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First Niagara Financial Group Inc. (NASDAQ:FNFG)

Q4 2013 Results Earnings Call

January 24, 2014 8:00 AM ET

Executives

Ram Shankar - Senior Vice President, IR

Gary Crosby - President and CEO

Greg Norwood - Chief Financial Officer

Analysts

David Darst - Guggenheim Securities

Damon DelMonte - Keefe Bruyette & Woods Inc.

Bob Ramsey - FBR Capital Markets

Casey Haire - Jefferies

Erika Najarian - Bank of America Merrill Lynch

John Pancari - Evercore Partners

Tom Alonso - Macquarie Capital

Josh Levin - Citi Research

Operator

Welcome and thank you for standing by. At this time, all participants are in a listen-only mode. After the presentation, we will conduct the question-and-answer session. (Operator Instructions)

This call is being recorded. If you have any objections, you may disconnect at this point. Now, I will turn the meeting over to your host, Mr. Ram Shankar. Sir, you may begin.

Ram Shankar

Thank you, Hershey, and good morning, everyone. Thanks for joining us this morning. With me today are Gary Crosby, President and CEO; and Greg Norwood, our Chief Financial Officer.

Before we begin, this presentation contains forward-looking information for First Niagara Financial Group. Such information constitutes forward-looking statements which involve significant risks and uncertainties.

Actual results may materially differ from the results discussed on these forward-looking statements. A copy of the earnings release and an earnings review deck are available under the Investor Relations section at firstniagara.com.

With that, let me turn the call over to Gary.

Gary Crosby

Good morning, everyone. Let me start by saying, how very excited I am for the opportunity to lead First Niagara and my 6,000 associates through the next phase of our evolution.

While this is an earnings call, it’s also my first opportunity to share with you my thoughts on First Niagara, our positioning and how we plan to accelerate our commitments to drive shareholder value over the long-term. In other words my view of where we are and where we need to be.

As Interim CEO, I was more than just the caretaker of the organization. Over those nine months, I had the opportunity to view the franchise through a very different lens than I had at any other time over my most five-year tenure here.

2013 was a year of good performance for us given the challenges the industry faced. But there is so much more we can and must accomplish to extract value over the longer term for our shareholders.

This means that we will be doing things differently from 2013 where we balanced near-term earnings performance with selective investments. Going forward, we will accelerate our investments in the franchise to increase our value proposition over the long-term. There is a renewed sense of urgency within the organization have better position us for the long-term.

During the investment period we will remain focused on new customer acquisitions, continued loan and revenue growth, and sustainable operating leverage. And at the end of it, you should expect us to deliver ROAs that are significantly higher than what the franchise can deliver today.

Before I get into that any further, let me do a quick review of what we accomplished in ’13. I’m proud of what we did this past year. In short, we did what we said we would do. We achieved our quarterly EPS targets throughout 2013. We squeezed out unproductive costs and achieved our fourth quarter expense target of $225 million, excluding some relatively small one-time expenses that Greg will discuss later.

We reduced our cost to serve through branch consolidations and restructurings and lowered overall headcount, while delivering strong loan growth across all our markets. We will rollout remote deposit capture for our retail customers and we will implement a new commercial loan origination system this quarter.

With that, let me give you my overarching thoughts about what will drive us going forward. My focus, our focus, will remain on organic customer growth and retention, being bigger is not a priority, there is no next M&A deal.

We need to accelerate our evolution from our thrift roots to a more robust commercial banking model. While we have been doing that, we need to accelerate the pace of change and also change the way we deliver technology solutions to better position us for the future.

While the acceleration of this evolution will weigh our near-term profitability, the Board’s priority is to deliver value to our shareholders over the long-term, and the accountability to deliver long-term value rests on me and my leadership team.

Here is where I think we are today. Bottom line, First Niagara is solid at its core, but we have been underperforming, and as a result, under delivering for our shareholders. While many of our peers have returned supported reserve releases that we don’t have, even excluding this, our returns are not where we want them to be, where they can be.

I like the footprint we have built, a very solid combination of strong commercial loan growth opportunities in Pennsylvania and New England balanced with strong deposit platforms in Western New York and Western Pennsylvania.

In combination of footprint, it works really well together, as the economy improves, the combined footprint will deliver growth opportunities that exceed national averages. I’d say this because the household income over the next five years in our combined markets is expected to increase 18%, outperforming the 13% national average.

We have top five deposit market share, and approximately 60% of our MSAs and an economic footprint that grows faster than the national averages with exposure to fast growing industries such as healthcare and manufacturing.

Over the last two years, we have increased the complement of talented people from large commercial banks to help complete our evolution into our commercial bank. Specifically, we expanded our commercial lending leadership and relationship manager complement by hiring top tier talent, while reducing our overall headcount.

As a result, we have acquired new customers and their unfunded lines of commitment. When the economy improves, and these customers increase their CapEx spend, which could begin this year, we will benefit from increased line utilizations and accelerated loan growth.

We have solid momentum in the consumer finance areas, with the new leadership that we have assimilated over the last two to three years. We’ve become a strong player in the mortgage market with room to grow our market share, even though there are some headwinds today in this business.

Since our entry into indirect auto lending in early 2012, we have generated $1.5 billion in new business volumes at attractive risk adjusted returns. Our credit card portfolio, albeit small is an attractive asset class for fee income generation as well as an important product to get more of our customers’ banking relationship.

Our securities portfolio, while outsized, relative to peers continues to be a solid source of risk adjusted returns. We will continue to manage it prudently from a risk perspective and use it to fund our investments in the franchise in the near-term, and fund loan growth when demand accelerates.

That means we will pause our balance sheet rotation strategy that we executed in ’13 and maintain the investment book that we have today. And clearly, there is a lot of chatter about CLOs under the Volcker rule, let me just say that we have been very active and shown real leadership here, and Greg will expand on that later.

We are unwavering on our credit and underwriting discipline, and this approach will always serve us well. We will not pursue loan growth for the sake of growth by compromising on credit.

On the other hand, customer acquisition and retention will play a larger role in how we price our products and services, so we will continue to be price competitive for the right long-term customer.

The objective for us will be to build upon our customer base so as the environment improves and our own ability to get more of the customer relationship improves, we will be able to drive even higher returns. Despite the improvement in our overall economic sentiment from even 90 days ago, the competitive landscape remains intense, particularly for good credits.

Moving to capital, I’m very comfortable with our position and our current dividend. As we have noted before, we are in capital accumulation mode, and we will be for the foreseeable future, but there is no need to raise capital today.

We fully expect to meet the regulatory thresholds under the DFAS Stress Test, as well as Basel III requirements. We have been working hard on this and the process has received positive feedback from our primary regulator.

Our relationship with regulators remains productive and constructive. It’s a relationship that is based on transparency, self identification of issues, and no surprises. We do not foresee any issues or mandates. However, generally speaking as we all know, regulators are raising the barren areas such as information security, compliance, and data collection, and we’ll continue to invest in these areas as is necessary.

So, as I said earlier, we have a solid core, but where we are today is just not good enough. We have some inherent gaps being in the middle of our thrift commercial bank evolution. There are opportunities that we can and need to address in the near-term in order to be better over the longer term. Translating the opportunities we have into better long-term performance will be my focus.

Our net interest margin is good when compared to peers, notwithstanding the outside securities portfolio we have. While these securities generate attractive returns today and outside book is not part of our long-term strategy, we would rather have assets that involve customer relationships.

A by-product of our thrift roots is that our fee income is not what it should be for top 25 banks. While we’ve enhanced our products and services by introducing new capabilities like customer derivatives, loan syndications, and equipment financing, and have been successful across selling these services to our middle market customers, we continue to lag our commercial bank peers and need to re-double our efforts to grow commercial fees.

With our move-up market over the last few years, we have the opportunity to generate additional fee income by building a robust suite of products to fully capture the entire commercial relationship, the primary deposit and cash management relationship in particular.

Our commercial deposits are lower than comparable peers right now. The marginal benefit of having a greater share of our customers business in both C&I and CRE is a significant opportunity that we need to execute at.

On the retail side of the business, we have the opportunity to provide a better integrated customer experience by improving feature functionality such as online account opening, online banking enhancements and single sign-outs.

We have to improve upon the value proposition to our current and prospective customers to provide them the ability to easily transact with us across the delivery channels of their choice. Customer acquisition and retention becomes all the more important when deposits become more valuable in a higher interest rate environment.

We’ll continue to invest in risk management. This is as true for the entire industry as it is for us. We need to keep pace with the ever growing list of regulations and continue our build-out of information security, credit data repositories as examples.

Information security has increasingly become critical for banks in the new regulatory environment and we will make the necessary investments. We’ll continue to manage our expense base and cease the opportunities to optimize our retail delivery and lower our overall cost to serve.

We achieved our fourth quarter expense target of $225 million as I said earlier. Our announcement this month to restructure out branch stuffing model to accelerate the move to universal banker model is a good example of our ongoing focus on expenses. However, the near-term benefits of such actions are limited. Going forward, the real opportunity for us is sustainable operating leverage.

Now let me cover how I’ll lead to address the opportunities I’ve just discuss. Staying the 2013 course of balancing short-term EPS against investments for the long-term will not improve performance in long-term value for our shareholders. Well, higher interest rates will benefit our future profitability that will be a tide that lifts all boats.

Starting now and over the next three to four years, we will be changing course by accelerating the investments needed to enhance revenues, fee income in particular and prove operating leverage and stay on top of growing regulatory requirements.

We ensure that we make these investments is effectively and as efficiently as possible. We must leverage significant innovations that are occurring in the technologies for infrastructure, product integration and product application development.

These innovations include rapidly maturing industry standards that will better facilitate product integration and provide a better customer interface while supporting big data and a cloud environment. We refer to the new underlying architecture that will enable us to take full advantage of these innovations as the common rails.

The investments that we make in common rails will not only improve efficiency by reducing overall cost to build and operate, will also ensure that the next set of investments to integrate a new product of platform will involve less cost and less risk and also increase speed to market and enable us to better address future regulatory compliance matters.

Now we’ll be investing $200 million to $250 million over this three to four year period that will address our common rails initiative as well as other programs to drive revenue growth, sustainable operating leverage, ongoing regulatory compliance and risk management.

Let me give you some context to understand what we mean by common rails. For decades, banks have sought the best product solutions for multiple vendors and created unique product integrations without standardized connection points. Every bank management team can show you this spaghetti chart of inner connectivity across all of their technology platforms.

The industry has already taken a big step. Banking industry architecture network or BIAN, a consortium of bank spenders and service providers, that’s a project underway that define uniform architecture standards. Some banks have begun integrating new applications with these uniform architecture standards already.

While not on a horizon in the near term, developing uniform architecture standards is clearly the path forward for more of an app store or plug or play approach for technology development for the banking industry. Our common rails approach has been designed to improve such technological developments and the most current banking in this regard to be better prepared for this transformation.

Let me tell you why we’re doing this now. There are three basic reasons. First, customer preferences are changing rapidly, more so than anybody imagine even 18 months ago. As products have developed to meet changing customer demands, we must be able to quickly unplug the old and plug in the new. Customer loyalty will dissipate quickly for those that take too long. Falling behind will decrease the bank’s competitiveness. The common rails will also better enable us seamless experience for our customers across multiple product lines to channel simplification and rollout overall cost.

Second, as I’ve said the way banks deliver technology in the future is changing, perpetuating the old main frank paradigm is an expensive proposition and will not enable us to meet the pace of changing customer demands. The old paradigm means more custom code which means more ongoing technology integration costs and risks. It’s also an unacceptable speed to market. For us to aggressively invest predicated and decades old model would require much work that would ultimately be throw away.

The third reason is we’re not competing with just banks of our size. With our market move, we consistently compete with the largest institutions in the country. While we do well today, this investment strategy will help us become even more competitive for a much large share of customer’s business and increase the profitability of the relationship.

Some instances, our investments will make us competitive with our peers, while in others it will help us significantly improve our value proposition relative to many of our peers. The board put me in this role to extract maximum value for our customers and shareholders and I believe this strategy is the right step to achieving success over the long run.

Greg will talk to you about what this means for our 2014 outlook later but our pivot will result in a higher expense base. These investments reflect the combination of higher staffing to execute projects and to operate the new product and service platform as well as higher technology and depreciation expenses and professional fees.

Our investments will not significantly impact revenues in the short term. Revenues in the short term will continue to be primarily enforced by rates, competition and the economy. As we noted in prior conference calls by the recent steepening of the yield curve is a modest positive. We need short term interest rates to increase before we see any material benefit to net interest income.

While elevated prepayment activity is limiting our total commercial loan growth. Strong momentum in our consumer finance platforms will help us offset this and still drive overall loan growth exceeding peers. Fee base revenues will be stable as mortgage banking headwinds are offset by growth and other fee income categories.

The objective of the accelerated investments is to improve ROA from where we are today, that’s how I will measure success. All in, when you consider the benefits from the improvement in the macro environment and the investments I described, we expect our normalized ROA will range between 115 basis points and 120 basis points. This improvement in ROA will drive largely by the topline growth, as it will process significantly less to earn that next dollar of revenue.

The revenue lift and better operating leverage, we achieved from executing our investment plan, coupled with the added revenue benefit from a normalized interest rate environment will lower our efficiency ratio to our mid 50% target level. Our fee income contribution to revenues will still be around 25%, but it will be 25% of a larger revenue base.

How do we get to our targets? Based on our estimates, the revenue projects that we have planned, we had a $50 million revenue opportunity in 2016, which increases to $80 million in 2017. The revenue lift will come from both higher net interest income and increased fee income.

First, net interest income, [Technical Difficulty], and DDAs and low cost core deposits as we can better attract to retain customer deposit accounts. With more deposit accounts, the potential to generate fee income from account analysis and other transaction fees is also greater.

By 2017, these investments together with expense synergies will drive about a 10 to 15 basis point increase in ROA before any benefit from interest rate normalization. This translates to a return on investment of nearly 25% on these projects. We factor the benefits from the more normal interest rate environment, the ROA would increase another 20 to 25 basis points.

We define normal interest rate environment as fed funds of approximately 4%. But I realize that I’ve covered a lot of ground today, but the objective from my communication with you was to outline with clarity and conviction, our strategy under my leadership and to give you specifics as to how I measure my own success.

My team and I are very confident that we can execute on this plan and deliver on our commitment to our customers and our shareholders. Shortly after my appointment of CEO, I announced my retooled executive leadership structure with the additions of our CIO and our Head of Operations, both reporting directly to me. This means that I will be personally and very directly involved in each and every significant component of this investment strategy.

Personal accountability is very important to me. Let me emphasize the value proposition that I see in First Niagara. We are investing in the future to deliver improved and incremental returns by directly addressing and leveraging our opportunities to grow our revenue base.

We're doing so thoughtfully with a forward-looking view of where customer consumption and technological advances are headed and where the regulatory demands will emerge. We are not continuing the old technology development paradigm by retrofitting newer applications on the old mainframe.

The long-term implications that are doing such inefficient solution implementations will only mean higher operating expense. We are doing it the right way and we are doing it now. It comes down to execution and I have a very strong team that can deliver on this strategy that I outlined. Our investments will enable us to leverage our collective footprint and translate our financial underperformance into solid operating results that will drive shareholder value.

That concludes my prepared remarks. Now, I will turn it over to Greg for a quick recap of the quarter and our 2014 outlook.

Greg Norwood

Thanks, Gary and good morning. I will start with key highlights for the quarter. We reported EPS of $0.20, consistent with the guidance we gave you last quarter. Pre-tax, pre-provision income increased 3% compared to the third quarter driven by expense control.

As Gary mentioned, we had a couple of unexpected expense items that we would call operational losses that totaled about $2 million. One item was related to the security breach of target, we’ve all heard about. We accrued for potential losses and have addressed our customer accounts by re-issuing credit and debit cards.

Excluding the $2 million non-recurring items, operating expenses were approximately $225 million, consistent with the targets we set to reduce inefficiency. Revenues were flat quarter-over-quarter as NII exceeded our guidance, driven by some non-recurring benefit and fee income declined primarily due to seasonality.

Overall loan growth was strong quarter-over-quarter at 9%. Commercial loan growth was 7% annualized over the prior quarter. Looking at credit and other good quarter, net charge-offs on our originated portfolio increased by 10 basis points in large part due to the large $3 million recovery that we had last quarter, coupled with the first full quarter impact of the HSBC credit card charge-offs which we previously charged to the credit market.

NPL picked up as a couple of commercial loans, different industries, different geographies went on non-accrual and were partially offset by resolution of others. Delinquencies were flat quarter-over-quarter and we see credit metrics remaining steady.

Let me give some prospective on the results relating to revenue on Page 5. Our NIM was 3.41% up 1 basis point from the prior quarter. Our NII this quarter improved $2.7 million or 1%. But last quarter, there were items that we do not expect to reoccur in the normal course of business. These items totaled about $7 million compared to $6 million last quarter and this is detailed on Page 6.

The most significant item that benefited the fourth quarter NIM and NII was the $3.5 million benefit related to slowing cash flows on the CMO portfolio. Net of this retro adjustment, premium amortization on our RMBS portfolio this quarter was 300,000. Excluding these items, adjusted NIM was 3.32% consistent with the guidance we provided last quarter.

Let me turn to the balance sheet. Balance sheet growth was strong. C&I loans increased 7% driven by growth across several platforms including healthcare, equipment financing and middle market lending. But we did not see any material uptick in CapEx expense by our customers in the fourth quarter. Our equipment finance business that we built just a few years ago is positioned well as one of the fastest growing leasing company.

As Gary, mentioned, we’re optimistic that our customers will begin to grow, including increase CapEx expenditures and they will draw more on their lines in 2014 compared to 2013. While CRE loan growth was a respectable 6%, the competitive environment continues to drive elevated prepayment activity particularly in our investor real state book.

As Gary noted, while the macro environment has improved from 90 days ago, the competitive environment continues to be challenging. We continue to see covenant light structures and significant increases in hold positions are both larger and smaller banks. For example, $90 million facility, a very large institution took out the entire amount of $90 million that was previously spread across four participants including First Niagara.

Our elevated refinancing and prepayment activity particularly in CRE, they reduced the pace of loan growth we experienced. We’re optimistic that the improved economic outlook will drive more new originations.

Indirect auto posted another strong quarter with almost $320 million in originations. The FICO scores for the new originations this quarter was 754. New money in the indirect portfolio priced at 3.06% down 5 basis points quarter-over-quarter.

Home equity balances went up for the third straight quarter, reflecting the success of targeted promotional campaign that we did throughout the year. Transactional and core deposit increased in the fourth quarter reflecting what is typical -- typically a high point for average balances. The favorable mix shift in our checking account suite to the more top tier pinnacle accounts were balances are typically six times more than the lower tier is also driving the improved. The negative side of this mix improvement is that these higher balances and pinnacle customers do not generate high NSF fees.

Switching to fee income, overall fee income decreased 2% quarter-over-quarter. As we noted in our guidance last quarter, insurance commissions and deposit service charge declined consistent with seasonal patterns. The seasonality of these categories is driven by the low point of insurance renewal cycle and lower NSF incident rates.

Capital market income increased over the prior quarter led by both good derivative and syndication activity this quarter. Mortgage revenues were consistent with our guidance and were driven primarily by modest increase in servicing income. Production income was flat quarter-over-quarter as 28% declined in volumes was offset by some moderation in the gain on sale margin, both consistent with industry trends. Other fee income declined due to lower gains on some of our equity investments and tax credit investment.

Moving to operating expenses, total expenses were $227 million and included about $2 million in the one time operational losses I discussed earlier. The decrease in salary and benefits was driven by lower temporary help and overtime expenses including baskets from the mortgage business. Our FDIC premiums decrease reflected the lower high-risk loans and lower insured deposits. Our efficiency ratio improved to 61% from 63% last quarter.

Let me discuss the impact of the Volcker rule on this -- our CLO portfolio before I discuss our financial outlook in 2014. Like the rest to the industry on December 10th, we were surprised to learn that CLO investments were declared impermissible assets under the final Volcker rule, based on the change in from the proposed rule. We earn approximately $1.4 billion of CLOs with 98% rated A or better and 72% percent rated AA or better. The portfolio has a book deal of approximately 3.2% on these floating rates securities.

So these are attractive assets at credit ratings better than even a middle market banking loan. At year end, our CLO book has approximately $40 million in unrealized gain, net of about $1.6 million gross loss on certain securities. We did not incur any OTTI charge in the fourth quarter.

As Gary noted earlier, First Niagara has been active in seeking a resolution to the punitive treatment of CLOs under the Volcker rule. We have engaged some of our peers in trade groups. We have met with regulators and legislators in D.C. to help them understand the unintended impact of the CLO quote ownership definition added to the Volcker rule.

So potential regulatory and legislator solutions are possible, similar to the announcement of the trust CDO issue earlier this month and may resolve it. If not, there are other structural solutions as well. Bottom line, we feel we can continue to hold these bonds to recover.

Now let me talk about our outlook for the first quarter of ‘14 and frame the impact of our accelerated investment strategy that Gary describe on our 2014 earnings, summarized on Page 10. Before I get into the line items, our 2014 earnings will be favorable impacted by tax benefits stemming from the taxable reorganization of our subsidiary. We expected benefit to income tax is to total $20 million or $0.06 per share.

Our outlook for the effective tax rate reflect this tax benefit. My outlook discussion also excludes the impact of approximately $8 million to $10 million or $0.02 cents per share in pre-tax restructuring and severance charges that we will incur in connection with the branch realignment, consolidation and executive departures.

As you all know the first quarter trends to be seasonally weaker quarter for net interest income and most fee income categories, given fewer number of days in the quarter. We expect loan growth to average mid single digits in 1Q and to be slightly higher for the full year 2014. This will be driven by continued strength in commercial businesses and indirect auto volumes, offset by lower growth in our larger commercial real estate resulting from elevated prepayments.

As the economy grows, we would expect to see commercial borrowers increase their CapEx spending which should drive higher activity in our C&I and equipment finance businesses. In a shift from what we’ve been doing earlier in 2013 as Gary noted, we will maintain our investment security balance as generally consistent with current levels given slower loan growth.

As a result, we expect earning asset growth to average low-to-mid single digits growth rate in 1Q and for all of 2014. We expect reported net interest margin in the first quarter to compress mid single digits basis point from the 3.41% reported in the fourth quarter of 2013. For all of 2014, we expect NIM to be consistent with the 3.25% to 3.3% range projection -- projected in the medium consensus models.

We expect NII in the first quarter of ‘14 and in 2014 to be consistent with the current consensus medium of $271 and $1.1 billion respectively. Consistent with seasonal trends, we expect fee income to be down modestly in Q1 from the fourth quarter levels with deposit service charges being the weakest. Throughout 2014, we expect deposit service charges to remain relatively flat to 2013 levels given the mix change we are driving.

We will continue the favorable mix shift in deposit accounts towards the higher end Pinnacle customers that carry higher balances but results in lower retail NSF fees. So the good side of the story is these customers are more engaging results, be in higher balances and greater cost sales.

As Gary noted, we expect to see the benefit of our investments in the revenue enhancement initiatives in outer years with minimal benefit in 2014. Overall, fee income at 2014 is expected to be modestly higher from 2013 levels

Given the accelerated investments that Gary discussed in detail, we expect first quarter and 2014 expense run rates to increase. While, first quarter tends to be higher due to payroll taxes, ongoing investments in people and projects through the year will drive expenses to approximately $245 million per quarter. These investments will primarily impact salaries, technology and professional services expenses.

Turning to credit, we expect net charge-offs on originated loans to average 40 basis points, plus or minus. Excess provision will remain consistent with the mix of originated loan growth. Based on that, we expect first quarter 2014 provision expense to be $25 million to $27 million.

Tax rate should range between 25% and 26% across each of the quarters in 2014, reflecting the tax benefit from the reorganization I mentioned earlier and other tax strategies. To sum it up, if there were couple of takeaways from the outlook relative to where consensus models are for 2014, the expense number needs to be higher and consistent with our 1Q ‘14 guidance and the tax rate needs to be lower.

Net-net, as a result of these updates, we expect 2014 operating EPS to range between $0.72 and $0.75. GAAP EPS will be approximately $0.02 lower, reflecting branch consolidations restructuring and severance expenses.

With that, Hershey, we can now begin the Q&A session.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Mr. David Darst. Sir, your line is open.

David Darst - Guggenheim Securities

Hey, good morning.

Gary Crosby

Good morning.

David Darst - Guggenheim Securities

So, Gary, congratulations, this is a fascinating strategy you're introducing. Could you talk about the leadership on the technology team, how long that person has been at the company, and more specifically what their experience is in integrating and developing a program like the common rails?

Greg Norwood

Well, our Chief Information Officer has been with us for little over a year now, and the reason I recruited him to the organization is because of his experience not only as relative to the common rails, which is something he has been working on from the day he arrived, but also because he is very, very experienced in enterprise program management.

So, it’s a dynamite combination given what we're undertaking. When he first arrived at the bank, I said to him look, the perfect world scenario where you have one vendor and one platform doesn't exist. We are proceeding to continue to add-on product services and technologies that continue to increase the number of vendors that we are working with, and we need to figure out a way that we can have an architecture in place, that does -- that avoids us being settled with ongoing integration costs and ongoing integration risk, and that was the goal of the common rails architecture.

Our CIO has big bank background, as I said, and he is on our website. So you’re welcome to go there and look at that. We have key people reporting to him that have been with us for many years and have been working with us as we evolve from a thrift into a full-fledged commercial bank.

David Darst - Guggenheim Securities

Okay.

Greg Norwood

One thing David, I might add to that too, obviously an important part of the strategy like this is the program and project management, the enterprise program perspective, and we’ve also in the late fall hired a very seasoned executive with a lot of experience in big change like this. So, I think that tandem both from the CIO leadership and the enterprise program offices is exactly the type of skills you want to have when you begin something like this.

David Darst - Guggenheim Securities

And I guess, based on the work you’ve done over the past year, does that give you confidence in the range of the cost, $200 million to $250 million over a three-to-four year period?

Gary Crosby

I would say as much confidence as any one could reasonably hope to have. These are estimates, and it’s not unusual for any organization, banks, or otherwise to run over. But our goal, we’re setting it up so that our focus will be staying on time, on budget, and getting the result that we intended to get when we started, so we have the process in place. We’ve got the EPMO organization in place to provide us with the single version of the truth in that regard.

David Darst - Guggenheim Securities

Okay. And then as you talked about the longer-tern ROA goals, did you mention some inflection point occurring in 2015?

Greg Norwood

No, the ROA goals are targets of 1.15 to 1.20, it begins at the end of the investment period, and during the interim period, the ROA will be driven by the level of investment that we talked about, but also what happens in the broader economy and in interest rates, so the ROA that we’re targeting is something that is several years out.

David Darst - Guggenheim Securities

Okay. And then just quickly on the margin and your guidance, it sounds like you’re going to be around 3.1 to maybe 3.15 in the fourth quarter of this year, and that’s your margin kind of running into 2015 unless the rate environment changes, is that fair?

Greg Norwood

No, I think, if you think of margin for ‘14, consensus has 3.25 to 3.30, and right now pegging the forward curve we would see us right in the middle of that.

David Darst - Guggenheim Securities

I’m sorry, for the fourth quarter not the full year, to get to that number for the full year, you’re going to wind up lot lower?

Greg Norwood

We’re not going to give quarter-by-quarter margin guidance, Dave.

David Darst - Guggenheim Securities

Okay. Thank you.

Operator

Thank you. Our next question comes from Mr. Damon DelMonte. Sir, your line is open.

Damon DelMonte - Keefe Bruyette & Woods Inc.

Hi, good morning and Gary, congratulations on the permanent position.

Gary Crosby

Thank you Damon.

Damon DelMonte - Keefe Bruyette & Woods Inc.

My first question is dealing with the expenses. Greg, you had mentioned 2.45 for a quarterly rate, is that what you’re expecting for the first quarter and then from there a build going each quarter out or is that what you expect kind of as the flat run rate for 2014?

Greg Norwood

Think of it more as a flat run rate Damon. When you think about first quarter, obviously it’s a little bit higher than other quarters, and then some of the benefits we get from the consolidations and the realignment, we think the expenses will be relatively flat quarter-over-quarter through 2014.

Damon DelMonte - Keefe Bruyette & Woods Inc.

Okay. And then with respect to some of the offset from the expenses. Could you just, if you said, I apologize if I missed it, what was the expected revenue impact in, you said probably nothing in 2014 but did you quantify whether it would be into 2015?

Greg Norwood

No, we haven’t given guidance beyond 2014 Damon but what Gary did say is if you look out to ‘16 and ‘17, the revenue from the initiatives and expense synergies is $16 million and $16 million and $18 million in ‘17.

Damon DelMonte - Keefe Bruyette & Woods Inc.

Okay. And then lastly, I think you said that the balance sheet location strategy using the cash flow from securities to fund loan growth. Did you say that kind of subside in and you can use those cash flows to help fund these project investments. Is that correct?

Greg Norwood

Yeah. We see the securities book flat basically throughout ‘14 and it’s year first to the same rotation strategy that we’ve been focused on but just too much smaller loan growth. So with a smaller loan growth, we will maintain the securities book and again as loan growth would pick up in ‘14 and ‘15, we would look at what’s the right level of the securities book.

Damon DelMonte - Keefe Bruyette & Woods Inc.

Okay. Okay. That’s all I had for now. Thank you.

Greg Norwood

Thanks.

Operator

Thank you. Our next question comes from Mr. Bob Ramsey. Sir, your line is open.

Bob Ramsey - FBR Capital Markets

Hey, good morning guys. Thanks for taking the questions. I guess, I know you all said that the 115 to 120 are away and I appreciate the target is sort of at the end of the investment horizon. Just one of you share, I understand the end of investment horizon is 2018?

Gary Crosby

Yeah. We’re looking three to four years out.

Bob Ramsey - FBR Capital Markets

Okay. And as I think about the trajectory of the ROA between now and then, it would seem it certainly goes lower before it gets better since earnings will be down in ‘14 and assets will continue to grow. How should we think about the trajectory from 85 basis points give or take today to get into that more normalized level. Where and when do you think it trough, so when does it begin to actually build?

Gary Crosby

Yeah, I mean, I think if you think of the jump-up point, at 82 basis points in the fourth quarter and 80 basis points for the year. So if you think of 80 basis points, you’re right. Over the median short term, it will moderate down a handful of basis points. And it tends to moderate back up later in the ‘16, ‘17 time period.

Bob Ramsey - FBR Capital Markets

Okay. So it will be down in the near term and won’t really start heading back up until the ‘16, ‘17 time period?

Gary Crosby

Correct.

Bob Ramsey - FBR Capital Markets

Okay. I guess, you laid out a lot of reasons for these investments and some of the opportunities that are out there on the call already in your prepared remarks which is helpful but I think obviously people were disappointed by the EPS guidance and the expenses are the big piece of that. How do you sort of balance, sort of, revenues or earnings I should say, not revenues but earnings over the next couple of years with the timing of these investments?

Gary Crosby

Bob, let me start with your comment on the expenses. I’m well aware that number of analysts we’re looking forward to some big expense initiative announcements. We’ve been working on our expenses right along and one of the reasons we were determined to get to our 225 target in the fourth quarter was because I wanted the confidence of knowing that we squeezed out as much inefficiency out of the business as possible before we embarked on this investment strategy.

And I go into this strategy knowing that we’ve done that. I suspect that some of the reason around, the thinking around some big expense initiative is that we’ve grown very rapidly over the four years and acquired a number of banks and branches. And so therefore there must be a lot of inefficiency in the organization still. And I can tell you that there isn’t. We’re very good at doing conversions and integrations and we have squeezed all of those expenses out.

We are fully integrated. We’ve got this one loan system. We don’t have multiple loan systems for each product, each geography. We have one deposit system. We have one general ledger. We don’t have an army of people supporting multiple systems and multiple reporting. So I’m very confident that we’re as efficient as we can be following our rapid growth.

What we need to do going forward to become even more efficient is to automate where we have human interfaces. And we do still have some human interfaces throughout our systems and processes that should be, can be and should be automated. And the other thing too is we’ve got a very good revenue machine here, but it can be a lot better with the investments we are talking about making, particularly in the fee income area, that’s one area we clearly fall down in and we need a better suite of products there and we are well on our way to achieving that.

For me, the decision -- in ’13, we did take our relatively short-term approach and we were selective and arguably almost stingy in terms of the investments that we were making. And I think that was a very necessary approach for us in ’13. What this is coming down not just for us but for any financial institution is paying now, will pay a lot more later.

This investment strategy has to be undertaken at some point and the sooner we do it, the better otherwise you risk falling further behind and you find yourself settled with a lot more integration costs and a lot more integration risk relative to technology. So while I wish we could find an opportunity here with a rising rated environment to undertake this, we can’t afford to wait for that any longer.

Greg Norwood

Yeah. I think, Bob, one of the things too and just how we look at this, as far as the timeline, we spend a lot of time to make sure we’re attacking this aggressively as possible and you see that reflected in the expense numbers. So far as the sense of urgency, we clearly are focused on that but one of the things you always have to be mindful of is that you are not beginning something without all the right analysis, perspective and plans.

So there is a clear balance there and I think as you listen back what Gary said about our CIO and project management, main reason of that experiences is really, really valuable is to make sure you're doing it quickly but not too quickly and balancing that. And obviously if you get involved in multi-year investments and I have at several places, you really got to be very deliberate in how you go about it, with a focus on quickness but not being quick with the risk of being wrong.

Bob Ramsey - FBR Capital Markets

Okay. All right. Thank you, guys for taking the questions.

Gary Crosby

You are welcome.

Operator

Thank you. Our next question comes from Mr. Casey Haire. Sir, your line is open.

Casey Haire - Jefferies

Hey, good morning, guys.

Gary Crosby

Good morning.

Casey Haire - Jefferies

Maybe a couple of questions just on the guidance, specifically the -- first the fees. Understand that there was some seasonality holding back this quarter, but to be up next year still facing some tough comps in mortgage banking and secular decline in service charges. I’m just curios what are the drivers that you see that give you an up year for fees in ’14?

Greg Norwood

Sure. Well, couple of things. Mortgage banking as you mentioned, will be challenging but again, we see some opportunities there on a year-over-year basis. Also in wealth management, that platform continues to perform well and better than expected over the last couple of quarters. We also look at the other categories, be it insurance. We see modest uptick there as well.

Casey Haire - Jefferies

Okay. And the tax benefit that takes the tax rate down to 25%, is that this year only, or does that carryover into ’15?

Greg Norwood

That is this year only.

Casey Haire - Jefferies

Okay. And then, Gary, just a question for you, you mentioned your comfort level with the capital ratios. It also sounds like you have pretty good relationship with the regulators. I’m just curios, is your comfort with the capital levels, is that -- currently is that blessed by regulators or they kind of onboard with below peer average capital ratios.

Gary Crosby

Our regulators are not taking any issue with our capital ratios. And they are looking at that in the context of our low risk balance sheet.

Casey Haire - Jefferies

Okay. And similarly these initiatives, the tax spend that you’ve guys have outlined, is any of this coming by mandate from regulators or is this all your own initiatives?

Gary Crosby

Not coming at all from the regulators. It’s all to our own initiatives.

Casey Haire - Jefferies

Okay. Thank you.

Gary Crosby

You are welcome.

Operator

Thank you. Next question comes from Ms. Erika Najarian. Ma’am, your line is open.

Erika Najarian - Bank of America Merrill Lynch

Yes. Good morning.

Gary Crosby

Good morning.

Erika Najarian - Bank of America Merrill Lynch

My first question is you’ve talked a lot about the need to invest in technology, common rails and a lot of the investors on the line probably were not bank insiders like you are, so we probably don’t understand what the impact could be. So as I think about what the near-term impact of that investment could be, or how you are thinking about in your business plans? If you had a 63.8% efficiency ratio this full year, last year, what does investing in the common rails and having it up to speed mean for efficiency ratio going forward?

Gary Crosby

Going forward, what it means in the very short-term? Our efficiency ratio will maybe deteriorate a little bit. But then it’s going to improve significantly as we head towards, as I said earlier, our target of mid-50 point ROA.

Greg Norwood

And Erika, as you mentioned, the common rails, you here a lot of banks -- several banks over the last six or eight months talk about using different terms. And from efficiency ratio and operating leverage, what we’ve tried to say in Gary’s remarks is on a go-forward basis, the efficiency of building on our common rail is night and day better then trying to continue the old approach. And again, I think folks are focused on that. We are not going to go beyond that the bleeding edge of this. But the experience that we have in our technology shop is certainly focused on. This is way to go forward.

So another way to think about it is, when we make this build, the next generation, the dot two, the dot three, speed to market cost is significantly less cost and faster to market and some people refer to it kind of more as Gary said the App Store or plug and play. So it doesn’t take a year to put in a version change. You can do it much, much quicker and cheaper.

Gary Crosby

Erika, let me just -- I caught myself there, I said mid 50s ROA, I’m so focused on ROA. That’s my ultimate measure of success. It is the efficiency ratio obviously and let me just say this that the most efficient financial institutions longer-term are going to be the ones that come to terms with how to minimize integration cost and integration risk.

As we shift more and more, become more and more dependent on technology as a place of bigger and bigger world going into digital, those institutions that have figured out how to minimize their integration cost and integration risk are going to be most efficient operators.

Erika Najarian - Bank of America Merrill Lynch

And I guess just a follow-up question to that, I think the market is going to appreciate the investments that you are putting in today to make the banks more efficient long-term. And as a follow-up to Bob’s question, at the same time even your long-term investors have two or three year time horizons for the stock and there seems to be a lot of room between any two basis points and 120 basis points in ROA, assuming that your target probably needs a short end to come up. As we think about, what you can help and what you can control over the next two to three years and of course, 2014 as an investment year, where can we expect the ROA to drift to within the next two to three years before we could reach a normalized environment?

Greg Norwood

Well, again, I’ve not given ROAs for the targets beyond 2014 I think, Bob, said it right. We are making a very conscious decision to create the business model that will perform better over the long-term and that that is an acceleration of the build and the technology shift. So ROA will reduce in the short-term. And frankly, our view is that the investment as Gary said, this is something that folks are doing, there are folks certainly ahead of us. And we believe that there is really no other option as technology evolves all around the banking sector and particularly evolve in non-bank competitors of ours is this is a must do. And frankly, our decision is, is a must do right now and to do it aggressively as quick as you can, but do it smartly.

Erika Najarian - Bank of America Merrill Lynch

And just one last question for Gary, you mentioned with the challenges are for the banking and technology fee income regulation. But as you take a step back and have gotten to look at the bank from your seat. Could you share with your investors or sort of what are the top three things that you think this bank is doing really well at the stage of your evolution? You understand what the challenges are? But where sort of the opportunity where your momentum is already strong?

Gary Crosby

So, I try to cover that in my earlier remarks. But let me say over the last four years, we've build a really strong franchise here with tremendous potential. So it's up to us to cease the opportunities that are coming from that franchise that we built. And that's what this investment strategy is design to do is to make sure we maximize those opportunities.

And we have great talent. We've been very good at talent retention and talent acquisition and hitting the right people in the right places. I think our biggest opportunity now is no longer having a focus on M&A and the distraction that comes from that and the resources that consumes and all of that time, energy and money is been redirected into making sure that we maximize the opportunities that are there in this franchise we built over the last few years.

Erika Najarian - Bank of America Merrill Lynch

Okay. Thank you.

Operator

Thank you. The next question comes from John Pancari. Sir, your line is open.

John Pancari - Evercore Partners

Good morning. Back to your capital levels discussion. Could you give us some thoughts on your long-term targets on the respective ratios, particularly on the TCE, as well as your total capital? Where you think that could go to over the next few years and what are your target?

Greg Norwood

Yeah. Well, I would answer that is a little bit on the past. We aren’t going to give targets for 2018, 2019 or other than that will comply with Basel, with what we think there will be appropriate cushion.

What I would also tell you is, as we look at as under 50 bank were OCI is not part of regulatory capital, we look at both the regulatory from market perspective too and also include TCE. So we don't prioritize one over the other, but we look at both of them.

And again, I think, as we said going back to 2011 is, we're going to build capital not raise access capital and again the process we are going through and looking at Basel III, we're very comfortable and certainly in the DFAS Stress Testing given where we are now, we feel very good about that as well.

John Pancari - Evercore Partners

Okay. And then what is the unrealized loss on the CLOs?

Greg Norwood

The gross unrealized loss is about $1.2 million or $1.3 million. Basically what it was at 9/30 and if you think about at the variable rate paper, so you don't have a lot of interest rate risks and even if you go back in the CLO market broadly, you go back to the mid-90s to date, the loss in the CLO portfolio for the industry CLOs is only like 1.6%.

So it's a very low loss content performed very well during the downturn as far as credit losses and again, there variable rate paper, so they generally carry a lot of interest rate risk.

John Pancari - Evercore Partners

Okay. And then you mentioned the willingness to compete on the lending front maybe environment. More specifically, can you help us identify or what the -- with your updated new money yields, already you are seeing a new C&I and new CRE loan production?

Greg Norwood

Sure. Generally unchanged, I think it’s the most important thing throughout 2014 versus our plan. So, yes, there was compression. And the ranges that we recorded in the fourth quarter are still in the LIBOR plus 250 to 280 with the better credits and the better CRE credits being at the low end of that.

We will continue to focus on IRR in the short-term. But in part in line with the strategy of getting more and more advanced treasury management for the right company where we see an opportunity to gain more fee income in the future through better future functionality and treasury management, cash management, that’s where we will be more willing to balance the return from the credit versus the return from fee services.

John Pancari - Evercore Partners

Okay. Thank you.

Operator

Thank you. Next question comes from Mr. Tom Alonso. Sir, your line is open.

Tom Alonso - Macquarie Capital

Hey. Good morning, guys. Just real quick, because I think, I missed the number that you gave earlier, Gary. Did you say there was mid 20 IRR in this investment spend?

Gary Crosby

Yeah. Absolutely right, yeah.

Tom Alonso - Macquarie Capital

Okay. And that just assume that after the initial 250, there is no incremental spend down the road and that $60 million to $80 million starts to flow back in?

Gary Crosby

Yeah. That’s fair.

Tom Alonso - Macquarie Capital

Okay. Okay. And then just, I guess, bigger picture on that, I mean, is some of this, 250 kind of based on things that maybe should have been done in the past in warrants just because of sort of you were at different institution then, is there some sort of an element of catch-up here?

Gary Crosby

I don’t think so. This really is all about looking forward and changing preferences and wanting to make sure we are in the best position to adapt the change. Maybe small part of it is catch-up, I think we are all playing catch-up to one degree or another, but the bulk of it is what we need looking forward.

Tom Alonso - Macquarie Capital

Okay. Fair enough. Thanks guys.

Operator

Thank you. Next question comes from [Mr. John Ash]. Sir, your line is open.

Unidentified Analyst

Hi. Good morning. I guess just a follow-up on that. Is it fair to say that despite the massive growth of the banks since the beginning of the financial crisis that the bank is underinvested in technology over the past five years?

And then second question would be the 20% IRR in the investment? Is that something that you have calculated internally or is that calculated by external consultants? Thanks.

Greg Norwood

On the -- on your question regarding the underinvestment, no, I don’t think, we have underinvested over the last five years. We have grown rapidly. So I get the nature of your question. But this is again, as I said, this is all about what we feel we need to do going forward to stay up on top of and not fall behind changing preferences.

Gary Crosby

Yeah. John, on the IRR, I mean, I guess, I’ll answer a couple ways is, it’s our assessment of what we thing if not “a vendor view” of what we will get and also, obviously, we have had a lot of folks helping us with this over the last several months, so its hard, just the reasonable (inaudible) it’s our number, it’s not a vendor driven number and the accuracy of it a very confident in the methodology.

And then on the bill too, I think, it’s really important and we can chat with folks to help everybody better understand the evolution of how banking technology needs to be delivered, that’s a major, major component of the pivot here.

Unidentified Analyst

Thank you.

Operator

Thank you. Next question comes from Josh Levin. Sir, your line is open.

Josh Levin - Citi Research

Thank you. Good morning.

Gary Crosby

Hi, Josh.

Josh Levin - Citi Research

You’ve laid out some long dated plans to sort of turnaround the bank and improve business? How do we evaluate in interim if you are making progress? I mean, well, we will be able to see anything show up in the metrics in 2014 to show us that you are making progress or not making progress?

Gary Crosby

Well, here is the saying that, a lot of what we are talking about is, fully disclosed is longer term benefit here. So for us in a very short-term from quarter-to-quarter as we are on these calls it’s the question for us from you would be, are you guys on time, are you on budget. And at some point the conversation, I concern to, are you getting the results that’s intend to be get when you signed up for this. And again, my overall measure of success in that regard that cut through it all is how we are doing on an ROA basis.

Josh Levin - Citi Research

Okay. And then, the follow-up question to that is, why should shareholders wait three to four years for you to build out the infrastructure when an acquirer could buy the bank and they have the infrastructure already, they could put you on their platform and they could integrate you with considerably shorter time of three to four years?

Gary Crosby

Well, again, it goes back to what I said earlier about the franchise that we've build over the last handful of years. It has tremendous potential and that's what this is all about is getting the most out of that potential. And we believe we can best increase shareholder value by mining that potential through staying an independent company.

And arguably, you got really -- you really got to ask yourself, do the buyers really have the infrastructure and is that infrastructure as far along as we are intending to be in the near -- in the short -- in the longer term. That's the real question.

Greg Norwood

I also think as we said, we know from all the work we've done that others have started this process. But I think if you were to canvas the industry, Gary is exactly right. Nobody position until you kind of pivot to a standardize implementation that's what the trade group Gary mentioned, which again is banks, vendor, service providers. Because again, you can't take unique, you can't have every new product application be a unique effort, it has to be more plug-in-play. And there is nobody out there that already have this.

Josh Levin - Citi Research

Thank you.

Operator

Thank you. Next question comes from [Mr. John Hatcher]. Sir, your line is open.

Unidentified Analyst

Good morning, gentlemen. As a tie into many of the capital questions and the pace of capital build. Would you discuss your thoughts and strategy regarding upcoming Moody's credit review?

Gary Crosby

Well, the Moody's review is about credit and capital. And we're, as I said earlier, we're very comfortable on both fronts. We're fully prepared to demonstrate that our asset quality is as solid as it’s ever been.

And on the capital front, we are prepared to show them now from stress testing standpoint, Basel III, overall regulatory view of the world relative to our balance sheet that we feel our capital is sufficient and how we will continue to accumulate capital as we go forward. So it's really as simple as that.

Unidentified Analyst

I guess tying with some of the other question. Can you speak it all to kind of the pace of the capital build? You allude to capital build but maybe not a 2018 target. But where would you see for example the TCE ratio at the end of 2014 or something like that, whatever you feel comfortable with?

Greg Norwood

The capital ratio at the end of '14, do build modestly across all of the platform -- across all of the measures. So, again, we continue to feel comfortable with that, we're in a capital accumulation, as Gary said. We're comfortable with the dividend rate. So feel good about the accumulation.

Unidentified Analyst

All right. Great. Thank you.

Operator

Thank you. I would like to hand the call back to the speakers. Thank you.

Gary Crosby

All right. Well, listen everyone, thanks again for joining us today's call. And I certainly appreciate the patience and attention to really atypical earnings call conversation. As a management team it’s very important that we focus on developing and executing strategies that benefit our customers, our communities and most importantly, our shareholders over the long run. I'm very confident that the investment strategy I highlighted today we’ll do just that and deliver the value. So have a great day.

Operator

That concludes today's conference. Thank you for participating. You may now disconnect.

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