BB&T (BBT) Kelly S. King on Q1 2016 Results - Earnings Call Transcript

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BB&T Corp. (NYSE:BBT)

Q1 2016 Earnings Call

April 21, 2016 8:00 am ET

Executives

Alan Greer - Executive Vice President-Investor Relations

Kelly S. King - Chairman, President & Chief Executive Officer

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

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

Analysts

Matthew Derek O'Connor - Deutsche Bank Securities, Inc.

Michael Rose - Raymond James & Associates, Inc.

Elizabeth Lynn Graseck - Morgan Stanley & Co. LLC

Lana Laiyan Chan - BMO Capital Markets (United States)

Gerard Cassidy - RBC Capital Markets LLC

Paul J. Miller - FBR Capital Markets & Co.

Stephen Kendall Scouten - Sandler O'Neill & Partners LP

John Pancari - Evercore ISI

Kevin J. Barker - Piper Jaffray & Co. (Broker)

Amanda Larsen - Jefferies LLC

Operator

Greetings ladies and gentlemen, and welcome to the BB&T Corporation First Quarter Earnings Conference. Currently, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this event is being recorded. And it is now my pleasure to introduce your host, Alan Greer of Investor Relations, for BB&T Corporation. Please go ahead, sir.

Alan Greer - Executive Vice President-Investor Relations

Thank you, Ebony, 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 first quarter of 2016. We also have with us other members of executive management who are with us to participate in the Q&A session, Chris Henson, our Chief Operating Officer; Clarke Starnes, Chief Risk Officer; and Ricky Brown, Community Banking President.

We will be referencing a slide presentation during our comments. 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 BBT does not provide public earnings predictions or forecasts. However, there may be statements made during the course of this call that express management's intentions, beliefs or expectations. BB&T's actual results may differ materially from those contemplated by these forward-looking statements.

Please refer to the cautionary statements regarding forward-looking information in our presentation and our SEC filings. Please also note that our presentation includes certain non-GAAP disclosures. Please refer to page two in the appendix of our presentation for the appropriate reconciliations to GAAP.

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

Kelly S. King - Chairman, President & Chief Executive Officer

Thank you, Alan. Good morning everybody and thank you very much for taking time to join our call. Overall, we had a what I'd call a solid quarter with nice increase in net income and record net interest income. Net income was $527 million, up 8% versus first quarter and 20% annualized versus the fourth, so solid performance. Diluted EPS was $0.67 which was flat to the first quarter 2015 but was up an annualized 18.9% versus the first quarter.

Capital ROA was 1.09%, GAAP ROTCE was 13.87%. Now, if you adjust for mergers charges only, adjusted ROA was 1.12% and adjusted return on tangible common was 14.2%, so solid returns there.

In terms of revenues, we had strong revenues growth despite related to some challenges in mortgage banking income and service charges on deposits. So revenues totaled $2.6 billion which was up 10.2% versus the first quarter and 4.2% annualized versus the fourth.

We did have record net interest income as I indicated at $1.6 billion, up 16.4% versus the first and 6.8% annualized versus the fourth. Really happy about the fact that net interest margin grew to 3.43%, up 8 basis points. and Daryl will give more color on that.

Had a nice, a small but nice improvement in efficiency to 58.3% from 58.8%. Non-interest expenses were very well managed, decreased $52 million or 13.1% annualized and we did have positive operating leverage. Our average loans were down slightly versus fourth quarter. But keep in mind, we continued to adjust our mix on letting our lower spread mortgage balances and sales finance portfolios decline.

We are improving our profitability in those areas, so that strategy is working, but it's just not producing loan volume increases. Keep in mind, we also have run-off in our Susquehanna Hann portfolio and we have a seasonal slower growth in a number of our specialized businesses. So average loans and leases for the quarter were $134.4 billion. And if you exclude our mortgage run-off and sales finance run-off, loans held for investment grew 2.2%, which is kind of the number that we look at. That was led by a good performance in income-producing properties, direct retail, other lending subsidiaries and our dealer floor plan.

In terms of our strategic highlights, I would point out we did convert Susquehanna in November. We've seen reductions in FTEs, other cost savings. Overall, it is going very well. We did complete our acquisition of National Penn on April 1. We'll be converting that in most likely mid-July. That's going very well. Scott Fainor, the CEO of National Penn, is now our group president for our northern region. He's off to a fast start. I feel really good about his leadership and the teams that we have in that area.

We did complete our acquisition of Swett & Crawford on April 1. This is an outstanding company, a 100-year old company with a great brand, has $200 million in revenue. Keep in mind, and this is a little complex, but last year, very importantly from a strategic point of view, we sold American Coastal because it was outside our risk appetite. And now we've effectively completed that process by replacing it with Swett & Crawford. So we got the revenue back and a virtually no risk basis. So that completes that transition, and we feel really good about it. The key now, of course, in the insurance business, in particular in Swett & Crawford, is to get cost saves and overall improvement in margins.

And now, before I go through the rest of the points here, I just want to make a few important key strategic points. So with regard to M&A, as I said, things are going well. After we announced National Penn, we said we would take a pause. All of the deals that we have, we're really excited about.

Texas for example, where we acquired those branches from Citigroup. Rick and I were down there a couple of weeks ago, in Dallas and Houston, and we could not be more pleased in terms of how we are being received and how well things are going. And frankly, the overall Texas market is still very, very vibrant notwithstanding the questions around energy. It's a really, really outstanding market of about 29 million people. It's growing 1,000 people a day. So it's a fantastic market.

Really excited about what's going on in Northern Kentucky and Cincinnati. Susquehanna as I said is off to a good start. National Penn is just getting started, but it has enormous opportunities of synergies with Susquehanna and in the overall revenue opportunities in Pennsylvania.

So we feel overall really good about our merger strategy, but now is the time for us to focus on the enormous opportunities that we have to improve performance in the areas of investment that we have made for last several years. So I want to be clear. Our focus is not on strategic deals but on improving our profitability through basically two areas, which is what you would expect, expense management and revenue enhancement. In the expense management area, we will be focusing on the cost synergies in the community bank. Primarily in the Pennsylvania area, we've done a lot in the rest of the community bank over the last few years, but there's still some opportunity, particularly in Pennsylvania.

We have a really good opportunity to rationalize the huge investments we've made in the back room in terms of processes and procedures. We spent a fortune in the last several years building all that up. Now is the time to rationalize that. In terms of digital transformation, while we will be increasing our investment in digital transformation, lots of opportunity to overall become more efficient as you link the front room and the back room, and that's what our recent executive management changes is designed to do, so we think that'll be a combination revenue enhancement, expense reduction. And then of course, there's huge opportunities for insurance integration, particularly in Swett & Crawford.

On the revenue side, we'll continue to get huge revenue enhancements from our community bank. The rate of momentum improvement there, particularly in our new markets is exponential, so we feel very excited about that. We will continue really, really strong performance in wealth corporate banking insurance and others.

So, given our intense focus on realizing new benefits from our previous strategic investments, stock repurchases or buybacks move up in priority as we think about CCAR 2016 versus strategic initiatives. I'd be happy to answer questions later with regard to that, but we wanted to be sure you were clear about where we are strategically.

If you'll turn to page 4, I'll just mention a couple of items that are unusual this quarter. We did have mergers that was about $23 million or $0.02 negative effect on EPS. We did take security gains of about $45 million, which is a part of our strategy in terms of matching all security gains and credit issues, so that was a $0.04 positive. And then the energy-related provision in excess of charge-offs was $28 million or $0.02.

Now with regard to energy credits, the provision exceeded charge-offs by $30 million or $0.02 as I indicated. Daryl's going to give you a lot of detail on this, but I just wanted to point out that the charge that we took does reflect the new regulatory guidance and the recent SNC exam results.

So, while it's fairly possible that we could have some more energy negative, we do not expect that. We think we built a significant allowance and we think we should expect our provision to be lower in the second quarter. So we feel, frankly, really good. It's a relatively small part of our whole portfolio, about 1.2%. But I know that's a big interest area and Clarke will be glad to give more detail on that later. But we feel really good about that.

If you look at the loan area, we feel really good about loan growth relative to the economy. Just a couple of comments about the economy. It is what I would call good but not great. It's okay. It's rocking along about like it's been rocking along, 2% to 2.5%. It'll vary a little bit quarter-to-quarter. But we, the United States economy is on a sustained 2% to 2.5% kind of growth pattern. And it will stay that way in my humble opinion for a good while.

We see no practical possibilities of recession, notwithstanding the fact there's been a lot of conversation about that. And the reason is because we think there is a very, very strong solid pent-up need for continuing investment. When I talk to business people, they're investing in a way that I call passive investment. That is to say, they're not excited enough about the future to go out and make major expansions and so forth. But they're driving trucks that have 250,000 miles on it. They got ten-year old equipment, and so stuff just wears out. And so, that's why you have to keep investing.

So that creates kind of a floor on the economy in my view. There's an upside if we were to get better positive leadership out of DC and make some changes in taxes and regulation, et cetera. But assuming that's not going take the place or case, we think there's a solid 2% to 2.5%. I would point out that I saw some numbers recently that suggested that most of our markets in the Mid-Atlantic and Southeast will be growing 1 point or 1.5 points faster than the national average. So being in the Mid-Atlantic and Southeast is still a good place to be.

So we are focusing on, as I said, profitability in our portfolio. We believe profitable loan growth is more important than absolute loan growth. So, just a little bit more detail with regard to the loan area. Our C&I loans were down slightly, mostly due to the decline in commercial loans in the branch network and mortgage warehouse. On the other hand, end-of-period loans were better with C&I up 2.5% annualized. Good news is C&I spreads are stable compared to last quarter. Growth is affected but our strategies of restricted growth in multifamily and REITs, so we continue to be pretty conservative. We're currently expecting C&I to grow at a faster pace in the second quarter, probably in the mid single digits. Daryl's going to give you a lot more color on energy as I pointed out, but I'll just emphasize again that we have built our reserves and we're very confident that our exposures are manageable.

CRE growth was essentially flat with a decline in construction and our growth in income producing. So in income producing, net increase 7% annualized, feel really good about that, fastest growth coming from office and hospitality and some small decline in retail. The good news is market fundamentals generally continue to improve. All the spreads are still tight. We expect CRE construction and development to continue to decline somewhat in the second quarter, and IPP to grow at a similar pace as in the first quarter.

Dealer floor plan had a very strong quarter, up $76 million or 26% annualized. That's being driven by expansion in our new markets and some new lines that we've introduced, so that's going very well. So floor plan is expected to continue to grow in the double digits for this year.

Average direct retail lending is a bright spot for us, increasing $211 million or almost 8% annualized. A lot of that is HELOC and direct order from the branches. Rick and his team have really made a sea change in terms of our consumer production out of the branches.

On the other hand, our wealth division continues to make a significant contribution in retail lending, really good production as they work closely together. So we expect the retail lending to continue to grow at a similar pace.

Average sales finance, primarily large prime auto declined $484 million or 18%. That's a continuation of our execution of our flat rate compensation program. That is going well. It does produce less volumes, but it produces better margins. And so we feel really good about that.

The lines will cross in terms of the old portfolio running off the new portfolio soon, so that will stabilize. We do have a contingent run-off of the Hann portfolio for a bit longer. And so overall we think once we get through the next quarter or so that portfolio will be kind of flattish. And then it will start to grow.

Average residential mortgage loans were down $470 million or 16% linked quarter annualized. So keep in mind we continue to sell essentially all of our conforming production. And we think again that's in terms of overall, our quality management of the balance sheet.

Originations in the quarter were $3.6 billion, about 2% more than the fourth. That was reflected in some seasonal improvement.

And application volume I was glad to see increased 39% compared to the fourth, in total $6.9 billion. So we're definitely seeing a bit of resurgence in new home purchases. Young people are back buying homes again. And that's a really good thing.

Our margins on gain of sale improved about 9%. Best level since the first quarter of 2015. So looking forward we believe this portfolio decline will slow and be about flat for the year.

Our other lending subsidiaries continue to do well. They grew $158 million or 5%. But keep in mind that's a weak quarter for them. They'll be back stronger in the second. Did a really good performance in Grandbridge and equipment financing. So we would expect the seasonally stronger other lending segment to accelerate in the second quarter because of seasonality.

So overall, the average loans are expected to be up 1% to 3% on a core basis next quarter. Obviously with the impact of National Penn, growth will be closer to 20%. And I will point out that is real growth. Those are real assets. But we like to distinguish between organic and core growth. So average loans in the second quarter are expected to be about $141 billion.

If you look at slide 6, overall deposit program is going very well. Our deposit mix continued to improve. We continued to do a really good job managing our cost of interest-bearing deposits. We're up only 1 basis point, even though we had the rate increase at the end of the year.

So average total deposits increased $1.4 billion or 3.7% annualized. And that's a really good growth rate given our intense focus on managing our cost.

So let me turn it to Daryl now for – give a bit more color on some of the numbers.

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

Thank you, Kelly, and good morning everyone. Today, I'm going to talk about credit quality, net interest margins, fee income, non-interest expense, capital and our segment results.

Turning to slide 7. Overall credit quality outside the energy portfolio remains stable. Net charge-offs totaled $154 million or 46 basis points. Excluding energy-related losses at $30 million, net charge-offs improved from the prior quarter to 37 basis points.

Loans 90 days or more past due declined $26 million, mostly driven by loans acquired from the FDIC, impaired loans, and a decrease in residential mortgage.

Loans 30 to 89 days past due decreased $205 million or 20%, mostly due to seasonality in Regional Acceptance, as well as decreases in residential mortgage, sales finance, C&I and CRE.

NPAs increased 27% to 42 basis points, driven by $206 million in energy-related credits moved to non-accrual. If you exclude energy, NPAs totaled 33 basis points, a modest improvement compared to fourth quarter levels.

We are about halfway through our spring redeterminations. We expect NPAs to remain in a similar range in the second quarter, assuming no unexpected impact from that process. We expect net charge-offs to be in the range of 35 basis points to 45 basis points.

Continuing on slide 8. Our energy portfolio consists of 100 clients with $1.6 billion in outstandings, consisting of 65% upstream, 27% midstream, and 8% in support services. And the coal portfolio totals $215 million in outstandings. We take a very conservative approach to energy lending. We do not lend to offshore producers, mezzanine and second lien facilities, or take equity positions.

During the quarter we fully implemented the regulatory guidance from the SNC exam. The allocated reserves totaled 8.5%. And 44% of the energy portfolio was criticized and classified. It's important to note today, all borrowers are paying consistent with their agreements. As a result we believe our energy portfolio is manageable.

Turning to slide 9. Our allowance coverage ratios remain strong at 2.4 times for net charge-offs, and 1.89 times for NPLs. The allowance to loans ratio improved to 1.10%, compared to 1.07% last quarter. Excluding the acquired portfolios, the allowance to loan ratio is 1.17%, so our effective allowance coverage is higher. Remember, our acquired loans have a combined mark of about $636 million.

We recorded a provision of $184 million for the quarter, compared to net charge-offs of $154 million. This includes $30 million in net charge-offs related to the energy portfolio and an additional provision of $30 million to build the allowance to 8.5%. Looking forward, our provision is expected to match net charge-offs plus loan growth. We believe that the provision will be much lower than this quarter's numbers, assuming no large deterioration in credit quality.

Turning to slide 10. Compared to last quarter, net interest margin was 3.43%, up 8 basis points and core margin was 3.18%, up 6 basis points. The margin increase resulted from a seasonal interest income on assets related to post-employment benefits, duration adjustments in acquired securities and higher repricing of variable rate assets combined was stable deposit rates.

Looking at the second quarter, assuming no Fed rate increases, we expect GAAP margin to decline a few basis points driven by the runoff of PCI loans and the loss of a positive seasonal impact of interest income on benefit plans, offset by National Penn. We expect core margin to remain relatively stable. Asset sensitivity remains relatively unchanged. We continue to forecast only one interest rate hike this year happening in November.

Continuing on slide 11. Non-interest income totaled $1 million, relatively flat compared to last quarter. The fee income ratio was 40.6%. Looking at a few of those components, insurance income increased $39 million or 41% annualized, mostly due to seasonal factors, higher employee benefit and property casualty commissions offset by lower life insurance commissions. Remember, our first quarter of last year included earnings of American Coastal, a business we sold last May. Excluding acquisitions, insurance income grew 1.9% versus last year.

Mortgage banking income totaled $91 million, down $13 million, mostly due to lower commercial mortgage production. Other income decreased $58 million due to a $43 million decrease in income related to assets of certain post-employment benefits and $14 million decline in client derivative income.

Looking ahead to the second quarter, including both acquisitions, our total non-interest income is expected to increase 9% to 11% versus second quarter GAAP of $1.016 billion.

Turning to slide 12. Non-interest expenses totaled $1.5 billion, down 13% versus last quarter. Personnel expense increased $22 million, driven by a $34 million increase in social security and unemployment taxes, as well as equity-based compensation for retirement-eligible associates, and a $10 million increase in higher pension expense, offset by $30 million decrease in post-employment benefits expense.

Average FTEs declined 311. Merger-related and restructuring charges declined $27 million, mostly due to Susquehanna conversion costs. In addition, other expense decreased $34 million, mostly due to the lower operating charge-offs and charitable contributions. Our effective tax rate was 30%, and we expect second quarter effective tax rate to be about 31%. We expect expenses to total $1.75 billion next quarter. This will include the initial expense base for National Penn and Swett & Crawford, plus $40 million to $50 million in merger-related costs.

We expect cost savings to accelerate after the third quarter systems conversion of National Penn and the first quarter 2017 conversion of Swett & Crawford. But in the second quarter, we may have a slight uptick in the efficiency ratio due to the timing of our acquisitions and the delayed timing of related cost savings and synergies. We remain confident we will achieve cost savings related to both acquisitions. We expect efficiency to improve later in the year.

Turning to slide 13. Capital ratios remain very healthy and fully phased in. common equity Tier 1 at 10.2%. Our LCR increased to 135% and our liquid asset buffer at the end of the quarter was very strong at 14.5%. We successfully issued $465 million in preferred stock at 5.625% which strengthens our regulatory capital in a cost effective way. Our tangible book increased 2.7% this quarter.

Finally, a comment on CCAR 2016. As Kelly mentioned, we expect to place greater priority on stock repurchases versus strategic initiatives.

Now let's look at some segment results, beginning on slide 14. Community Bank's net income totaled $310 million, an increase of $38 million from last quarter and up $101 million from the first quarter of last year. Net interest income increased $64 million from the fourth quarter, with about two-thirds of the increase driven by Susquehanna.

Turning to slide 15. Residential Mortgage net income totaled $39 million, down $10 million from last quarter, driven by seasonally lower production and lower servicing fee income. Production mix was 55% purchase and 45% refi.

Looking to slide 16, Dealer Financial Services income totaled $42 million, essentially flat as declines in segment net interest income were substantially offset by lower loan processing expense. Regional Acceptance continues to generate stable loan growth with prudent underwriting discipline. This portfolio totals $3.3 billion, and losses have normalized to the 8% range. Net charge-offs for the prime portfolio remained excellent at 16 basis points.

Turning to slide 17, Specialized Lending net income totaled $56 million, down $7 million from last quarter, driven by lower commercial mortgage and leasing income and higher provision.

Turning to slide 18. Insurance services net income totaled $53 million, up $17 million from last quarter, mostly driven by a seasonal increase in employee benefits and higher property and casualty commissions, partially offset by seasonally lower life insurance commissions. We expect Swett & Crawford to add revenues of approximately $160 million for the remainder of this year, coupled with $140 million in expenses. In 2017, we will realize synergies from the deal that will drive improved operating margins going forward.

Turning to slide 19, the Financial Services segment had $26 million in net income, down $77 million from last quarter, largely driven by a provision increase of $92 million related to the energy portfolio. Corporate banking generated 15% loan growth and wealth had 6% loan growth along with 29% transaction deposit growth.

In summary for the quarter, we achieved improved efficiency, net interest margin expansion, positive operating leverage and we feel that we are set up to have a very strong second half of 2016.

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

Kelly S. King - Chairman, President & Chief Executive Officer

Thank you, Daryl. So overall, we feel like our M&A strategy is executing very, very well. Loan growth is good, particularly in the environment. Credit quality is very good ex-energy and energy relative to the marketplace is extremely good. And so, we feel like now we have just this really wonderful opportunity to focus on realizing the advantages that we've invested in for a number of years now. So we feel really great about our opportunity to improve efficiencies and our operating profit as we go forward, so we continue to believe our best days are ahead.

So now, we will turn it over to Alan.

Alan Greer - Executive Vice President-Investor Relations

Thank you, Kelly. At this time, we'll begin our Q&A session. Ebony, if you could please come back on the line and explain how our listeners can participate and ask questions.

Question-and-Answer Session

Operator

Absolutely. Thank you. And we will take our first question from Matt O'Connor. Please go ahead.

Alan Greer - Executive Vice President-Investor Relations

Matt? Matt, we can't hear you. You're on mute.

Operator

One moment. And Matt, your line is open. Please go ahead.

Matthew Derek O'Connor - Deutsche Bank Securities, Inc.

Can you, guys hear me?

Alan Greer - Executive Vice President-Investor Relations

We can hear you.

Kelly S. King - Chairman, President & Chief Executive Officer

Yeah, Matt.

Matthew Derek O'Connor - Deutsche Bank Securities, Inc.

All right. Great. Okay. Just starting on the cost saves, could you just remind us how much is still to come from all the deals that have closed, and then will these fall to the bottom line or are there some offsets as we think about, call it core BB&T or legacy BB&T?

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

So Matt, if you go back a year-plus ago, the Citi branches and Bank of Kentucky, all those have basically come in, both the cost saves and revenues and all that. From Susquehanna's perspectives, we are probably 85% to 90% through the cost saves from that. So the rest of the cost saves will probably bleed in into our run rate over the next couple quarters or out of the community bank area. But that's where we stand there.

As far as the two deals that we just closed April 1, there's really no cost saves in those transactions. We expect National Penn had systems conversion third quarter, so you might see a little bit third quarter but more of that in fourth quarter and first quarter. And Swett & Crawford, maybe a little bit on revenue synergies this year but their systems conversion is the first part of 2017, and their cost saves and efficiencies will come in in probably in the first half of 2017.

Matthew Derek O'Connor - Deutsche Bank Securities, Inc.

Okay. That's helpful. And then just on the revenue side, I mean bigger picture, like how should we think about what areas you're trying to cross sell into, just the broader Mid-Atlantic franchise? Obviously there is the scale benefit, but what other product sets do you think can get ramped up in that franchise, and when do we start seeing some of those benefits in a more meaningful manner?

Kelly S. King - Chairman, President & Chief Executive Officer

So, Matt, we think the number, it's kind of pervasive, but the standout ones are continuing to expand the benefits from our corporate banking relationships. Recall that over the last several years, we've been starting those relationships on the credit side, and then the follow on residual benefits in terms of deposits and other fee services come. So that will be a big one. Our wealth management continues to integrate very, very well in terms of loan balances and other fee balances that are coming in. Our retail banking, retail lending is coming on very, very strong, and then the huge benefit from the insurance area as we integrate Swett & Crawford and continue to integrate Crump, and continue to use the Crump cross-sell abilities throughout the entire community bank in terms of selling life insurance. All of those are some of the ones that are really big standouts.

Matthew Derek O'Connor - Deutsche Bank Securities, Inc.

Okay. Thank you very much.

Operator

And we'll now take our next question from Michael Rose with Raymond James.

Michael Rose - Raymond James & Associates, Inc.

Hey. Thanks for taking my questions. Kelly, I just wanted to touch on the efficiency ratio. You may not hit your target this year, but that's okay. You obviously announced another insurance acquisition. Can you just give us your thoughts in light of the environment in terms of what we could expect for the insurance – or for the efficiency ratio, both maybe in the nearer term and then longer term, if there's any changes? Thanks.

Kelly S. King - Chairman, President & Chief Executive Officer

Yeah. I think we will end up this year with improvement. It may be in the 57%-ish kind of range. Feel pretty confident about that. We still think over the next two years or three years, we'll get to the mid-50s%. And I know some people talk about the low 50s%. That is not going to happen unless you get a substantial ramp-up in the yield curve. Remember this is a numerator/denominator problem.

So we're assuming that the economy will grow at 2% to 2.5%. There'll be a slow ramp-up in the yield curve, but not dramatic. Therefore, it makes it harder to grind out efficiency improvements. Still though, with opportunities that we have to generate additional revenues out of our investments we've made, and the ability to generate additional efficiencies from the investments we've made, we think we'll be able to hit those targets.

Michael Rose - Raymond James & Associates, Inc.

Okay. That's helpful. And then just as a follow-up. How should we think about the dividend payout ratio going forward? You guys are trending a little higher than you have historically. You mentioned in the prepared remarks about CCAR being more focused on buybacks this year. But should we actually expect a dividend increase this year?

Kelly S. King - Chairman, President & Chief Executive Officer

So our strategies in terms of capital deployment remain the same. But we've always said they adjust from time to time. The ones that don't change is you always use capital investment to get the nice organic growth you can get.

Number two has been and will remain dividends. The swing is between buybacks and M&A. So what I was leading to earlier is that there's a slip there for the – going forward for a while in terms of buybacks being more important than M&A, as we focus on realizing these opportunities.

Now with regard to dividends, we can certainly hope. I mean our CCAR application is in. And as you know we never can say for sure what's going to happen. But we would certainly expect to have a dividend increase, because even though our dividend payout's somewhat high, it's not high by traditional standards. And it's not the high relative to the stable revenues streams that we have. So we're very comfortable with a dividend increase this year.

Michael Rose - Raymond James & Associates, Inc.

Okay. And then maybe just one final one for me. Just on your – and I know it's small. But just in your coal portfolio, it seems like the criticized number of 15% seems a little low from what I would expect. Any sort of trends there that give you confidence that that portfolio will – the loss content won't be a lot worse than maybe my expectations? Thanks.

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

Yes, Michael. This is Clarke Starnes. Fair question. I would tell you that we have been methodically reducing our exposure in the coal space for a long time. And we believe a number of the residual borrowers we have are bankable, although we would continue to expect exposure to go down from here. We also took – as part of that $30 million this quarter, we opportunistically exited one of our larger long-time legacy watch list coal credits and got it out completely. So we feel like what's left we can manage through. Although the watch list could go up, we feel like the exposure is manageable.

Michael Rose - Raymond James & Associates, Inc.

Okay. That's helpful. Thanks for the color. Appreciate it.

Operator

And we'll move next to Betsy Graseck with Morgan Stanley.

Elizabeth Lynn Graseck - Morgan Stanley & Co. LLC

Hi. Good morning.

Kelly S. King - Chairman, President & Chief Executive Officer

Good morning.

Alan Greer - Executive Vice President-Investor Relations

Hey, Betsy.

Elizabeth Lynn Graseck - Morgan Stanley & Co. LLC

So a question, just one follow-up to the question on energy, is you did indicate – and I appreciate the color around the percentage of the portfolio that's criticized and classified. That's against a denominator that is both funded and unfunded? Or is that just a denominator that is funded?

Alan Greer - Executive Vice President-Investor Relations

Betsy, that's based on funded balances.

Elizabeth Lynn Graseck - Morgan Stanley & Co. LLC

Right. Okay. Got it. That's great. And then separately as you're thinking about how the industry progresses from here, can you give us a sense as to how you work with your clients? And how you're making the decisions to either continue to reinvest with them or to potentially help them shrink or sell or exit or reduce your exposure with them? Or is it too late for that, and what you have is what you have?

Kelly S. King - Chairman, President & Chief Executive Officer

Betsy, are you talking about primarily the energy area?

Elizabeth Lynn Graseck - Morgan Stanley & Co. LLC

Correct.

Kelly S. King - Chairman, President & Chief Executive Officer

So we made a decision, Betsy, some time ago to be a long-term player in the energy market. We are not going to change that long-term strategy. Energy is an important business for the country, for the world and for us.

We enter into relationships on a very conservative selection basis and a conservative underwriting basis. Obviously everybody is really energized about – no pun intended – about concerns about energy now. But – and we're taking it very seriously. And we're marking our book really aggressively and all that.

But look, I think there's a much higher chance that oil will be at $50 by the end of this year than $30. And I think over the long term, the energy business still will be a really good business. And so we will stick with it. And we will stick with our really good clients. And we'll continue to be supportive to the industry.

Elizabeth Lynn Graseck - Morgan Stanley & Co. LLC

And so – and do I have it correct that if oil were to be at $30 for a while that you've already done all the reserving that you need to do? Or the vast majority of the reserving? Never say 100%. But the vast majority of the reserving you need to do, in which case we should expect the provision could come down a bit next quarter?

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

Absolutely, Betsy. We believe the provision expense, unless we get something totally unforeseen, would be much lower than last quarter. To remind you we kind of said our NCO guidance is 35 basis points to 45 basis points. We would assume that we will be in low to mid range of that if we don't have an energy surprise. If we have more energy deterioration it might be mid to high.

So as Daryl said, we're expecting to fund charge-offs and keep our reserve rate for growth. And we would not expect a larger build for the second quarter. So in our 8.5%, we've assumed I think prudently and conservatively draw assumptions, and we've fully implemented the guidance. So we would not anticipate from here a significant increase in the provision.

I would mention, too, we've been through about 60% of our spring redeterminations already. Our average loan reductions were about 20% and about two-thirds of those redeterminations, we've got structural enhancement with any hoarding provisions or more collateral. So to your, Kelly's point, we're working with these borrowers and what we certainly have that we've reserved for what we know today.

Elizabeth Lynn Graseck - Morgan Stanley & Co. LLC

Okay. Great. That's helpful. Thank you.

Operator

And we'll move next to Lana Chan with BMO Capital Markets.

Lana Laiyan Chan - BMO Capital Markets (United States)

Hi. Good morning. Two follow-up questions. One, on the CCAR ask for 2016 and prioritizing buybacks and dividends, is that just for the second half of this year or does that go extend into 2017?

Kelly S. King - Chairman, President & Chief Executive Officer

Yeah. That would be for entire CCAR period, which would extend into 2017.

Lana Laiyan Chan - BMO Capital Markets (United States)

Okay. Thank you. And Daryl, if you could help me run through how we get from the first quarter expense level to the $1.75 billion in the second quarter. It just seems a little bit higher than what I would have modeled in with the adds-on. I know you gave the Swett inclusion. What else is going up in terms of the step up and what's coming from Nat Penn?

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

Yeah. I mean, if you look at National Penn and Swett & Crawford, those two add in approximately $100 million to $110 million in expenses into the second quarter off their base. And if you add in maybe an additional $30 million more in expense saves, then that leaves about $60 million left approximately. And I would say second quarter, usually we have higher revenues, so you pay out higher commissions. That's a percentage there. And then probably then the next biggest increase that we have across the board is probably just in technology and IT. We continue to invest in those areas and those areas continue to increase some.

But I feel that we are very focused on our expenses. I think we have a chance of maybe exceeding what we're saying, beating it. But right now we're just putting out conservative numbers from an expense base. But as Kelly said, we will focus on improving efficiency throughout the year. With all these acquisitions closing first of this quarter, it's going to be really messy trying to put it all together.

Lana Laiyan Chan - BMO Capital Markets (United States)

Okay. And then that starts really stepping down starting in the fourth quarter?

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

Yes. Correct.

Lana Laiyan Chan - BMO Capital Markets (United States)

Thank you, Daryl.

Operator

We'll move next to Gerard Cassidy with RBC.

Gerard Cassidy - RBC Capital Markets LLC

Good morning, Kelly. Good morning, Daryl.

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

Hey, Gerard.

Kelly S. King - Chairman, President & Chief Executive Officer

Morning.

Gerard Cassidy - RBC Capital Markets LLC

This question maybe is more for Clarke. Clearly, BB&T has done a very good job in improving its credit quality post the financial crisis. And BB&T, along with many of the other banks, all have built up the reserves this quarter for the energy, SNC exam that took place very recently. And so the question is, what did the regulators do that was so different that none of the banks had anticipated back in the fourth quarter? I know energy prices fell to below $30 in February, but were they doing stuff that just was unusual and we have not seen before which forced everybody to build up these reserves?

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

I think, Gerard, what I think the fundamental – my opinion – the fundamental change in the guidance. Historically as you know, reserve based lending, asset classifications, accrual status, impairment view was based more from a senior secured collateral asset base coverage standpoint against that primary bank debt. What's happened with this boom in the shale production with this cycle is you have a lot more secondary bond financing behind the bank grew. And the new regulatory guidance is very explicit around you have to make sure that you have sufficient cash flow coverage and asset coverage for the total debt including the secondary debt. And obviously, with the plunge in prices that nobody could have predicted, it puts enormous pressure on those ratios. So that's really the big sea change. We still believe, given all that, with enough time and with recovery in the prices that we have a good shot at getting, having better recoveries. But we have to prudently reserve in the meantime.

Gerard Cassidy - RBC Capital Markets LLC

Thank you. And then speaking of Shared National Credit exams, obviously we have the national one going on right now for all loan categories. Clarke, are you hearing of any sea changes there? Excluding the energy since you guys all just did that, but is there any talk of looking at different categories of loans quite a bit differently?

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

We are not hearing anything yet, any sort of chatter like that like we had heard with the first exam around energy. So at this point, we are not.

Gerard Cassidy - RBC Capital Markets LLC

Okay. And then, Kelly, in looking at your slide 11 in the presentation where you focus on the fee income ratio, it's dropped down quite a bit. And one of the hallmarks of your company has always been a 45% or so fee revenue to total revenue. Is this a new change that we're going to be seeing it now closer to 40% or is this a temporary change?

Kelly S. King - Chairman, President & Chief Executive Officer

No, Gerard, I think this is more temporary. I think that we've had a range of 41%, 42%, to 40% has been kind of high, frankly. But we think in terms of 42%, 43% as kind of normal. We don't want to get too far out of balance one way or the other.

So and it depends on, again, the interest rate environment. So if your interest rates go down, then your non-interest income goes up as a percentage. But on a normalized basis I'm fairly comfortable with our non-interest income, meaning we're in the 40%, 42%, 43% kind of level.

Right now so you got – recently you had the net interest income being down, which would drive the ratio up. On the other hand, insurance is not at the level that it would be relatively, because of the pace of business. And so that would affect it.

And the temporary impact has been the removal of American Coastal last year, which of course will come right back now when we added Swett & Crawford. So it's not a change, Gerard, from a long-term point of view at all. It'll be right back where we wanted to be, 42%, 43%. And then probably, hopefully, hang at that level, because hopefully the net interest income comes back up.

Gerard Cassidy - RBC Capital Markets LLC

Great. Appreciate the color. Thank you.

Operator

And we'll move next to Paul Miller with FBR & Company.

Paul J. Miller - FBR Capital Markets & Co.

Hey, thank you very much. Hey, can you – Kelly, can you talk a little bit more – the comments, you mentioned that you're going to focus less on M&A going forward. Does that mean both in the insurance side and the banking side? And you're going to focus more on capital management through buybacks?

Kelly S. King - Chairman, President & Chief Executive Officer

Yeah, Paul. That's exactly right. I'm not trying to say that we wouldn't dare do any tiny little bitty something. But as a practical matter, we are just not focusing on M&A now in insurance or bank, which is our two primary areas.

The truth is we just got a lot going on in both of them. We've just (47:31). And there's a time to buy, and there's time to run. And the last 24 months was a time to buy, because the times were right. There was a window for us, and there was some really good opportunities. And we're really happy about what we did. And now is the time to take time and to adjust what we've done and run it really, really well and get the benefit for the benefit of our shareholder. I mean this is a shareholder-driven strategy, gearing our profitability up and reaping some of the benefits of the previous investments we've made. And that applies to insurance and banking and basically everything else.

Paul J. Miller - FBR Capital Markets & Co.

So should we be modeling a higher buyback level? Or should we wait to – the Fed comes out with their tests where – what's got approved?

Kelly S. King - Chairman, President & Chief Executive Officer

Well, I mean all of us have to wait to see what the Fed approves. But I mean as a practical manner, if I were you modeling, I'd be modeling for higher buybacks.

Paul J. Miller - FBR Capital Markets & Co.

Thank you very much, guys.

Operator

And we'll move next to Stephen Scouten with Sandler O'Neill. Please go ahead.

Stephen Kendall Scouten - Sandler O'Neill & Partners LP

Hey, guys. Thanks. I had a question for you on the forward loan growth expectations. I see you put 1% to 3% kind of guidance for 2Q. Is that an expectation of slower kind of resi runoff and sales finance runoff? Or is that just higher overall originations? What's going to drive that delta quarter over quarter?

Kelly S. King - Chairman, President & Chief Executive Officer

Yeah, it's lower. The resi runoff is cleaning out if you will, and then you get the seasonal activity buildup in the second.

Stephen Kendall Scouten - Sandler O'Neill & Partners LP

Okay, makes sense. And is that kind of what you expect for the full year as well, in that 1% to 3% range?

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

So it's going to be – from an organic basis I would say we'd have a little bit more loan growth from second to third, how we sit now. I mean visibility out a couple quarters is not perfect. But if we're 1% to 3%, you might add another 1% or 2% to that for second to third. But we'll see how the economy plays out.

Stephen Kendall Scouten - Sandler O'Neill & Partners LP

Okay. Great. And then one follow-up just on the kind of uses of capital, buyback versus M&A. I mean is that something that you would consider to be a hard and fast kind of decision at this point through the next CCAR request? Or will you still have flexibility like you had kind of this year to either do repurchases or M&A, depending upon opportunities? Or is your request even submitted as simply buybacks, and we won't see them change it back?

Kelly S. King - Chairman, President & Chief Executive Officer

No, no. Our request has the same flexibility in it that we've always had. But the guidance I'm giving you with regard to our focus on profitability management versus M&A is very hard.

Stephen Kendall Scouten - Sandler O'Neill & Partners LP

Got you. Thanks, guys. I appreciate it.

Operator

And we'll move next to John Pancari with Evercore ISI.

John Pancari - Evercore ISI

Good morning, guys.

Alan Greer - Executive Vice President-Investor Relations

Morning, John.

John Pancari - Evercore ISI

On the buyback topic could you help us in how to size it up? And if it is something that's much more of a – that we could have much greater confidence in now, Kelly, how should we think about the magnitude of it? I mean you're at a 40% payout right now on the dividend. You indicated that could go up a little bit. Where could we go on the buyback? And could we be approaching somewhere in the 80s% or 90s% in terms of a combined payout when you factor in the buyback activity? Thanks.

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

Yeah, John, this is Daryl. What I would say from a CCAR perspective, obviously nothing is approved yet. But last several years we've focused and we've traditionally been one of the higher ones on the payout ratio on dividend. We hope that that would continue with CCAR 2016. Now as far as the total payout ratio goes, I would say we like where our capital ratios are today. So as Kelly said, we're going to probably use 25% plus up in capital for organic growth. So the remaining percentage would probably be in buyback.

John Pancari - Evercore ISI

Okay. All right. And then separately, Kelly, I just want to get a little bit more color around the change in tone on that front in terms of looking at more of the buyback opportunity with capital deployment versus M&A. Was there anything else that prompted that change in terms of either a regulatory environment and/or anything in terms of your – the trend in your efficiency that you're trying to get on top of something here? Thanks.

Kelly S. King - Chairman, President & Chief Executive Officer

John, it's really a matter of looking at the number of deals. Ideally to be honest we wouldn't have done as many deals in as short a period of time as we did. It's just they were available. And you can't – I wish you could, but you can't ideally lay out your M&A plans on a linear basis and project them whenever you want to have them. They come when they come. And you take advantage of them when they're there.

So we took a bit more in the last year and a half at one time than I personally would like to have. And so – and you combine that with all of the other activities we have going on, like these huge investments in the back room in terms of systems and processes and so forth. And it's just my very strong intuitive judgment, our collective team's judgment that it's just time to focus on taking advantage of what we have.

See, sometimes people think about M&A and all this as a kind of linear upward sloping line. It's not. It's more like a stair step. You ramp up in terms of acquisitions, then you take a period of time and you rationalize them and then you ramp up again. So we're in that flatter part of the stair step where we're going to be focusing on rationalizing what we've already invested in.

We think that's shareholder-friendly because if you just continually roll up all the time, you're never getting a real payback till you stop doing M&A for a little while and that's not fair to the shareholders. So this is more about taking advantage of what we did in the last year and a half. When we get that done, we'll be interested in M&A again. But for right now, we're focused on getting the advantages of what we already done.

John Pancari - Evercore ISI

Okay. Thank you. Then one last thing if I could, on the margin. I know you indicated you got one rate hike modeled in the back part of the year. If that doesn't materialize, is it fair to assume that the margin sees some erosion here if there's no Fed hike this year?

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

What I would say is right now we would be forecasting margin to probably be in the low 340s, probably for throughout 2016. Our rate hike that we have in November helps us but it's not a huge impact in the fourth quarter. So, and we're pretty much not assuming on any real rate rise help that (54:31). So we feel really good about the mix, the mixes going in our favor, loan mix, funding mix, and our spreads are coming in nicely. So our core margin has stabilized. So I feel GAAP margin in the 340s, low 340s is about right.

John Pancari - Evercore ISI

Got it. Thanks, Daryl.

Operator

And we'll move next to Kevin Barker with Piper Jaffray.

Kevin J. Barker - Piper Jaffray & Co. (Broker)

Thank you for taking my questions. Regarding net interest income and your expectations going forward, you're modeling a rate hike. Bow are you looking at the long end of the yield curve at the same time?

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

Good question, Kevin. So the rate hike is in November so it really doesn't have a huge impact on net interest income. You look at the yield curve, we would keep our yield curve relatively constant where it is today. We don't really think it's going to steepen up much in our forecast that we have. If you look at our balance sheet, our balance sheet is pretty balanced. About half of our assets are floating rate, half are fixed. So when the curve actually came down some in the early part of 2016, the fixed portion got hurt a little bit from a net interest income perspective because those get priced off the yield curve. But, and we did a great job with our funding costs, keeping that very stable. All that's very sticky. We're having huge growth in funding and wider margins in our deposit franchise right now.

Kevin J. Barker - Piper Jaffray & Co. (Broker)

Okay. And then you mentioned that Regional Acceptance had a net charge-off rate of 7.9% and the prime bulk is roughly 19 basis points, which is very good. How does that compare to the year-over-year numbers and then quarter-over-quarter?

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

Yeah, Kevin, this is Clarke. Regional Acceptance's losses are up year-over-year, so they're probably up 50 to 75 basis points or so. Our prime portfolio today is about 16 basis points, not 19, and is relatively stable quarter-to-quarter and year-over-year. So while it's very manageable, Regional Acceptance had experienced some higher loss severities. They primarily finance economy cars. If you look at Manheim over the last year or 18 months, that class of vehicles has been hit a little harder. We've adjusted for that over the last year. So and we're actually forecasting, notwithstanding the view of car prices over the next remainder of the year, we expect losses to be down more in the 7% range or so by the end of the year in regional.

Kevin J. Barker - Piper Jaffray & Co. (Broker)

What would cause that decline in charge-offs given we're continuing to see pressure in used car prices? Sorry, guys.

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

No, absolutely. It's the adjustments we made 12 to 18 months ago on our advance rates. And as those burn through, we believe will be in a much better severity position even with the decline in prices. We've been lending into lower advance rates that we feel like we'll work through some of the older credits and we'll be in a better position.

Kevin J. Barker - Piper Jaffray & Co. (Broker)

Thank you for taking my question.

Operator

And we'll move next to Ken Usdin with Jefferies.

Amanda Larsen - Jefferies LLC

Hi. This is Amanda on for Ken. Daryl, given your strong first quarter NII results and the NIM dynamics you discussed, the guide range that you guys gave at the end of last year for plus I think 12% to 14% year-over-year for NII growth. Is the high side of the range in play now?

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

On a year-over-year basis, Amanda, I think I grew very comfortable that we'll have 12%-plus growth on NII on a year-over-year basis from 2016 to 2015.

Amanda Larsen - Jefferies LLC

Okay. Thanks. And then are you expected to have some NPBC PAA in the second half?

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

Could you translate that for me a little bit, Amanda?

Amanda Larsen - Jefferies LLC

I guess do you expect to have some purchase accounting accretion from NPBC?

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

Okay, yeah. So purchase accounting, what I could tell you is, is that the Susquehanna purchase accounting is starting to come off a little bit, but we have National Penn that we have a first time for go on for this quarter. So purchase accounting is going to be pretty robust for most of this year and will trend down over time. But 2016, I feel very comfortable that GAAP margin will be in the low 340s, second, third, fourth quarters and core margin we feel has stabilized, starting to improve some. So that could actually get into the low 320s.

Amanda Larsen - Jefferies LLC

All right. Thank you.

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

Yeah.

Operator

And that concludes today's question-and-answer session. Mr. Greer, at this time, I will turn the conference back over to you for any additional or closing remarks.

Alan Greer - Executive Vice President-Investor Relations

Okay. Thank you, Ebony, and thanks to all of our listeners for joining. This concludes our call for the day. If you have further questions, please don't hesitate to call Investor Relations and we hope that you have a good day.

Operator

And this concludes today's call. Thank you for your participation. You may now disconnect.

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