BB&T (BBT) Kelly S. King on Q2 2016 Results - Earnings Call Transcript

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BB&T Corp. (NYSE:BBT)

Q2 2016 Earnings Call

July 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.

Elizabeth Lynn Graseck - Morgan Stanley & Co. LLC

Gerard Cassidy - RBC Capital Markets LLC

Stephen Moss - Evercore ISI

John Eamon McDonald - Sanford C. Bernstein & Co. LLC

Jennifer Demba - SunTrust Robinson Humphrey, Inc.

Marty Mosby - Vining Sparks IBG LP

Stephen Kendall Scouten - Sandler O'Neill & Partners LP

Matthew Hart Burnell - Wells Fargo Securities LLC

Paul J. Miller - FBR Capital Markets & Co.

Christopher William Marinac - FIG Partners LLC

Nancy Avans Bush - NAB Research LLC

Operator

Please standby, we're about to begin. Greetings ladies and gentlemen, and welcome to the BB&T Corporation Second Quarter 2016 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. It is now my pleasure to introduce your host, Alan Greer of Investor Relations, for BB&T Corporation.

Alan Greer - Executive Vice President-Investor Relations

Thank you, Levy, and good morning, everyone. Thanks to all of our listeners for joining us today. We have with us today Kelly King, our Chairman and Chief Executive Officer, and Daryl Bible, our Chief Financial Officer, who will review the results for the second quarter of 2016, and give you some thoughts about next quarter. We also have other members of our Executive Management Team who are with us to participate in the Q&A session, Chris Henson, our Chief Operating Officer; and Clarke Starnes, our Chief Risk Officer.

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 BB&T does not provide public earnings predictions or forecasts. However, there may be statements made during the course of this call that express management's 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

Thanks, Alan. Good morning everybody, and thanks to your interest in BB&T. We always appreciate you joining our call. So we had a very strong quarter from an organic performance perspective, and a strategic perspective. Net income totaled $541 million, up 19.2% versus the second quarter of 2015, and 10.7% versus first quarter of 2016. If you look at diluted EPS, it totaled $0.66, up from $0.62 on a like quarter, but down $0.01 from the first quarter, but that was due to higher merger-related and restructuring charges in this quarter, as you would expect. Adjusted diluted EPS totaled $0.71 excluding merger-related and restructuring charges, and the benefits from the special tax-advantaged assets, which I'll cover in a minute.

Our GAAP ROA was a strong 1.06%, and return on tangible common was 14.33%. And if you make the adjustments, we alluded to, our ROA adjusted would be 1.16% and adjusted return on tangible would be 15.76%, which is very good.

Record FTE revenues totaled $2.8 billion, up 17.7% versus second quarter 2015, 31% versus first quarter, obviously that was driven by our two acquisitions in this quarter. We had record net interest income of $1.7 billion, which was up 22.9% versus the second quarter, 22.8% versus the first quarter of 2016. Margin did decline two basis points in line with what we projected, and Daryl will give you a little color on that in a little bit. Efficiency was 59.3% compared to 59.2% in the second quarter of 2015, and 58.3% in the first quarter of 2016. It was up a bit as we had guided you on that because due to timing of the acquisitions and related conversions and the cost savings would impact.

Non-interest expense has increased $250 million versus the first quarter 2016, but that was led by the impact of National Penn, Swett & Crawford and the merger-related and restructuring charges. If you ex out these items, we hit the number that we had projected. And again, Daryl will give you more color on that when we go forward.

Average loans and leases, held for investment totaled $141 billion in the second quarter. It was an increase of 20.2% versus the first quarter. If you exclude the impact of National Penn, growth was still a solid 2.6%. We do continue to have runoff in our residential mortgage portfolio by design and our prime auto portfolio because of our design, structural change, due to very strategic decision related due to costs and the spreads in each one of these segments.

If you exclude residential mortgage loans and National Penn, average loans held for investment grew a very respectable 4.7%, which frankly on an economy growing 2% to 2.5% is about right what we would expect to have happened. Loan quality is great. Net charge-offs were 0.28%, lowest levels since 2006.

We did not get an objection to our FRB CCAR plan. So as you've seen, we've proposed a 7.1% increase in quarterly dividend, $640 million in share repurchases. So if you recall over the years, we've said very clearly that our priorities with regard to capital disposition is number one organic growth, number two dividends, number three M&A, and number four buybacks. So we've also said when things change, then the priorities change. So, today, organic growth is somewhat slower. We are increasing our dividend at a very nice rate. M&A is off the table, and then also buyback rise up to the higher level of importance, and that's exactly what we had said, and exactly what we plan to do.

We did complete the conversion of National Penn this last week. And it's going absolutely, absolutely great. We cannot be more pleased about that. We are very, very excited about all of our acquisitions over the last 18 months. And we really, really focus on the execution on the profit improvement that will come from them. But we continue to not be interested in M&A for a while as we said. We got plenty to do, and frankly, we owe it to our shareholders, to execute on what we already done, and that's what we are doing. If you're following on the slides, look at the slide four in your deck, this is what I was relating to before. So our merger-related restructuring charges were higher than we had expected. It is $92 million pre-tax and $58 million after tax, which was $0.07 on the diluted EPS basis.

That $92 million was made up of $63 million on merger charges from Nat Penn and Susquehanna, and Swett & Crawford, $29 million was in restructuring charges, which is including severance, branch and facility restructuring, and other real estate write downs. All of these will improve our run rate going forward. And so, while that $92 million is higher, the truth is we just simply found more opportunities than we had expected to accelerate our write-downs, and therefore, make it easy to do asset dispositions, and also reduce FTEs where we have to pay some severance that helps us going forward. So it's a good news story, a little higher, but it was higher for very, very good reason.

I do want to reinforce that we are intensely focused on expenses. We've been focusing for a number of years, as you heard me describe about reconceptualization of our business, that continues, but I would say to you, it continues at a much more intense rate. The economy is relatively slow. We project a relatively low flat yield curve for a period of time. And as a result, we are accelerating our focus on expense reductions. We still do it from a kind of top down, bottom up perspective, focusing on allowing our people to have figure out the best ways to restructure their businesses versus us trying to sit in our offices and make the decision. We think that's just about a way. Our people are excited about the endeavor, and I think that – I think we'll get really, really good results from that.

Following along on slide five, just a couple of comments only in loan area. It was a really good quarter with regard to loans. Our average loans, again, excluding Nat Penn increased 2.6%, primarily due to strong growth in C&I and CRE-IPP. C&I on a linked quarter basis was 9.4%, which is very, very strong, and CRE-IPP was 4.3%. So we feel very, very good about that. So if you exclude the residential mortgage rundown, which was by strategic design and Nat Penn, we had an annualized growth rate of 4.7% which I frankly feel very, very good about.

We did have our typical very strong seasonal performance in a number of our consumer related businesses, like Sheffield which was up 33%, dealer floor plan was up 21%, Premium Finance up 12%, and Regional Acceptance up 11.2%. So those, remember, are our very good diversifying businesses, and they are performing very, very well, very, very good quality and very, very good profitability.

So looking forward, we expect about the same kind of loan growth in the third quarter as we had in the second quarter, about 1% to 3%, unless there is some dramatic change in the economy, but that's what we would expect.

Speaking of the economy, we think the economy is okay, still growing at about 2% to 2.5%. It's been an interesting six months as we came out of the first of the year when everybody thought the world was coming to an end with changes in China and so forth, and then it settled down, more recently everybody has gotten very, very excited about Brexit. We think the Brexit change is serious, but it's been over exaggerated in terms of its impact on the world and certainly on us.

Our exports to the entire European Union is relatively small, and it just not will have a material impact on us, and probably not will have a material impact on the world, once it starts to settles. And also, as the political uncertainly wanes, we think businesses will have more confidence. Lack of confidence has been withholding back investment for several years. The way things seem to be developing on the political front, it looks like – I think the business community will feel pretty good, and certainly they will feel more confident going forward. And they do need to invest, but there has not a lot of active investments for the last several years, and I think, you're likely to see that as we head into 2017.

Nonetheless, we are planning on a continuation of the same, slow economy 2% to 2.5%, low rates. If we get higher rates, then more confidence, more investments, that's just good, but that's not what we're planning on in terms of running our businesses.

If you look quickly at slide six. We continue to improve our mix and lower our overall deposit costs. Our total deposits stand at $160 billion. That was an increase of $10 billion, obviously merger-related. If you exclude acquisitions, total deposits increased $3.9 billion, still a very strong 10.5%. And what I'm particularly pleased about is our mix improvement where our non-interest bearing deposits ex acquisitions increased $1.4 billion, or 12.1%, which is really, really strong, and we reduced our total cost of funds on deposits by another 2 basis points, which is really, really good down to 0.23%. So our deposit machine is working great, our loan machine is working solid, and as Daryl will report to you, our overall fee income businesses and our expense management is really hitting on all cylinders. So let me turn now to Daryl for some more commentary.

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 margin, fee income, non-interest expense, capital and our segment results.

Turning to slide seven. Overall, we had a really strong quarter with regard to credit quality. Net charge-offs totaled $97 million, or 28 basis points, a decrease from 46 basis points last quarter. This is our lowest charge-off rate since 2006.

We restated loans for 90 days or more past due because of our Ginnie Mae buyback program. Given this change, loans 90 days past due were essentially flat from last quarter. Loans 30 days to 89 days past due increased $89 million or 10.8%, mostly due to seasonality in our consumer-related portfolios.

NPAs decreased 1.9% to 40 basis points, with the majority of the loan portfolio showing improvement. If you look at the graph, excluding energy, NPAs have improved steadily in recent quarters.

In the third quarter, we expect NPAs to remain in a similar range, and net charge-offs to be in the range of 35 basis points to 45 basis points, assuming no unexpected deterioration in the economy.

Continuing on slide eight. We had a stable and quiet quarter in our oil and gas portfolio with lower non-accruals and substantially lower charge-offs compared with last quarter. The balances decreased 6%, and we will continue to have a good mix with less than 10% in oilfield services.

Our reserve coverage for oil and gas has risen to 9.3%, and the coverage for coal, a very modest portfolio, has risen to 9.7%. Following the spring redeterminations, we reduced our average commitments.

Turning to slide nine. Our allowance coverage ratios remain strong at 3.88 times for net charge-offs and 1.9 times for NPLs. The allowance-to-loan ratio was 1.06% compared to 1.11% last quarter. Excluding the acquired portfolio, the allowance-to-loan ratio is 1.16%. So our effective allowance coverage is strong. Remember, our acquired loans have a combined mark of about $750 million. We recorded a provision of $111 million compared to net charge-offs of $97 million. Looking forward, our provision is expected to match charge-offs plus loan growth.

Turning to slide 10. Compared to last quarter, net interest margin was 3.41% down 2 basis points. Core margin was 3.16%, also down 2 basis points. Net interest margin decrease resulted from lower interest rate environment and higher security balances as a result of National Penn. Looking into the third quarter, we expect GAAP margin to decline a few basis points, driven by lower rates, including a flatter yield curve and a reduction in benefits from purchase accounting.

We expect core margin to remain relatively stable, as lower rates will be offset by asset mix and funding cost and mix changes. We do not anticipate average earning assets to remain relatively stable next quarter. Asset sensitivity increased primarily due to changes in free funds as well as investment in deposit mix changes.

Continuing on slide 11. Non-interest income totaled $1.1 billion, up $114 million compared to last quarter. The fee income ratio improved to 42.8%. Looking at a few of the changes in non-interest income. Insurance income increased $46 million, driven by several factors. First, the acquisition of Swett & Crawford, which added $57 million in the second quarter. We also had $34 million seasonal increase in property, casualty commissions, and a $13 million increase in other insurance revenues. This was offset by a seasonal decline in employee benefit commissions of $36 million and a decrease of $23 million, which is mostly due to lower bonus commissions.

Excluding acquisitions, insurance income grew about 1% versus the same quarter last year. Mortgage banking income totaled $111 million, up $20 million, mostly due to higher gains on sale and increase in saleable residential loan volume, and seasonally higher commercial mortgage income.

The other income increased $65 million due to $65 million increase in income related to certain post-employment benefits. Looking ahead to the third quarter, total fee income is expected to be relatively flat due to a seasonal decrease in insurance revenues.

Turning to slide 12. Non-interest expenses totaled $1.8 billion, up $252 million versus last quarter. Personnel expense increased $124 million, driven by several factors. First, we had a $44 million increase in salary expense, mostly due to the addition of approximately 1,900 FTEs from recent acquisitions. We also had a $40 million increase in post-employment benefit expense, and a $36 million increase in incentives. This was due to the acquisition of Swett & Crawford and higher overall volume. Excluding acquisitions, FTEs were lower by 276. Merger-related and restructuring charges increased $69 million. We also had $29 million in restructuring charges related to severance and real estate write-downs.

In addition, other expense increased $33 million, mostly due to operating charge-offs, charitable contributions, and travel expense. Our effective tax rate was 30%, slightly below expectations due to the tax benefit this quarter. We expect the third quarter effective tax rate to be about 31%.

Going forward, our expenses will include an $11 million quarterly increase with the FDIC insurance premiums. Even with this increase, we expect expenses to decline 1% to 2% mostly due to cost saves from recent acquisitions, excluding merger-related and restructuring charges. We are still targeting to generate positive operating leverage in the second half of 2016.

Turning to slide 13. Capital ratios remain very healthy with a fully phased in common equity Tier 1 of 9.8%. Our LCR was 135%, and our liquid asset buffer at the end of the quarter was very strong at 13.7%. Finally, we were pleased to receive a non-objection to our capital plan. As a result, we will seek board approval to increase our quarterly dividend to $0.30 per quarter, and initiate a share repurchase program in the third quarter, repurchasing up to $160 million of our shares.

Now, let's look at segments, beginning on slide 14. Before I walk through the Community Banking segment, I would note that National Penn is not included. Now that the conversion is complete, those results will become part of our segment reporting next quarter. Net income totaled $294 million, a decrease of $7 million from last quarter, and up $63 million from second quarter of last year. Net interest income increased $5 million from the first quarter, and $188 million from the second quarter of 2015. A little more than half of the increase was driven by Susquehanna.

Turning to slide 15. Residential Mortgage Banking net income totaled $44 million, up $5 million from last quarter, driven by higher gains on residential mortgage loan production and sales. Production mix was 57% purchase and 43% refi, similar to last quarter.

Looking to slide 16. Dealer Financial Services totaled $51 million, up $9 million, mostly due to lower charge-offs in Regional Acceptance. Our subprime auto portfolio totaled $3.4 billion, and losses totaled 6% in the quarter, a significant improvement. Net charge-offs for the prime portfolio remained excellent at 15 basis points.

Turning to slide 17. Specialized Lending net income totaled $61 million, up $5 million from last quarter. This was driven mostly by loan and production growth in both Sheffield and equipment finance, as well as good strong production in Grandbridge, our commercial mortgage business.

Looking at slide 18. Insurance services net income totaled $44 million, down $9 million from last quarter. Non-interest income totaled $465 million, up $44 million mostly driven by the addition of Swett & Crawford and higher P&C and life commissions, partially offset by seasonally lower employee benefit commissions. Non-interest expense increased $58 million, mostly due to Swett & Crawford. Going forward, we will continue to focus on achieving both cost savings and the revenue synergies from Swett & Crawford acquisition.

Turning to slide 19, Financial Services segment had $87 million in net income up $60 million from last quarter. This was largely driven by a provision decrease of $84 million related to charge-offs and increased reserves in the energy portfolio last quarter. Corporate Banking generated 24% loan growth, and Wealth had 14% loan and 16% transaction deposit growth.

In summary for the quarter, we achieved excellent credit quality, a relatively stable net interest margin, the successful restructuring of some of our corporate real-estate, and as Kelly mentioned earlier, successful conversion of National Penn. We're working hard to achieve synergies and efficiencies from our merger partners. With a steady outlook for loan growth and tight controls on our core expenses, we're setup to have a strong second half of 2016.

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

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

Thanks, Daryl. So in summary, it was a solid quarter from an organic and a strategic perspective. We're pleased with earnings up 19%, record revenue of 18%, loan growth was very good, given the challenging environment, deposits were excellent. National Penn has been converted in a very, very excellent manner. We're executing on the cost saves from that and continuing with Susquehanna. M&A, as we said, is off the track, off the table, so we are focusing on our expense management. We're very pleased with our shareholder friendly capital plan, with the 7% increase in dividends and proposed buybacks.

And so, in this type of environment, we think the most important think to focus on is to execute with precision, generating all the revenues that we can generate out of our businesses. Having made a number of investments over the past several years, we have a lot of opportunities in our various businesses, so a lot of opportunity there. Huge opportunity to continue to focus on rationalizing our cost structure, which is our primary focus at this time.

So, let me turn that over to Alan now for Q&A.

Alan Greer - Executive Vice President-Investor Relations

Okay, thank you, Kelly. At this time, we'll begin our Q&A session. Levy, if you would come back on the line and explain how our listeners may participate by asking a question.

Question-and-Answer Session

Operator

Thank you. And we'll take our first question from Matt O'Connor with Deutsche Bank.

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

Good morning.

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

Good morning.

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

Good morning.

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

If I could follow up on the expense outlook, a very modest decline from the second quarter. I guess, first, did the conversion of National Penn, was that a little bit sooner than you had thought, for some reason I thought it could be later in the quarter, is that driving cost saves coming a little bit sooner than you had expected?

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

Matt, it was about what we had planned. Early on we said, the second quarter, but then as we went along, we realized we'd get it done at the very first part. And so, yeah, relative to in the very beginning when we announced it, it was earlier and that did accelerate some of the cost saves. That's really good for us, but that's what drove that.

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

Okay. And then just my follow-up is on the underlying expense trends at kind of call it core BB&T, maybe you could give us an update there. I know there had been some ramp-up, maybe a year ago or so, and then hope that some of those costs would run off. Maybe give us an update on how those are trending and the outlook there?

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

So generally, Matt, what's happening is exactly what we had projected. If you go back to two or so years ago, again just speaking into core area, we started a pretty major rebuild of our backroom with three major projects, our new general ledger system, which is now completed, our new commercial loan system, which is about 75% completed, and our new state-of-the-art data center, which is complete and getting ready to open. So there have been substantial upfront expenses and time commitment with regard to all of those.

We're now heading into the period of time over the next year or so as that will crest, and then we'll begin to get the benefits on a relative basis. Two kinds of benefits, one will be, you will see relatively less expenses forward versus what we just invested in the previous periods, and then we'll begin to, and this will take two years, three years, but we'll begin to get the efficiencies out of these new investments, which will be meaningful over a long-term point of view. So the core fundamental operating expenses of BB&T are poised to improve as we go forward. We're not making any grand big promises for the third quarter and that kind of thing. It was not the way we operate. But in terms of our focus today with the major projects underway and substantially complete, and with our intense focus on continued reconceptualization, we feel good about expense management going forward.

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

Okay. Thank you very much.

Operator

And we'll take our next question from Betsy Graseck with Morgan Stanley.

Elizabeth Lynn Graseck - Morgan Stanley & Co. LLC

Hi, good morning.

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

Good morning.

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

Hey, Betsy.

Elizabeth Lynn Graseck - Morgan Stanley & Co. LLC

I wanted to ask about the loan growth, and there are couple of questions here. One is, you came in towards the higher end of your range, just wanted to understand what's going on in C&I that drove some of that. It looks like to me that what else is going on? And then just bigger picture, how you think about the growth in the specialized services relative to the rest of the portfolio. Are you comfortable with allowing the specialized services growth to be a such high delta relative to the rest of the portfolio? Does it matter for RWA; does it matter for capital return longer term?

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

Betsy, this is Clarke. Regarding the C&I growth that was centered primarily much like the industry in our large corporate lending area. We still have a relative base to our peers, and we continue to have expansion in our verticals, so that you saw a lot of growth there.

This quarter our mortgage warehouse lending with low rates, that certainly seasonally moved into public finance area, in our dealer floor plan. So it wasn't any one area, it was pretty much across the board, but it was slanted toward more the corporate side. As far as our Specialized Lending area, we have said that other than subprime auto we would expect those platforms to grow relatively faster than the core bank. Now we are purposely constraining the growth in the subprime sector to make sure it doesn't grow any faster than the core bank, so we don't increase our relative exposure there. But we believe those specialized lending areas even with higher RWA still represent with the yields a very strong risk return advantage for us.

So we want to be sure we do that in a measured fashion, but we certainly would expect those to grow relatively faster than the core.

Elizabeth Lynn Graseck - Morgan Stanley & Co. LLC

And does it matter from an RWA perspective, or it's just too small to matter really as it relates to RWAs?

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

Yeah, it really doesn't impact our risk weighted assets that much, Betsy. They're good quality loans, and they're consumer portfolio, so they really don't hang around very long to figure they'll go on non-accrual. So I would say there is really minimal impact here.

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

Low variability, high resiliency in those portfolios.

Elizabeth Lynn Graseck - Morgan Stanley & Co. LLC

Great. Okay. Thank you.

Operator

And we'll go to our next question from Gerard Cassidy with RBC Capital Management.

Gerard Cassidy - RBC Capital Markets LLC

Thank you. Good morning, Kelly, good morning Daryl.

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

Hey Gerard.

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

Good morning.

Gerard Cassidy - RBC Capital Markets LLC

Kelly, you guys obviously put out very good return on average tangible common equity number today, 14.3%. The return on average shareholders equity was basically flat at 8.2%. Can you share with us how you expect to get that 8.2% higher, and if we assume cost of equity capital is around 9% to 10%, how do you surpass that in the next 12 months or 18 months?

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

Well, Gerard, as you know, I think that's a grand question for all of us in the industry today. Pre-crisis we and the other good banks were operating at about 15%. You got to start from kind of the top. Way I think about it is about 2% kind of right off the top because of higher capital. And then, you've got about 1% to 1.5%, which is just the economy, margins, et cetera, and then the difference really is in increased regulatory costs and some technological cost.

So from the capital point of view, we're going to continue to try to manage our capital efficiently, but it's going to stay high compared to past period. So that 2% at least for the short run is kind of non-retrievable, but that gets us to, say, 13%.

So the 1% to 1.5% in terms of economy, obviously, can come back, and come back quickly, depending on the growth rates in the economy and the margins. We're not counting on that, but I personally think the flat rate scenario that everybody projecting is overstated. The underlying strength of our economy is not great, but it's good. Fed, I believe, clearly knows they need to raise rates, and I think they will the minute they see a window, which could still easily happen at least one rate increase towards the fall. And then the whole thing about regulatory and technological cost is about becoming efficient; scale is part of that, and then they just need to settle in that we have put into place.

And then finally, Gerard, I would say, this is a brave new world. You can't run a bank today the way you did 5 years, 10 years, 15 years ago. Everything has to be re-conceptualized. We have a very intense focus right now on looking at our businesses, and here's kind of how I've asked our people to approach it. I'm saying go back 20 years ago when things were pretty good, and take a look at what our structure was then and examine anything today that we're doing that we weren't doing 20 years ago. If it's something that we are doing that we're absolutely required to do by regulation, then obviously we have no choice.

If it's something that has evolved, or creeped into the structure, which can happen when times are fairly good, then it is suspect. And so we're going to examine every one of those in terms of the economic productivity. And I suspect that we will find material changes. So we will be restructuring the business.

We already have a number of things underway. I'm not quite ready to announce it this morning. But we have a number of things that we're working on, not going to be any big grand announcements, not going to be any big grand announced cost saving plans; that's not our style. But you can count on the fact that we are laser focused on running our business as efficiently and getting those returns up.

I frankly think in the bottom line, Gerard, that it's a material change, and that over the next couple of years, I certainly think we'll be in the 10% range over the next couple of years, and covering cost of capital. I don't have any concerns about that. From 10% to 12% or 13% is more difficult, as I've described, and somewhat circumstantial based on what's going on in the world, but we will be in the top tier of the performing banks based on the then existing circumstances.

Gerard Cassidy - RBC Capital Markets LLC

Great. As a follow-up question to, Daryl, you pointed out on slide 10 that the interest rate sensitivity of the balance sheet has increased due to the acquisition. Do you expect to keep it at this level, or do you think you'll bring it down in the second half?

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

You know me, Gerard, I've been doing this my whole career, asset liability management, and really not a big believer in taking one big position one way or the other. We really want to be slightly asset sensitive, and just trying to invest, balance and diversify over time. You really can't project interest rates, and if you do guess right and get interest rates right once, what are you going to do the next time around. I mean, you just can't do it. I mean, our job is to produce predictable and repeatable earnings. So we will continue to invest our securities, derivatives and all that to keep very balanced approach. We'll try to stay slightly asset sensitive, and that number might move around a little bit, but you're not going to see any big change out of us.

Gerard Cassidy - RBC Capital Markets LLC

Great. Thank you, gentlemen.

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

You bet.

Operator

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

Stephen Moss - Evercore ISI

Good morning. It's actually Steve Moss for John. I want to circle back to the efficiency and the expenses, your expense plans. Wondering if you could provide updated thoughts on the efficiency ratio for 4Q 2016 and also 2017?

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

Steve, I've mentioned this before on these calls. I know everybody likes to be hyper-focused on the efficiency ratio, and we're willing to talk about it. But remember that it is a ratio, and so we have a lot of visibility in terms of the numerator, but we don't have as much visibility in terms of the denominator, that is revenues. Obviously if we did nothing today with our expenses, and the economy got better and margins got better, our efficiency ratio would go down. I mean, you wouldn't give us any credit for that, but that's what would happen.

Conversely, if you have a period where revenues go down, maybe if you're doing a great job on expenses, then your efficiency ratio goes up, you will blame us for that. So I think that efficiency ratio is taken out of context.

Having said that, we think we are generally on a downward trajectory with regard to the efficiency ratio. We're just not going to be able to give you exactly what this could be quarter-by-quarter. We think for the rest of this year and into next year, it will be down. Our intermediate term, I'll call that two years to three years to get into the 56%, 57% range, assuming reasonableness with regard to revenues, which I think will happen.

And that will be very good. That will be a top performing level of efficiency. We're not trying to drive expenses so low that we put revenues at risk. And so, I'm very, very confident about our ability to execute on a very efficient organization, and I think that will show up as a very slow, but methodical decline in the efficiency ratio.

Stephen Moss - Evercore ISI

Okay. Good. And then with regard to commercial real estate, just wondering what your appetite for growth is there, and if there are any markets you may be pulling back from?

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

Yeah, Steve, this is Clarke. We feel really good about the quality of the underwriting of what we're putting on our books today and have been doing. We saw some additional growth this quarter, a lot of that was, we're not seeing projects go out across the industry quite as fast as the secondary markets, so some of that was more around the velocity of outflows. But we are trying to be a little more measured in certain segments. We think, for example, multi-family and hospitality might be peaking or have peaked. We don't want to get ahead of the market fundamentals in any asset class. So we do not want to wake up with more concentration if there are issues in the future.

So I think you will see us be a little more measured in those sectors, and in CRE in general, although we certainly take care of good high quality clients. So, for us, we are a little concerned about some of those asset classes, and we are watching specific markets and submarkets very closely. So no particular market per se individually, but just in general, the fundamentals for each of the areas we operate in.

Stephen Moss - Evercore ISI

Great. Thank you very much.

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

Thanks.

Operator

And we'll go to our next question from John McDonald with Bernstein.

John Eamon McDonald - Sanford C. Bernstein & Co. LLC

Hi, good morning, guys. I was looking for a little perspective on the CCAR this year, you went in, looking to do more on capital return due to the hiatus on M&A and your new approval reflects that. Just wondering on the actual numbers, how did your process land on the $640 million buyback, and what looks like the total payout probably in the mid $60 million range?

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

Yeah, John. When we went through the process, you go through and you really evaluate your risks in the company, you run your stress models. The CCAR 2015, we actually used up over 100% of our capital, so our capital ratios came down a little bit. So when we did CCAR 2016, we wanted to make sure our capital ratio stayed above 10% in tangible common Tier 1, which is really what we're targeting. So you'll see us slowly accrete even with the repurchase and dividend increase, a little bit more capital over this next four quarters, probably around 20 basis points or so, which is exactly what we planned for.

If you look at our (40:00) in total in 2016 versus 2015, it's basically 5% higher. I know we did an extra acquisition and all of that, but the actual (40:10) that we came in with, came in a little bit higher overall, if you don't count the acquisitions.

John Eamon McDonald - Sanford C. Bernstein & Co. LLC

Okay. Great. And Daryl, just on your NIM outlook, could you give a little bit of color on the puts and takes on the core NIM holding flat, and then the purchase accounting drag on the reported NIM, you mentioned for next quarter. How many more quarters beyond this would you still have that?

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

In our slide, we show you GAAP margin and we show you core margin; we feel very good that core margin has stabilized. Most of our assets for the most part have been repriced. With the flatter curve, you've seen a little bit pressure on some longer assets like security investments there, but we're also still bringing down our deposit cost a little bit. You saw those come down a couple of basis points. So we feel pretty good that core margin will be pretty stable for the foreseeable future.

On the GAAP side, it's basically the difference is purchase accounting. And you're going to see – if we did no other acquisition, whatsoever, GAAP will converge to core over several years, and there will be a trajectory down over time. I wouldn't say, it's going to be steep, but just by definition, it's got to come in if we don't do any more acquisitions.

John Eamon McDonald - Sanford C. Bernstein & Co. LLC

Okay, great. And just to clarify, did you say earning assets flat next quarter, so NII is growing a little bit or what would you...

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

Yeah, yeah. So earning assets are a little bit flat, on a linked quarter basis, because when we purchase, close Nat Penn, we pre-bought their securities, and so their security portfolio, so we were a little bit big in the second quarter. So our securities will right size this quarter be around $46 billion, $47 billion in total. So that will come down a little bit. But that will be more than offset in the loan growth side. You actually get a positive mix change there, because you're getting higher yielding assets on the loan side versus what we're giving up on the security side.

John Eamon McDonald - Sanford C. Bernstein & Co. LLC

Thanks.

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

Okay.

Operator

And our next question comes from Jennifer Demba with SunTrust.

Jennifer Demba - SunTrust Robinson Humphrey, Inc.

Thank you. Good morning. Question on your M&A hiatus. How long do you think that hiatus will last, and what would cause you to get back into the acquisition game, sooner than maybe expected?

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

Well, Jennifer, we've not projected an exact timeframe, and the reason is because there is no exact timeframe. The fact is we're going to stay focused on expense management and improving our profitability and hopefully resulting in improvement in our relative stock price, until it's done. And people push me in a corner, I'll say it's longer than 90 days and less than five years, and that's about as close as I can give you. And I'm not going to try to do any less than that. I just won't. Our shareholders understand we are not going to do M&A, until we feel good about executing on what we already have invested in. Recall we bought $35 billion worth of assets over the last year and a half, and we got plenty of work to do to right size that, and get the returns for our shareholders. So I think where we are, I think this is where we're going to be, and is just really that simple.

Jennifer Demba - SunTrust Robinson Humphrey, Inc.

Thank you very much.

Operator

And we'll go next to Marty Mosby with Vining Sparks.

Marty Mosby - Vining Sparks IBG LP

Thanks. Daryl, I had a couple of very kind of technical specific questions. When you look at the postretirement benefit, you had $55 million fee income increase, $40 million in expenses, did that $15 million drop to the bottom line? And then, I think you talked about that also affecting the insurance sub-segment, where you saw expenses outpacing revenue, so I just had to know if there was some operating leverage in that segment, that maybe there was some noise that you're going to eventually see. So I just wanted to see those two things, and see if they are connected in anyway.

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

Yeah, Marty, I appreciate it. It's confusing. If you go back to the first quarter, the deferred comp pieces in the first quarter of every year there's always a piece that goes into net interest income. That was $15 million. That only happens once a year, and it's basically a result of the investments done in mutual funds.

So that really balances it out. So you have the $15 million, and then the $55 million and $40 million kind of all balance out. As far as the insurance business goes, when you bring that in, net-net day one, just their efficiency costs versus the bank, they're just a little bit higher overall, but Chris and his team are working really hard in achieving cost saves and synergies. I don't know if you want to comment?

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

Yeah. That's right, especially with Swett. We talked about a $30 million synergy opportunity. We've already actioned half of that. We won't – we'll probably realize about little less than a third of it this year, but the balance will come next year after we convert in the first quarter. But if you look back at our business over the last, say, four years, what you'll see is a relatively stable declining efficiency. So we're always trimming and pruning, but the acquisition does give us a really good opportunity to try to take the efficiency up or down.

What I would also say about Swett is it's gone exceptionally well. In fact, I can't think of one that has gone any better. We have no revenue distractions and our margin, just after having them in three months, is actually better than it was last year. So all things going really well with Swett & Crawford.

Marty Mosby - Vining Sparks IBG LP

And then, mortgage, Daryl, the mortgage-backed security rate actually went up this quarter. We've been seeing a lot of impacts on prepayment speeds and some amortization of premium because that's kind of the bonds you've been having to buy. I think it didn't have an impact on you this quarter. And then also, was there any servicing valuation adjustments embedded in your mortgage banking number for the quarter?

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

Yeah, so on the investment portfolio, you are correct and that the agency securities we've been buying, we've been buying at premiums. We're very disciplined to try to have a handle of one or two or less if at all possible. We did actually have an advantage. Now, if you go back to the crisis, we got a lot of non-agency securities back then at discounts. So we, overall, you go back quarter-after-quarter, we've been relatively balanced where the premiums on the higher quality agencies have been offset by the non-agency securities. This quarter was the big drop in interest rates. We actually saw a slight benefit in the guidance that were at a discount, the non-agency guys were prepaying faster and we were accreting more, and that's kind of that duration adjustment you saw come through. So we actually had a slight benefit in the security yields. As far as mortgage banking income goes, is that what your other question?

Marty Mosby - Vining Sparks IBG LP

That was, servicing valuations.

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

Servicing valuations. Our servicing valuations really haven't improved, or it's within a couple of basis points to what it's been of late. Now on a go forward basis, pricing has expanded. And as pricing expands and rates continue to fall, you might see an increase on a perspective basis in valuations. But right now, you look at our historical numbers and what we reported were pretty much status quo.

Marty Mosby - Vining Sparks IBG LP

Thanks.

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

Yeah.

Operator

And our next question comes from Stephen Scouten with Sandler O'Neill.

Stephen Kendall Scouten - Sandler O'Neill & Partners LP

Hey, guys. Thanks. Don't mean to continue to ask questions that have maybe already been answered on expenses, but just as it pertains to the Nat Penn cost saves in particular, would there be any of those cost saves, or any material cost saves that have already been realized, or is still the bulk of that to come kind of 3Q and 4Q?

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

The cost saves that we announced was a total of $60 million. My guess is we're probably a quarter of the way through, probably kind of $15 million right now.

Stephen Kendall Scouten - Sandler O'Neill & Partners LP

And that would have already shown up in the 2Q numbers, or those were just completed late in the quarter?

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

I would say some of that would be in the 2Q numbers. I mean whenever you announce an acquisition, you don't want it to happen, but people just start looking for other opportunities. And you saw some attrition out of National Penn as it got closer and closer to close. So you saw some of those cost saves come through a little early.

Stephen Kendall Scouten - Sandler O'Neill & Partners LP

Okay, great. And maybe just on the growth that you're seeing in Consumer Lending, specifically maybe some of the specialty sectors there, any concerns there longer term from increasing that exposure on the credit front? I know there was maybe some seasonal just kind of weakness on the consumer side here in 2Q, but any kind of longer-term apprehension about increasing that exposure?

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

Stephen, I just remind you that we strategically invested in those businesses, about 15 years or 20 years ago. We believe we have very proven, stable, sustainable platform. So our underwriting servicing approaches to these areas are very consistent. You'll see what we have experienced over the years is competitors come and go and we try to avoid reaching when they come in, and we just stay the course. And so for us, it's back to we take a long-term approach to this with a very measured view on growth and we don't try to hyper-accelerate it in any period. So I would say we don't see any big change in our strategy.

Stephen Kendall Scouten - Sandler O'Neill & Partners LP

Okay. Great. And maybe one last quick thing is on the provision, you mentioned kind of net charge-off plus provisioning for new growth. Would that be kind of a 1% provision on new growth, or how do you think about provisioning for the new loan growth?

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

More or less similar to the absolute reserve rate that we have on the total portfolio. So I think marginally for growth about what our allowance percentage is today.

Stephen Kendall Scouten - Sandler O'Neill & Partners LP

Great. Thanks so much guys. I appreciate the clarity.

Operator

And we'll go to our next question from Matt Burnell with Wells Fargo Securities.

Matthew Hart Burnell - Wells Fargo Securities LLC

Good morning, guys. Thanks for taking my question. Just, Kelly, I wanted to follow up on your comments about the efficiency ratio. Last quarter you mentioned that you were confident in getting the efficiency ratio in the fourth quarter down to sort of the 57%-ish level. It sounds like from your comments earlier today that you're getting – that you're not going to be quite as specific about that going forward. I just wanted to make sure that I heard that correctly.

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

You did. And the reason is because when we made that comment last quarter, we were assuming certain projections with regard to the denominator, revenue level, and the revenue level because the economy is just a little bit softer. So it just makes that a little bit harder to get to that, maybe to 57%, 58% level. I'm hedging a bit, to be honest, because if revenues come in stronger, we might hit that.

But I'm mostly trying to say that this is not that kind of a precision ratio that you can project with absolute certainty. So I'm not saying anything in terms of our taking away from our commitment to expenses. We hit our expense number for the second quarter. We will be able to do exactly what we said in conceptually with regard to expenses for the next several quarters; and the ratios will pop around based on what happens to the revenue.

Matthew Hart Burnell - Wells Fargo Securities LLC

Okay. Understood. And then just a question on the insurance business, which you mentioned ex-acquisition over the past year is up about 1% in terms of revenue. I'm curious in the newly acquired markets, I guess, specifically Susquehanna, are you seeing greater traction in those markets in terms of your ability to get into those markets and sell insurance products, or is it at this point a little too early to tell?

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

That's a fair question. It is up about 1% common quarter, year-to-date it's actually up closer to 1.4%, 1.5%. So it was both Susquehanna and National Penn, which is unusual. We picked up small retail agencies. So they already had agencies in market. They're not big enough long term. We'll have to add to that chassis. But they are very excited about the horsepower their overall agency brings, and we'll be able to bring much larger variety of product like aviation, performance payment bonds, access to things they never had before, they'll get through our franchise. But it does take some time, but I would say that we're already in the market, rattling the sabre, and there is a lot of excitement, and we would anticipate more momentum as we go in that market; just like we would and will for example. Good insight.

Matthew Hart Burnell - Wells Fargo Securities LLC

Okay. Thanks for taking my question.

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

Sure.

Operator

We'll go to our next question from Paul Miller with FBR & Company.

Paul J. Miller - FBR Capital Markets & Co.

Hey, on a follow-up on that. Thanks a lot guys. And a follow-up on that question, you've been in Philly, you've been in Philly now for over a year. What are some of the opportunities that you see there that maybe you didn't see when you first entered the market? Because everybody is always talking about how Philly is a very tough market for outsiders.

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

So from a general point of view, Paul, the receptivity we've had in Philly has been fantastic. We are a top 10 U.S. bank, and we have very, very good capabilities to help medium size, larger businesses. And the people there frankly like us. I mean we are very well received in terms of our culture and our style of doing business, and so the receptivity has been very strong. And keep in mind that with National Penn and Susquehanna, while they have good relationships with a lot of the players in that market, they haven't had the capacity to be able to meet a lot of their needs.

So the hardest part in those kind of relationships is developing trust with the leaders of the companies, the CEO and the CFO. We have that kind of trust and relationship built up for years and years and years through our people up there and all of our people are in place. And so now what we have to do is lever those trust and relationships with our additional capacity. So early feedback from our people is frankly very, very positive.

Paul J. Miller - FBR Capital Markets & Co.

Okay. Hey, guys. Thank you very much.

Operator

And we'll go to our next question from Christopher Marinac with FIG Partners.

Christopher William Marinac - FIG Partners LLC

Thanks. Good morning, guys. Kelly and Daryl, I was wondering if you could elaborate on the ability to organically grow in markets that are tangent towards BB&T, whether that's in Pennsylvania, Ohio or really other parts of the Southeast?

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

Chris, I think that Pennsylvania obviously is a major growth for us, but as far as growing tangentially, we're not focused on it trying to grow really around our footprint. The only exception to that I would say is, we are now in Ohio technically through Cincinnati. We'll certainly spring forward through our Corporate Banking efforts up into all of the major markets in Ohio. But frankly, we've been working on that for a while anyway.

As you know, our Corporate Banking initiative is a national platform anyway. So you're probably talking specifically about retail, and we do not expect any retail movement outside of the existing defined footprint for a period of time. We've got a lot of work to do in all the areas we're in, and that's where we will stay focused.

Christopher William Marinac - FIG Partners LLC

Okay. So the digital banking efforts really it's hard to push those beyond the current borders of the footprint?

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

Well, I think as digital transformation – that's an insightful question, digital transformation continues to occur, there will be the possibility of expanding beyond your footprint, obviously not through branches, but through pure social media and other techniques with regard to expanding digitally. That's why, Chris, last year we named one of our new executive management members as our Chief Digital Officer. He has assembled his team. He is aggressively working on what is our strategy with regard to expanding digital within our "geographical footprint" but much broader than that. So it is – that will be a much broader footprint initiative.

Christopher William Marinac - FIG Partners LLC

Great, Kelly. Thank you for the feedback. I appreciate it.

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

You bet.

Operator

And we'll go next to – we'll take our final question from Nancy Bush with NAB Research.

Nancy Avans Bush - NAB Research LLC

Good morning, Kelly. This might be a good way to end. I'm listening to your guidance about expenses, and you said that there would be – the efficiency ratio would have a downward trajectory, but you can't predict quarter-by-quarter. We've got one significant piece of news this morning and it's apparently Jamie Dimon and Warren Buffett and Larry Fink and some others have gotten together, they are going to put forth a set of principles, I guess, for corporate governance or corporate behavior, and one of them is a lessened emphasis on quarterly guidance. And I would contend that the banking industry has probably been one of the ones most negatively impacted by the need to guide on a quarterly basis. Can you just reflect on that and can you envision a time in which your company would not give quarterly guidance?

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

Well, Nancy, it's good to hear from you, and obviously I just heard that announcement this morning as you did, but I really agree with where they are coming from. I think that businesses in general and the banking industry in particular are doing an injustice frankly to the market at large and to our own shareholders, in terms of trying to be that specific, in terms of projecting quarter-to-quarter. It just makes no sense. That's the way, it's always been. And so, we've kind of fallen into that trap. But as you've heard me say over the last year or so, I've been trying to dislodge us from just talking about efficiency ratios and things like that because of exactly what Jamie and them are talking about.

So we will definitely follow us along with that momentum, and yes, I can foresee us not giving guidance. Frankly, what I like to say to our shareholders is that, my pledge to you is that we are going to work really hard to provide a good long-term growing, steady, less volatile total shareholder return that will be a top tier type performance. That's about as far as I think we're ought to give. And then, they measure us over time, and if they like what we do, they buy more stock, they don't they sell.

Nancy Avans Bush - NAB Research LLC

Okay. All right. Thank you very much. It's an interesting concept and I hope, it develops as well. It's just hard to see at this point, how we would get from here to there. There would have to obviously be a transitional time, particularly for the banking industry to put forth certain ratios or whatever that would be the guiding principle. But anyway, let's keep hoping.

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

I think that folks like you that are well respected in the industry can help. And I think, the major banks, I'm glad that Jamie is on board, and I think if all the major banks will start moving in that direction, I think, you will see it move very quickly.

Nancy Avans Bush - NAB Research LLC

Thank you.

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

Thanks. Have a good day.

Operator

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

Alan Greer - Executive Vice President-Investor Relations

Okay. Thank you, Levy, and thanks to everyone for joining us today. This concludes our call. If you have further questions, please don't hesitate to contact Investor Relations. Thank you, and I hope you have a good day.

Operator

This concludes today's conference. We appreciate your participation. You may now disconnect.

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