upward pressure on it now. We still think, over the long term, we can end up in the low 50s in the next year or 2, probably hovering in the mid-50s is going to probably be where it's at. So it's a challenge for us all long term right now, but the encouraging thing to me is these reconceptualization approaches are really working.

Operator

We'll go next to Matt O'Connor with Deutsche Bank.

Matthew D. O'Connor - Deutsche Bank AG, Research Division

Just looking out beyond the third quarter on the net interest margin, any thoughts on where it goes from there? And maybe I missed it, but the purchase accounting accretion schedule, any meaningful changes to that as we think out next year and beyond?

Daryl N. Bible

Yes, Matt. So I think, as you forecast out from the covered assets, if you recall, our commercial covered asset portfolio, for the most part, will be pretty much off the books by third quarter of '14. So it won't all be gone by then because you still have the mortgage portfolio that lasts for several years after that. But I think we're pretty much tracking to what we projected. I'd say your interest income is falling around $10 million, give or take every quarter, as that kind of progresses over the next several quarters. Your fee income line, which is the offset is also falling at about the same amount. This quarter, we did have a pickup in reversal on the provision. That's really just a onetimer, when that happens, we really don't forecast that. But overall, margins, the core margin and the GAAP margin should be close to in sync as we get towards the end of '14.

Matthew D. O'Connor - Deutsche Bank AG, Research Division

And I guess just on the absolute level, down 5 to 10 basis points going from 2Q to third quarter, and then just the NIM beyond that just trending down, or when does it stabilize?

Daryl N. Bible

Core margin should stabilize. I mean this steep of a yield curve, if you really look at it, a little over half of the loans and assets on the books are fixed rate. So as we're repricing not just securities but as well, repricing auto loans, home equity loans, some of our fixed commercial real estate loans, they are repricing off the higher part of the curve now. That takes time as that new volume comes in onto the balance sheet. But over the next couple of quarters, core margin should start to stabilize. So I'd say in the 3.30s is kind of where I'd put core margin. And then it's really just the covered portfolio running off.

Operator

We'll go next to Ken Usdin with Jefferies.

Kenneth M. Usdin - Jefferies & Company, Inc., Research Division

Kelly, just on the expense side again, just trying to look further out as well. This year, you had talked about having GAAP expenses down a few percent. That looks a little bit harder given the step up we saw this quarter, even though a lot of the costs are, of course, related to these initiatives. But I just wonder if you could take us a step a level higher and say, "Are you still committed to having total expenses down this year?" And then any thoughts you might have about how that progression leads to next year, just on a total expense base would be helpful.

Kelly S. King

Yes. So I think as the rest of the year goes through, we'll end up down. Because you've got these mitigating factors but you have other factors that are coming down. Remember, our credit expenses are continuing to come down. And we're starting to get some of the run rate savings of what we just already just put into effect because that happens fairly immediately. So I think that projection still holds for the total of this year. As we head into next year, I really think it -- a lot of it depends on what happens to the economy and to volumes. I mean, obviously, we have a certain level of fixed overhead expenses. And to the extent that we can get some faster loan growth and revenue growth, that will help push down relative expenses as we lever up the fixed expenses. So I'm fairly optimistic about expense control as we head into next year. It's a little early to make any kind of projections, but I can tell you that our intents will be in terms of focus, will be the same next year as it is this year. This reconceptualization focuses will continue throughout the year. And so, while again, there are certain expenses in the technological and the regulatory area that are very difficult to control, there are many areas of the bank that still have a lever opportunity in terms of expense focus and we're absolutely focusing on all of those.

Kenneth M. Usdin - Jefferies & Company, Inc., Research Division

Okay, got it. And my second question, Daryl, could you just update us on the purchase accounting deltas that you expect for the next couple of years? You've been giving us that update as far as the '13 to '14 and then the '14 to '15. If you have those handy on the revenue side, and then the FDIC expectations?

Daryl N. Bible

Yes. So for the rest of the year, I would say on the margin side, expect about a $10 million drop -- $10 million per quarter drop of interest income. And as you get into '14, that would probably continue to maybe a $15 million to $20 million drop on a per quarter basis. On the fee income, on the FDIC offset, similar amounts for '14, about $10 million per quarter. And then, that basically continues down about $10 million per quarter in '14. So by the end of '14, the net benefit of the purchase will be only a couple of pennies, maybe about $20 million benefit from where it is today.

Operator

We'll go next to Kevin Fitzsimmons with Sandler O'Neill.

Kevin Fitzsimmons - Sandler O'Neill + Partners, L.P., Research Division

Guys, just on the preferred dividend, is there -- I understand that the full quarterly amounts going to be $37 million going forward, but is there going to -- have to be any kind of true up next quarter on top of that for this low pace of preferred dividend this quarter?

Daryl N. Bible

No, Kevin, really, what we did is we were really syncing up preferred dividend payments to equal what we have in the common. We will sync up the common basically so that it will fit within the CCAR process. So we declare our dividend in the first month of the quarter and pay them the third month of the quarter. All we really did is we move the preferred dividend. We had a short stub payment for the second quarter, which is all we really had to declare in the second quarter. You don't accrue a preferred, you only accrue it after you declare it. So what we declare this next week will be for the next full quarter, but rather than the preferred shareholders getting paid a month or 2 later in the quarter, now they're going to get paid earlier in the quarter, so it's really just a timing difference.

Kevin Fitzsimmons - Sandler O'Neill + Partners, L.P., Research Division

Understood. Quick question for Kelly. I know on capital distribution, you guys made the point of taking a conservative approach over the balance of the year, and I know there has been a lot of talk in media about the regulators' attitude toward large bank M&A. Kelly, can you just give us what your latest outlook on that? Do you feel, as a lot of people suggest, that large bank M&A is basically shut down in terms of the attitude for upfront regulators, or do you think that is a viable option for you all in 2014 if you get opportunities?

Kelly S. King

Yes, I think it's a viable option in 2014. I think today, large bank and the medium-sized bank acquisitions basically shut down for 2 reasons. One is, I suspect the regulators, if they were really honest, would probably say they just assume not to see any acquisitions right now just because they want everybody kind of focused on settling down with all the new rules and regulations. They haven't said that, but I suspect that's kind of how they feel. But I think more importantly, from the acquirer's point of view, I don't think many acquirers are interested in doing acquisitions today, because there's so many uncertainties that need to be settled. We just found out last week kind of what the preliminary indications are on capital. We're still trying to settle out the focus on liquidity. How some of these new rules and regulations going to work out, what were the risks in terms of embedded issues in the acquired company that might trip you up in terms of regulatory concerns in this very tight focused market. So I think the acquirers are very conservative today, including ourselves, in terms of being willing to do a deal. And so I think whether you look at the regulatory side or the acquirer side, it's probably the same answer. As you head into '14, I think a lot of that smoothes out. I think enough would have settled down so that regulators will feel more comfortable. They're never going to be like really, really easy in this environment, but I think they'll be more comfortable. And I certainly expect that we would be in a position to consider acquisitions as we head into '14, obviously, it depends on the economics of it. That's always going to drive it from our point of view, but I wouldn't be surprised if you don't begin to see acquisitions as we head through '14.

Operator

We'll go next to Todd Hagerman with Sterne Agee.

Todd L. Hagerman - Sterne Agee & Leach Inc., Research Division

Just a couple of questions just in terms of mortgage. Kelly, again, the mortgage did pretty well this quarter, relatively speaking. But I'm just wondering, can you talk a little bit more about the production mix? It was very good in the quarter in terms of the balance on the purchase side versus the refi side, and kind of the drivers there and how you think about that going forward?

Kelly S. King

So the refi volume will continue to moderate, obviously. It does ebb and flow. Every time the tenure pops up and down, we get some volume immediate impact, but it will be steadily down. But you're right, the purchase percentage is very, very satisfying now. The overall roadside market frankly is good and improving. Purchase activity is robust in most of our markets. We continue to move market share in terms of our markets, frankly, because our mortgage business is extremely high quality. We just haven't had any service quality issues. For example, J.D. Power has just announced, for the third year in a row, we got number 1 in overall service quality, while others are having challenges in that area. We've been fortunate not to have those challenges. And then frankly, our correspondent business is really good, and we continue to supplement our organic business with our correspondent business, which is very high quality. And so we think that the kind of relationship you see this quarter will kind of continue as we go forward over the next couple of quarters.

Todd L. Hagerman - Sterne Agee & Leach Inc., Research Division

That's terrific. And then just in terms of a follow-up, how -- what do you see -- with the change in terms of the channel originations, where -- as you mentioned, the correspondent, what are you seeing now -- well, I should step back a moment, gain on sale, you're seeing some pressure obviously, definitely, a factor of the origination channels. But I'm just curious, as you mentioned referred to the retail buildout, kind of where you're seeing directionally that momentum as you kind of build out both the correspondent retail, kind of how you see the deltas and the proportional gains?

Daryl N. Bible

Yes, Todd. From a spread perspective, the retail channel spreads dropped a little bit this past quarter as rates rose. We expect the retail channel to continue to drop into this next quarter. The actual correspondent spreads actually again did really well this past quarter. If you look at our total production, we had about 35% retail, 65% correspondent was the mix. I'd expect the spreads for our business to decline a little bit from the 1.31% that we had this quarter, but not significantly, just mainly what we have, a little bit pressure on the retail channel side. But as Kelly said, these businesses are performing really well, the strong markets, a lot of volume. We focused on really purchase activity several years ago. 44% of our volume was purchase activity. That is a really huge percentage and we'll probably be north of 50% this quarter.

Operator

We'll go next to Betsy Graseck with Morgan Stanley.

Betsy Graseck - Morgan Stanley, Research Division

Couple of questions. One, on getting back to the M&A question, and it's wrapped up in the reality that BB&T is the largest bank now that is able to not have to account for AOCI in your regulatory capital, and you've got a little bit of flexibility there with that. So I'm just wondering how you think about balancing the potential opportunity for acquisition versus the fact that you're in a competitively strong position given your size, and what that has allowed to do from a regulatory perspective? I mean, when you sketch out, you've got about 9 years of organic growth before you hit that $250 billion. So Kelly just want to understand how you're thinking about using that to your advantage competitively, versus the potential for an acquisition that will get you to that threshold.

Kelly S. King

Yes, that's a good one, Betsy. So we're obviously already thinking about that. It would put practically more pressure on the metrics of the acquisition because we are in a sweet spot and that is a competitive advantage, and we're not going to throw that away by doing a relatively unprofitable acquisition that would trip us into a less competitive advantage. So that's not to say we wouldn't look at one, but yes, we could do a couple of 10s or 15s and still have runway. But if we looked at anything that was really substantial, we would factor in that consideration and we just have to look at the Math of it. But the good news is, either way, it's a good deal for us.

Betsy Graseck - Morgan Stanley, Research Division

Sure. Okay, that's helpful. And then, Daryl, just a quickie. In the PowerPoint, you indicated that the $22 million of restructuring charges should provide a similar annual cost savings beginning in 4Q '13. I'm just wanting to understand, are you suggesting that, therefore, as we get to the end of '14, that full $22 million should be -- come out of expenses?

Daryl N. Bible

Yes, Betsy. I think what we're saying there, and Kelly started off with the Community Bank in trying to show what that impact is, we'll probably be down in personnel costs, not the incentive fees but the personnel costs, at least $20 million in the next quarter or 2. Most of the reductions enforced occur mid in the third quarter, so we'll get a partial benefit third quarter and a full benefit in the fourth quarter. But that's where the personnel cost line will come down there.

Betsy Graseck - Morgan Stanley, Research Division

Okay. So you're going to get that annualized impact sooner, then a 12-month period, that's going to be within the first quarter or 2?

Kelly S. King

Yes, Betsy. We'll get the annualized impact of that not later then the end of this year, probably, maybe by the end of the third quarter.

Operator

We'll take our next question from Matt Burnell with Wells Fargo Securities.

Matthew H. Burnell - Wells Fargo Securities, LLC, Research Division

Just wanted to get a little more detail on your deposit reduction. Daryl, you all spoke about a meaningful decline -- continuing meaningful declines in CDs. But we also -- but I also noticed declines in interest-bearing checking. Is that basically the same concept or are you actually starting to see some depositors, on their own, pull out deposits for their own investments? Is there any of that going on in your footprint?

Daryl N. Bible

I think what I would say, we've had runoff in our CD portfolio for the last couple of years at this low rate environment. It's just hard to get the consumers to buy CDs when rates are just so low. I think as rates start to climb, you're going to see that behavior start to switch back, but it's too early for that to happen. So we definitely will continue to see a lower cost in CDs for the next several quarters. That's where the bulk of that benefit is. As far as the now and savings deposit categories, there really isn't a whole lot left there to reprice down for the most part. You do see seasonal flows in those activities this past quarter. Some of that was lumpy in some public deposits, but the core still is really strong. If you look at our DDA, I mean DDA still continues to grow. I mean our mix now of deposits is up to 26% DDA. That's a huge movement for us if you look over the last 3 years. We've had tremendous growth in DDA and that's really a reflection of how well we're executing on both our retail and commercial strategy and wealth strategy that we have out there.

Matthew H. Burnell - Wells Fargo Securities, LLC, Research Division

Okay. And Clarke, I'm not going to let you get away totally scot-free this morning. Just a quick question on foreclosed property expense, that's obviously come down dramatically over the past year. Can you remind us where we should be thinking about a normalized level of foreclosed property expense might be?

Clarke R. Starnes

Fair question, Matt. I think it's pretty close to where it is. But you should know that, included in that expense, we've always focused heavily on the real estate component of that, and as our problem real estate credits have come down, that's where the big swing has been. But we also included our auto repossession expenses in there, and so I think you're petty much at a normalized level where we are today.

Operator

We'll go next to Bryan Forne [ph] with Autonomous.

Unknown Analyst

The -- Kelly, I guess on -- you did an interview this morning and made some comments about where you thought lending standards were and kind of halfway back to where they were last cycle. And I guess, I just want to maybe deep dig on that, and is it still kind of the leverage lending market which you've been talking about for a while that's most concerning you? Or are there more markets, more pieces of the lending market where you think underwriting standards have gotten over their skis a little bit?

Kelly S. King

Well, obviously levered lending is the most pronounced and then, large whole positions is kind of second to that. But in terms of just basic underwriting, it's kind of across the board, disappointingly. I mean you're seeing substantial term extensions relative to credit restructuring. You're beginning to get back to the "covenant-light" structuring deals, not as bad, again, as I've said about halfway back, and hopefully, we won't go all the way back. But we are seeing a lot of deals that are being unwritten -- underwritten out there in a fashion that we would absolutely not do it. And so I think what's happening is that people are just really, really eager for revenue, which is understandable. And as I indicated in the interview, memories tend to be short, and so I worry that the industry is beginning to underwrite some credit so it will be problematic as we're going forward, so discipline is important. And we believe it's more important to have good profitable long term loan growth than short term loan growth might turn into very unprofitable growth down the road. And so no, we're not trying to be critical of anybody else, but I'm just trying to honestly give an observation about what's going on in the industry.

Unknown Analyst

That's helpful. And then if I could follow up on capital. I know you don't get to resubmit the resubmissions, so to say, but if you had known you were at a 9% Basel III ratio, you've made some comments about the buyback expectations being low in the back half of the year because you didn't know that yet but you also made some comments about M&A potentially accelerating in 2014. So I guess if we put them together, ultimately, what I'm asking is how should we think about the scope for buybacks if you had known you were at a 9% Basel III ratio, and ultimately, into 2014 and beyond?

Kelly S. King

Well, it's a good question, and obviously, you only know what you know. And so when we did do our submission, we didn't -- what we did know was the probability of capital problems are going up. And all of the rhetoric that's been out as -- the expectation at that time was it could go up really substantially. And we didn't know what the final conditions of Basel would be. In the earlier versions of that, we would have been substantially penalized 100 basis points almost, based on what the original projections were. So yes, now we know all of that and now we are in a much stronger position than we were that -- but that's why I've been saying consistently for the last several months, you should expect us to be very conservative with regard to capital flow for us this year because of what we did know at the time we made a submission. Now as we look forward to '14, we're in a strong capital position. We'll be accreting substantial capital. M&A, frankly, the kind of deals we would do would probably not be requiring capital. It would probably -- it could be capital accretive because of some of the institutions that we've been acquiring. So as we go forward, I fully expect that we will have good flexibility in terms of capital deployment. I still like to think in terms of the priorities I've talked about in terms of organic dividends and acquisitions and buybacks. But to the degree that we continue to get downward pressure from the regulators with regard to percentage of payouts, which continue to exist, and to the extent that acquisition opportunities that require capital are not out there, that certainly increases our appetite with regard to buyback.

Operator

We'll go next to John Pancari with Evercore Partners.

John G. Pancari - Evercore Partners Inc., Research Division

Back on the expense side, on comp expense, how much of the comp expense increase this quarter was production related?

Daryl N. Bible

I would say probably at least 3/4 of the increase was probably on production related incentives, mainly in mortgage insurance, capital markets areas is where it came from.

Kelly S. King

Yes, because our FTEs went down, remember?

Daryl N. Bible

They were down 88, yes.

John G. Pancari - Evercore Partners Inc., Research Division

Okay. All right, good. And then separately, on loan demand, can you just give us a little more color there on where you're seeing good demand right now, what types of areas? And a little bit more color around your pipeline and trending commitments?

Ricky K. Brown

Yes, this is Ricky Brown. We're seeing good activity in real estate right now, particularly multi-family. Some office activity, our focused areas have been good there. We've put a lot of emphasis on that, got our specialized force, sales force, that is helping us in that area. That's good. Clearly, the auto space with the wholesale has been a really nice improving area for us, partnering with our folks in the field, in the banking network, Community Bank, as well working with our folks in the Sales Finance area, got some great professionals helping us do that business very, very well. Saw some nice improvement in ABL linked-quarter, which is good. We also saw some nice small commercial increase linked-quarter, which is a very nice trend for us, we feel good about that. And then good production in DRL in the quarter and small business that's done in the branches, so it was a really kind of across-the-board improved level of production from Q2 versus Q1. And we hope that, that will ultimately show continued good loan growth as people use those loans that we're making to them. So pretty broad-based actually across-the-board. C&I, as you saw, was pretty good. It was pretty good in the Community Bank as well, up positively, close to 2% or so.

John G. Pancari - Evercore Partners Inc., Research Division

And then lastly on the C&I side there, the line utilization for overall C&I, do you have that?

Clarke R. Starnes

John, this is Clarke. It's actually still flat for us, it's around 37%. So again, a big future opportunity for us as our commitments have clearly grown, but our utilization is still pretty flat.

Operator

We'll go next to Michael Rose with Raymond James.

Michael Rose - Raymond James & Associates, Inc., Research Division

This question is for Kelly. Just outside of M&A, you guys have done or made a lot of investments in other areas of the franchise. Where do you see the greatest opportunities for additional expansion or products?

Kelly S. King

So Michael, right now, I think there are probably 3 that I would think about. I really think continuing to deploy capital and this organic commercial growth strategy in Texas, and frankly, if that goes as well as I think it's going to go, in other markets like that in other parts of the country. It's a very efficient way to expand our franchise. So I think expanding the Community Bank in the targeted approach. The Corporate Banking space is going to continue to get a substantial amount of our investment. The margin of returns for us are fantastic, and our execution ability is really, really good. And then in terms of marginal investments, we're going to continue to throw it at Wealth management. That machine is working really well for us now. Chris Hanson and his team have done a great job developing that. We've got virtually all of the infrastructure cost in place and the marginal returns on investment are very high, so those would be the 2, the 3 in terms of organic. Other than any unique bank acquisition that might come along, we'll continue to look at insurance acquisitions over time but to be honest right now, we've kind of got our plate full on insurance acquisitions and not to say we wouldn't do one -- because I wouldn't want anybody listening to think we wouldn't but we've got some really good opportunity to continue to execute on the Crump advantages. And so expect to see most of our attention focused on those organic areas.

Michael Rose - Raymond James & Associates, Inc., Research Division

Okay. And just as a follow-up. As you've expanded those business lines geographically as well, could we, at some point down the road, whether it's 5 or 10 years, see you kind of follow with more of a traditional branch network to maybe fund some of that growth over time?

Kelly S. King

Yes. So a natural long-term organic path would be -- in Texas, for example, you expand with this commercial strategy. You build around that your wealth strategy because it's very closely tied to your promotional strategy. You build your insurance around that and commercial P&C because that's tied to that. When you get to pure bread-and-butter retail, that's a long, long ground game. And so in 5 to 10 years, I'd expect to say probably not doing much in terms of retail, we'll continue to focus on the organic commercial strategy. Over 30 years, yes, but I would rather expect the most likely scenario is we'll build out that retail network in places like Texas with appropriate retail acquisitions. There are many good partners down there, folks we know very well that we're very close to, and we think that time will come for a good partnership somewhere along.

Operator

We'll go next to Gerard Cassidy with RBC.

Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division

Can you share with us what your view is on now that you have your Tier 1 common ratio at 9%, you're required to be at 7%. What -- where are you going to be comfortable running at when we get to a more normalized state in banking, let's say, sometime next year?

Kelly S. King

Gerard, that's a question that we're all kind of struggling with right now. Fortunately, now, we don't have to have a cushion for OCI variation. So that takes a -- some off the table. You do want to always have some dry powder in case of really good cash acquisitions. And then you want to have some comfort around that 7% because, recall, if you go below that 7%, that's not a good day. That triggers the dividend issues and some compensation issues so you want to have a nice cushion around that. And so, then you've got the question of a domestic SIFI charge that may come, we don't know. I still bet this will be a small one, but it might be just 25 basis. So we're not really ready to hang a number out there, Gerard. But it's something south of 9% based on what you know today, but it's not 7.5%, so I mean it's a number that we're going to have to fill our way through, does a SIFI charge come, that changes it. And then we will probably keep some buffer in there frankly because even though we're not a advanced approach bank today, we're not that far away from it and so we're not going to be too aggressive in terms of trying to push that number to closest to the 7%. Plus to be honest with you, Gerard, as you know, we're just really conservative on capital. I'd like to rather make you all happy with relatively more capital, with much harder work and much better execution than trying to jack up returns based on skimming down capital.

Gerard S. Cassidy - RBC Capital Markets, LLC, Research Division

Okay. And then as a follow-up, you guys showed some very strong growth in certain loan areas, such as net average deal of floorplan loan in the Community Bank. Is there anything you can share with us, other than the numbers down the road, of course, but share with us to ensure that proper controls and procedures are in place so that very rapid loan growth doesn't lead to some credit issues in a couple of years?

Christopher L. Henson

Yes. Gerard, as I said, we've got a great partnership with our dealer services area in the bank. We hired some great professionals that really know the business to help us to ensure that we're underwriting these credits appropriately. We're also working to beef up our standards in terms of servicing to ensure that we get out CD singles every month, inspect our inventories, a lot of work there. We're going to be very aggressive at monitoring and executing if things get out of trust, and so we feel very good that we are handling this business well. Remember that with the great indirect business that we have, we had so many dealers that knew us very well, that wanted to do this business with us and we were doing their capital so just a natural extension so it gave us a great growth area. But I feel very good in our partnership with Clarke. He's going to allow us to handle this credit and do it in a way that the risk is managed very well. Clarke, you want to comment to that?

Clarke R. Starnes

Yes. I might just add, Gerard, remind you all that we've been in this business for many years. We just chose to stay out of it for a while because the capitas had beaten the returns down so low, so it's not a new business for us, but it is a new targeted initiative because the returns are better. But the risk management oversight is in place, we have specialists on the sourcing side. We have specialists on the enterprise risk side behind that, so we feel very comfortable with the a good measured plan.

Operator

We'll go next to Christopher Marinac with FIG Partners.

Christopher W. Marinac - FIG Partners, LLC, Research Division

Kelly and Daryl, I'm just curious if you look out beyond the near-term and perhaps a Fed change in policy late next year or even 2015. Do you have a sense of how much of that you can retain, and also I guess it's partially a question of how much deposits and funding cost can lag into that scenario?

Kelly S. King

How much retained in terms of capital?

Christopher W. Marinac - FIG Partners, LLC, Research Division

Really, in terms of margin, just kind of margin and a funding cost question.

Daryl N. Bible

Yes. So we have about 45% of our balance sheet that's a variable rate. So the slide that we show on our deck shows that we are slightly asset-sensitive. When the short end starts to move, we will definitely benefit even more stronger than what we are just with the steeper yield curve and it'll be a more immediate impact on us. So the wildcard is how quickly do you have to reprice your deposits and how sticky are your deposits. It really comes down to being competitive with the competition and other places in the marketplace. We believe that we've had really good strong core growth, good new clients come into the bank and believe that the deposits will stay with us. That said, some of the dollars will leave the company and go to other alternatives, so we are conscious of that. We've put strategies in place to do other liquidity and funding so that when that does, or to happen, it won't have a material impact on our margins and all of that. So we feel pretty good that if you look at our sensitivity, up 200 basis points. We're almost at 4% increase in net interest income over our 12-month time period. So we think we are positioned the right way. We really haven't changed that position for the last couple of years, and eventually, rates will rise both on the short end and as well as the long end, continues to steepen.

Operator

And that's all the time we have for questions today. At this time, I'll turn the call back over to the speakers for any additional or closing remarks.

Alan W. Greer

Thank you for joining us today. We do have a couple of folks still in the queue, so I apologize for that but we've gone a couple of minutes over. So thank you. If you have further questions, please don't hesitate to call Investor Relations. Thank you, and have a good day.

Operator

That does conclude today's conference. We appreciate your participation. You may now disconnect.

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