Truist Financial Corporation

Ladies and gentlemen, thank you for standing by. Welcome to the SunTrust fourth quarter 2018 earnings results. As a reminder, today's conference is being recorded. I'd now like to turn the conference over to Ankur Vyas. Please go ahead.

Thank you, Stacey. Good morning and welcome to SunTrust's fourth quarter 2018 earnings conference call. Thank you for joining us. In addition to today's press release, we've also provided a presentation that covers the topics We plan to address during our call. The press release, presentation, and detailed financial schedules can be accessed at investors.suntrust.com. With me today, among other members of our executive management team, are Bill Rogers, our Chairman and Chief Executive Officer, and Allison Dukes, our Chief Financial Officer. Before we get started, I need to remind you that our comments today may include forward-looking statements These statements are subject to risks and uncertainty and actual results could differ materially. We list the factors that might cause actual results to differ materially in our SEC filings which are available on our website. During the call we will discuss non-GAAP financial measures when talking about the company's performance. You can find the reconciliation of these measures to GAAP financial measures in our press release and on our website, investors.suntrust.com. Finally, SunTrust is not responsible for and does not edit nor guarantee the accuracy of our earnings teleconference transcripts provided by third parties. The only authorized live and archived webcasts are located on our website. With that, I'll turn the call over to Bill.

Thanks, Arthur, and good morning, everyone. I'll begin with an overview of the fourth quarter and full year, which we highlight on slides three and four, and then I'll turn it over to Allison for some additional details. I'll conclude with some more strategic perspectives on our 2018 performance, our purpose, and thoughts heading into 2019. Core earnings per share were $1.50 this quarter, which excludes 10 cents per share in previously disclosed charges associated with the settlement of a legacy pension plan. Overall, I'd characterize this quarter as a good conclusion to a strong year for SunTrust. We delivered 3% revenue growth driven by net interest income as a result of both margin expansion and strong, broad-based loan growth. The loan growth we delivered this year is driven by the strategies of and the investments in our businesses, including consumer lending, CRE, and commercial banking, the success of our advice-oriented model, and our increasing relevance with our corporate client base. Market conditions made fee income growth more challenging in 2018, particularly within capital markets and mortgage. Nonetheless, the diversity of our business model enabled us to deliver solid overall revenue growth. We achieved our sub-60 adjusted tangible efficiency ratio target a year earlier than we anticipated. We originally set this target back in 2012 when our efficiency ratio was 72%. At the time, this was a highly aspirational target. We did not know when we would get there, but it was important to be ambitious. While this is a milestone, as we've said before, it is not a stopping point. And finally, we delivered 41% growth in capital returns to our owners. Our dividend per share increased by 36% and today we have a 3.5% dividend yield. Additionally, over the last two quarters we've purchased $1.25 billion worth of shares and have $750 million of capacity in the first half of 2019. The net result of our progress across these three fronts, coupled with a favorable operating environment, was a 40% increase in adjusted earnings per share. Importantly, our progress this year is consistent with a longer term trend. 2018 marked the seventh consecutive year of higher earnings per share, improved efficiency, and higher capital returns. This progress, which builds upon a higher base each year, is just one indicator of the culture of continuous improvement and high performance we've instilled across the company. Relatedly, we're adding a new medium-term efficiency target of 56% to 58%, which formalizes comments I've made in the past that we see several hundred basis points of additional opportunity. Our pace of improvement in any given year will vary based on macroeconomic environment and the investments we may pursue. but I have confidence in our ability to make continuous improvements each year as we work towards this targeted range. As it relates to fourth quarter results, I'll let Allison get into the details, but at a high level, we ended the year with strong revenue. In fact, revenue in the fourth quarter was a high watermark for the year. This was primarily driven by continued growth and net interest income, in addition to a very good quarter in commercial real estate related fee income, which more than offset the impact of market conditions out on capital markets revenue. Separately, credit quality continues to be a strength for us, not only because of the favorable operating environment, but also because of our disciplined risk culture. Our consistently low charge-off ratio, which was 26 basis points in the fourth quarter and 23 basis points for the full year, combined with the strength in asset quality drove a four-basis point decline in our A-triple-L ratio for the fourth quarter. Leading and lagging indicators of credit quality continue to be very strong, and we remain optimistic on our outlook for the U.S. economy. We will be diligent in monitoring for any changes, and most certainly will maintain our focus on diversity and a conservative credit risk posture, helping position our company and balance sheet for more consistent through-the-cycle performance. So with that, let me turn it over to Allison to cover some more of the specifics.

Thanks, Bill, and good morning, everyone. I'll start with net interest income on slide five. Our net interest income increased by $36 million, or 2% sequentially, driven by strong loan growth. Our net interest margin was stable sequentially as the benefit of the September rate hike was offset by higher wholesale funding to support the loan growth in the quarter. Looking to the first quarter, we expect the net interest margin to be generally stable relative to the fourth quarter. Beyond that, NIM trends will depend on the rate environment, future levels of loan growth, and funding costs. As a reminder, there are two fewer days in the first quarter compared to the fourth quarter, which negatively impacts net interest income by approximately $10 million per day, all else equal. Now moving to slide six, non-interest income increased by $36 million sequentially, driven primarily by commercial real estate related income. Specifically, our structured real estate business had a good quarter, and the other two components of this line item, SunTrust Community Capital and SunTrust Agency lending, are seasonally higher in the fourth quarter. Our strength in CRE fee income more than offset the decline in capital markets-related income, which was impacted by market conditions. Investment banking income declined due to lower high yield and equity origination activity, as investor sentiment declined throughout the quarter. Within trading income, our corporate bond inventory for clients was marked to market lower. However, we had record capital markets revenue from our non-CIB clients, which tend to be less impacted by market conditions. Mortgage-related income was stable sequentially as lower production income was offset by higher servicing income, both generally consistent with seasonal trends. Separately, going forward and beginning with the 10K, we will combine our mortgage production and servicing line items into a consolidated mortgage-related income line item. Other non-interest income increased sequentially as mark-to-market losses on certain FinTech equity investments were offset by mark-to-market gains on our credit default swap hedge portfolio. Moving to expenses on slide seven. As we disclosed last quarter, we terminated a legacy pension plan that we acquired as a part of the National Commerce Financial Acquisition in 2004. This resulted in a one-time $60 million charge and helped de-risk the balance sheet. This charge had a minimal impact of book value as the settlement simply shifted unrealized losses within AOCI through the P&L and into retained earnings. Excluding this, expenses increased by $38 million, driven by certain discrete items and normal quarterly variability. Within operating losses, we had higher legal-related expenses and elevated fraud costs. Additionally, a large tenant in one of our owned office buildings terminated their lease early, which benefited net occupancy expense in the third quarter. Lastly, other non-interest expense increased due to the cost associated with the termination of a vendor contract, a decision we made as a part of our ongoing efficiency efforts. These discrete items were partially offset by lower regulatory assessments as a result of the removal of the FDIC surcharge, which was a $19 million benefit, in addition to a separate one-time $9 million FDIC refund. Outside processing and software expense increased 3% sequentially and 13% compared to the fourth quarter of 2017. The primary driver is increased software amortization expense for new and upgraded technology assets. As a reminder, our core personnel expenses, which excludes the $60 million pension charge in the fourth quarter, should increase by approximately $60 to $75 million in the first quarter due to the typical seasonal increase in benefits and FICA costs. Our effective tax rate was 16% in 2018 as we benefited from certain discrete tax benefits, as a result of the finalization of tax reform. Looking into 2019, we would expect our effective tax rate to be approximately 19% and 20 to 21% if you model us on an FTE basis. As you can see on slide eight, the adjusted tangible efficiency ratio was 58.6% for the quarter and 59.6% for the full year. We achieved 150 basis points of improvement this year, the highest degree of improvement we have delivered since 2014, even more notable when considering the 40 basis point FTE calculation headwind from 2017 to 2018 given lower tax rates. This strong progress enabled us to reach our sub 60% target one year earlier than our stated goal. The benefits of this progress, combined with less macroeconomic tailwinds, will mean that 2019 improvement will be less than 2018. However, we continue to expect momentum as we work towards our medium-term target of 56% to 58%. Equally important, we remain focused on continuing to create capacity to invest in technology and talent, given the compelling opportunities we have, which we believe will create the most long-term value for our clients and our owners. Our performance in 2018 validates our ability to do this. As an example, outside processing and software costs, which is where a portion of our technology spend resides, increased by 10%. However, our overall adjusted expense base declined by 1% as a result of our ongoing efficiency initiative, including a significant organizational restructuring we conducted in the latter half of 2017. Moving now to slide nine.

Our net charge-off ratio was 26 basis points in the fourth quarter, consistent with our prior guidance.

The low level of net charge-offs reflects the relative strength we are seeing across all of our portfolios. Performance we are extremely pleased with, though we remain cognizant that there could be some variability and normalization going forward. Non-performing loans declined from 47 basis points to 35 basis points sequentially. This improvement was driven by the resolution of certain CNI credits. The A-triple-L ratio declined by four basis points sequentially as a result of continued asset quality improvement. Provision expense increased by $26 million as a result of higher loan growth in the fourth quarter. More broadly, we continue to maintain a strong overall risk discipline. In addition to the credit quality results, this is evidenced by the effectiveness of our low-bar approach in CIB, our ability to fully syndicate all leveraged lending transactions in the fourth quarter, are proactive hedging process in both our credit and MSR portfolios and our relatively neutral interest rate risk positioning. Looking into 2019, we would expect our net charge off ratio to be between 25 and 30 basis points for the full year. We do expect the A triple L ratio to generally stabilize from here, which would result in a provision expense that modestly exceeds net charge off given loan growth. Moving to the balance sheet on slide 10. The improved lending trends we saw in the second and third quarters continued in the fourth quarter with average loans up 2.5% sequentially and 4% year-over-year. The growth was diversified across CNI, CRE, consumer lending, and mortgage. Wholesale loan growth was broad-based across each of our lines of business. Within CIB, loan growth was primarily driven by M&A activity and modestly higher revolver utilization. Commercial banking growth was largely driven by seasonal increases in our auto dealer portfolio, in addition to continued positive trends in our aging services vertical and our expansion markets. CRE growth continued as a result of investments we have made in permanent lending and bridge lending capabilities, which is being partially offset by runoff in the construction portfolio. Within consumer, the ongoing investments we have made in our digital and point-of-sale lending capabilities, which provide for superior client experience, are also driving good growth and enhancing our returns. Our mortgage, auto, and credit card portfolios also demonstrated solid and steady growth in the quarter. Across both wholesale and consumer, our underwriting discipline has not changed, and we remain highly focused on ensuring that the quality of our new production is consistent with the quality of our existing portfolio. On the deposit side, average balances increase sequentially, driven by seasonal growth and now accounts. As anticipated, we continue to see a migration from lower-cost deposits to CDs, largely due to higher rates and our targeted strategy, which allows us to retain our existing depositors and capture new market share. Interest-bearing deposit costs increased 10 basis points sequentially, slightly lower than the prior quarter increase of 11 basis points. We expect deposit costs to continue to trend upwards, but the trajectory will be influenced by the rate environment in addition to the levels of loan growth we are delivering. At the same time, we remain focused on investing in products and capabilities which enhance the client experience outside of rate paid. Moving to slide 11, which provides an update on our capital position. Our estimated Basel III common equity Tier 1 ratio was 9.2% and the Tier 1 ratio was 10.3%. Both are down relative to the prior quarter due to strong loan growth and a higher share repurchase in the fourth quarter. We continue to make progress towards our 8% to 9% target CET1 ratio. In accordance with our 2018 capital plan, we have $750 million of remaining authorization for the first and second quarters of 2019. Our capital plan does contemplate a preferred issuance as we work towards optimizing our capital ratios. However, the timing of that issuance will depend on market conditions.

Now moving to the segment overviews, we'll begin with consumer on slide 12.

We made good financial progress across most metrics in consumer in 2018. We delivered strong operating leverage with revenues up 4% and expenses up 1%, resulting in 200 basis points of efficiency improvement and a 55% increase in net income, which was bolstered by lower tax rates and strong credit quality. Coming into 2018, a key area of focus and investment for us was to build on the momentum we had with our digital and point-of-sale consumer lending platforms. Specifically, within Lightstream, we focused on enhancing our marketing and analytics efforts, adding new product offerings, including a new home improvement loan, and growing our partnership and referral channels. Within point-of-sale lending, we focused on adding additional partners to diversify our portfolio. We added two additional partners, both focused on aspects of home improvement. While these two partnerships are small in the context of the overall company, they reflect our investments in purpose-based, point-of-sale digital financing. These investments have put us at the forefront of when and where consumers make their lending decisions. Lightstream and third-party partnerships combined delivered approximately $2 billion in loan growth in 2018, improving growth and returns within the consumer segment. The loan growth we delivered continues to be high quality. Our new production FICOs within consumer lending averaged 766 in 2018, stable relative to 2017, which is a reflection of our consistent underwriting discipline and conservative risk posture. Importantly, we were able to fund the entirety of our loan growth in consumer with deposit growth. We were early and intentional in promoting CDs to both attract new clients and retain existing clients. This proved to be an effective strategy. We generated approximately $3 billion in CD growth within consumer, and 42% of our production was new money. On the fee income side, there were headwinds, particularly within the mortgage line of business, which represents nearly 20% of consumer's fee income and was down $80 million compared to 2017, as a result of lower volumes and compressed margins. Some of these declines were offset by wealth management, where we are seeing positive underlying trends. One of our primary areas of focus within wealth management in 2018 was hiring new advisors and expanding into new markets. New production AUM in 2018 was $4.2 billion, 70% higher than 2017, which helped offset the market pressures we felt in the fourth quarter of 2018. Improved revenues coupled with our ongoing expense discipline drove a 200 basis point improvement in efficiency, helping consumer make significant progress towards its medium-term objectives. This was driven by a number of actions in 2017 and 18, including organizational restructuring, more automation within the middle and back office of private wealth, the merger of SunTrust Mortgage into SunTrust Bank, and increasing digital adoption, which is directly correlated with our ability to rationalize our physical footprint. We also made significant strides in improving the client experience, largely driven by our ongoing investments in technology. We created the first API to connect our front-end and back-end mortgage system, the result of which is a fully digital mortgage application, Smart Guide, which we introduced in March. Since its introduction, we have already achieved 64% adoption and should see further progress from here. This not only provides for a superior client experience, it also streamlines our underwriting process and reduces loan cycle origination time. For our private wealth clients, we introduced a new digital client portal which provides clients with a bespoke, holistic view of all aspects of their financial lives and includes enhanced financial planning tools. These investments, combined with our talented team, played a significant role in the national recognition we received in 2018, some of which is highlighted at the bottom of slide 12. 2018 was a good year for consumer, and we're pleased with the progress we made in enhancing the client experience, improving our efficiency and effectiveness, and making investments which position us for future success as we work to anticipate and exceed evolving client expectations. Moving to the wholesale segment, on slide 13, where we had another strong year despite challenging market conditions in the last few months of the year. Our success is evidenced in both top line and bottom line results. We achieved record revenue and net income in 2018. Revenues grew by 2%, driven entirely by net interest income as a result of NIM expansion and 1% loan growth, and net income grew by 24%, driven by $67 million or 3% increase in pre-provision net revenue. Big picture, it's clear that we have a competitive advantage within this business. We win because of our focus on the middle market, the quality of our people, the advice they deliver, and the way we work together. It was encouraging to see lending trends improve relative to 2017 when our strong production levels were being masked by elevated pay downs and lower utilization. On the CNI side, much of our growth was driven by M&A, increased revolver utilization, and the investments we've made in expanding our aging services vertical and the geographical reach of our commercial banking business, most recently evidenced by the announcement of our new Houston Commercial Office in November. On the CRE side, we saw good growth and positive remixing within the portfolio as a result of the investments we made in new lending capabilities. Historically, we did not have the product suite to participate in the full life cycle of an asset, and we were heavily weighted towards the construction phase. In 2017, we added permanent and bridge financing capabilities, which helped us replace the runoff in the construction portfolio with high-quality funded assets. Importantly, this land growth did not come at the expense of risk or return discipline. Our model is focused on leading with advice, not structure or price. As proof, our revenues from loan syndications were down 15%, which is a reflection of both market conditions, the impact non-bank lenders had on the space, and our discipline. We have a highly skilled and disciplined syndications team, and we passed on a number of transactions where the structures did not comply with our standards. While non-interest income was down, largely as a result of market conditions, there are very positive underlying trends which validate our strategic progress. First, we had record performance in M&A and equity originations.

Two strategic areas of our capital markets platform, which are in earlier stages of their maturation and growth.

Second, as I mentioned earlier, we're seeing great momentum in delivering capital markets products and solutions to our commercial banking, CRE, and private wealth clients. Compared to 2017, capital markets revenue from these clients increased 49%. a clear reflection of our ability to work effectively across lines of business within wholesale as one team. And third, we had a particularly good year in structured real estate as a result of our strong client relationships and deep structuring expertise. As within consumer, across wholesale, we remain focused on investing in technology with the goal of arming our teammates with the tools they need to maximize their effectiveness and provide clients with an improved experience especially within Treasury and Payments. In 2018, we completed the transition to Sunview, our new Treasury and Payments platform. And we're now focused on expanding Sunview into a broader wholesale client portal. Big picture, we continue to see the benefits of our advice-driven model and are pleased with the progress we made in meeting more client needs, providing superior execution for our clients in varying market conditions, elevating our relationships and making investments which position us for future success as we work to anticipate and exceed client expectations. Our investment banking and lending pipelines are solid. We feel well-positioned to meet our clients' needs, both in benign and more challenging markets. With that, I'll turn the call back over to Bill.

Thanks, Allison. So to conclude, I'll point to slide 14, which highlights how our performance this year builds upon our longer-term trends. As you can see, for each of the last seven years, we've delivered higher earnings per share, improved efficiency, and higher capital returns. While our financial performance in 2018 was strong, I want to highlight some of the underlying trends and progress we made in 2018 which drove these results, all of which supports our investment thesis. The first pillar of our investment thesis is investing in growth and technology. We have been and will continue to be incredibly disciplined about making consistent strategic investments to diversify our revenue mix, improve the client experience, and position us for future success. As an example, one of our key priorities has been to deliver on our capital markets capabilities to our commercial banking, CRA, and PWM clients. As Allison mentioned, we saw the benefits of our successful execution here in 2018 Capital markets revenue from non-CIB clients reached a record level in the fourth quarter of 2018, and for the full year, this client segment grew to represent 20% of our total capital markets revenue. Our ability to capture additional market share within this non-CIB client segment, which tends to be less impacted by market conditions, helped offset some of the headwinds we faced. Within consumer, we made significant investments in technology that put SunTrust at the center of our clients' decision-making and financial planning. We recognize that consumer preferences are evolving rapidly and investments we have made in our digital and point-of-sale lending capabilities have put SunTrust at the forefront of when and where clients make a decision. The growth we produced in consumer lending this year was a key driver of our loan growth, our improved net interest margin, and our balance sheet diversity. More broadly, we made good progress in advancing our technology position in 2018. Between ongoing improvements to our mobile and online capabilities for consumer clients, the introduction of our enterprise client portal for private wealth clients, our new Smart Guide digital mortgage application and the final rollout of Sunview, we significantly improved the client experience in 2018. In addition, we made investments in teammate-facing platforms such as our Digital Client Conversation Guide to make it easier for teammates to anticipate and meet more client needs. Lastly, we made good progress in modernizing our infrastructure by moving more of our digital properties to the cloud and making further enhancements to our security capabilities. The second pillar of our investment thesis is improving efficiency and returns. While you can see the strong progress we made in 2018, What may not be as evident is the performance-based culture we've created. Continuous improvement is embedded in all aspects of how we run our company and will deliver further efficiency progress each year as we work towards our medium-term target of 56% to 58%. As we do so, we're highly focused on making the right tradeoffs between saving and investing to maximize our long-term potential. Relatedly, focusing too much on one metric will not maximize long-term value for owners, which is why we have a broader focus on returns. In 2018, our ROA improved by 20 basis points and our adjusted ROTCE improved by 470 basis points. Clearly, some of this improvement is reflective of the benefits of tax reform, but it's also due to our internal focus on maximizing risk-adjusted returns and being disciplined about the client business we'll pursue and accept. We'll maintain the same level of discipline in 2019 and beyond. The third and final pillar of our investment thesis is our strong capital and risk position. In 2018, we stayed true to our key tenets of diversity and discipline. The loan growth we produced was high quality and broad-based. Our discipline around areas like leveraged lending prevented us from experiencing any latent distribution risk. The low VAR approach of our trading business protected our downside risk in the final months of the year as did our credit risk hedging strategies. And finally, a relatively neutral interest rate risk profile positions us well for potential change in the rate environment. On the capital side, our continued strong performance in CCAR afforded us the ability to increase capital returns by 41%, reduce our share count by 5%, and maintain a healthy dividend yield. Going forward, we remain focused on ensuring we have both a strong offense and defense in order to demonstrate more consistent through the cycle performance. I assure you we have been and will remain incredibly vigilant by looking for early warning signs, anticipating future risk and taking actions accordingly. I'm also proud of the actions we took and behaviors we demonstrated in 2018 to exemplify our purpose and culture. We are a purpose-driven company focused on lighting the way to financial well-being. This provides the foundation for our strategy and focus. Our purpose-driven culture is exemplified in our ability to work together as one team, agnostic to products and lines of business, with the ultimate goal of providing clients the solution that meets their needs, not ours. At SunTrust, our diverse team is critical in meeting and exceeding client expectations, delivering top financial performance through multiple cycles, and ensuring our purpose-driven success. And I'd be remiss if I didn't pause here for a minute and thank all the great SunTrust teammates whose tireless dedication to our purpose and relentless focus on our clients were the key contributors to our financial success in 2018. So team, thank you. While market conditions may present certain headwinds in 2019, we're focused on the factors we can control, and I'm highly optimistic about our future. We have a tremendous opportunity to bring our advice-oriented, purpose-driven model to more wholesale and consumer clients and prospects. We'll continue to make investments to enhance our technology position, and we'll continue to deliver improvements and efficiency, and we'll maintain our disciplined, conservative risk posture. So with that, let me turn it back over to you and the Q&A.

Great. Stacey, we're now ready to begin the Q&A portion of the call. As we do that, I'd like to ask the participants to please limit yourself to one primary question and one follow-up so that we can accommodate as many of you as possible today.

Thank you, ladies and gentlemen. If you wish to ask a question, please press star then 1 and you may remove yourself by pressing the pound key. Once again, if you have a question, please press star then 1 at this time. And our first question will go to John McDonald with Bernstein. Please go ahead.

Hi, good morning.

Good morning, John.

Guess there's a question for Allison. Your loan growth was really strong and accelerated this quarter. So I was kind of wondering if you could discuss your expectations for loan growth to continue exceeding core deposit growth and how you guys think about kind of evaluate filling that funding gap, you know, and choosing between wholesale borrowings, debt issuance on the one hand versus going out, paying up for online deposits, even starting up a national digital strategy. Just kind of how you think through that funding gap option, and also what's your comfort zone on where you'd like to be on loan to deposit ratio. Thanks.

Sure. Let me just start with loan growth and our outlook there. I mean, you did hear us say we've got solid pipelines. I think you can expect our loan growth to continue to be good throughout 2019. As Bill noted, our outlook on the economy is optimistic. Markets look healthy. Consumers look healthy. Businesses look healthy. As I think about our funding sources, I do expect that loan growth likely will continue to modestly outpace deposit growth throughout the year. As we think about funding, we're obviously balancing growth and deposits with profitability. It's a balancing act, and we're carefully looking at the marginal cost of deposit funding against the marginal cost of wholesale funding sources. From a loan-to-deposit ratio perspective, we're at 93% finishing up the year. I think we'd be comfortable in that 95% to 100% context. I wouldn't expect to see us go any north of that, but we feel good about the access we have to alternative funding sources, whether that's the unsecured debt markets or the FHLB.

Okay, great. And then just to follow up, Alison, what are the puts and takes to your NIM outlook for the fourth quarter that you gave? And if you could just let us know how you're thinking about how helpful a rate hike is and how you behave on the NIM when there's not a rate hike, that would be great. Thank you.

Sure. And I think you're asking the outlook on our first quarter NIM guidance and the puts and takes there. First, there's certainly the benefit that we will receive from the December rate hike. Second, As we noted, there are two fewer days in the quarter, so while that does have a negative impact to NII, it's helpful to NIM. And then third, offsetting that would be our expectation that funding costs do continue to modestly increase throughout the quarter. Take that all together, and we think NIM will be generally stable in the first quarter, and it really will be dependent on loan growth and just overall balance sheet trends Also, as a reminder and as I noted in the prepared remarks, you do see a seasonal increase in now accounts in the fourth quarter. That's really a function of public funds, public deposits coming in in the fourth quarter, and you'd expect to see those flow out over the course of the first quarter. So that's factored into the guidance as well. Thinking about quarters beyond the first quarter and what we might expect with or without a Fed rate hike, If we assume the rate environment doesn't change materially from here, as I said, I would expect loan growth to continue to modestly outpace deposit growth. With that in mind, I would expect NEM to be generally stable to maybe slightly down in any given quarter. If we did get the benefit of a Fed rate hike, that would be modestly helpful to NEM, but it really will be a question of the increase in betas from here. As we approach a 50% beta or so in any given quarter, that does largely offset the impact or the benefit of a Fed rate hike.

Great. Thank you.

And we'll go to the line of Sal Martinez with UBS. Please go ahead.

Hey, good morning, everybody. Congratulations on the results. First, on the efficiency ratio, this is a bit more of a clarification. Sorry if I missed it. It's a lot of multitasking this morning. Allison, I think you mentioned for 2019 you do expect to see continued efficiency ratio improvements, but maybe not at the pace you had in 2018, which was, I think, about 140 basis points on the tangible efficiency ratio. Did I Did I get that right? And I think in the past you guys have highlighted, you know, something, you know, close to maybe 50, 100 base points per year. That's still sort of a reasonable, you know, glide path, acknowledging, you know, the uncertainties in the revenue environment.

Yeah, you know, let me kind of first reflect on what drove that, you know, really strong absolute drop in the efficiency ratio in 2018, 150 basis points. That was The most significant improvement we've made in any given year. And there were a couple of tailwinds that were helpful there, not the least of which was the rate environment, which was very helpful to revenue in 2018 and not one that we would expect to repeat itself in 2019. Also, we conducted a pretty broad organizational redesign in the second half of 2017, and we were able to fully realize the benefits of that in 2018. So those are two elements that won't repeat themselves in 2019. That said, we have a host of ongoing efficiency improvements that are constantly underway. And so in any given year, the pace of improvement is going to vary year to year. And it really depends on the investment opportunities we have and the economic environment that presents itself. And we're going to make trade-offs inside of a year. And I think you would expect to see us do that. You would want us to do that, not sacrifice long-term growth for short-term efficiency gains. All that being said, continuous improvement, as Bill said, is really built into our culture. It is hardwired into everything we do now in terms of our strategic planning, our short-term and our long-term planning. It's built into our incentive compensation. Our incentive comp is tied to year-over-year efficiency ratio improvements at every level in the company. So the pace of improvement won't be 150 basis points this year, but we're committed to continuous improvement, hence the medium-term target of 56% to 58%.

Okay, got it. I guess a related, more specific follow-up. This quarter, you obviously have the $60 million of pension settlement charges, and you flagged a few other discrete items. Could you remind us what those were in this quarter and what the magnitude of those discrete items were in the fourth quarter?

discrete item in the fourth quarter that was of any real magnitude was the $60 million NCF pension termination. There were some discrete tax items, a lot of puts and takes, as I mentioned, nothing of real significance, and they generally all offset each other.

Okay, okay, so it's really just the 60. Okay, great, thank you.

And we'll go to Ken Houston with Jefferies.

Please go ahead. Hi, this is Amanda Larson on for Ken. Can you talk about the expectation for medium-term efficiency to the 56% to 58% range? Where do you expect that improvement to come from by segment, and what are those targets within the firm-wide view?

If the question was what is medium-term, I think we view medium-term as three to four years, and then where it will come from. is a lot of different things. I think as we've talked about before, we have strict targets for efficiency in virtually all of our businesses, and it'll come from all the things we've been working on, leveraging technology investments, robotic process automation, cloud computing, getting more benefits from the loan origination systems and mortgage and wholesale, Digital, all end-to-end, agile mindset, third-party leverage, which we achieved this year, continued migration down of our real estate footprint, maximizing all the skills that we have in our overall chassis. So it's a lot of things. It's not one thing, and it's not centered in one business. You saw, in this case, improvements in wholesale and consumer, and we'd expect them both to continue to improve.

Okay, great. And then separately, can you please talk about pipelines and expectations for growth in capital markets in 2019 by product group and also in pre-banking?

Yeah, I think the pipelines are strong. They continue to be strong. They were Good coming into the third quarter. They're good coming into the fourth quarter. They're strong coming into the first quarter. It appears that, you know, as of today, the markets are starting to respond, and we're responding accordingly with opportunity. I'd expect capital markets to grow. If you look at sort of the individual segment lines, M&A has continued to be strong. I think that'll have good growth characteristics in 2019. Obviously, that's lumpy by any one quarter. I think our syndication leverage finance will continue to be a strong part of what we do. The derivative business has continued to be strong. Trading will bounce back. It's not a big item, but it'll bounce back from where it was in the third quarter. and our equity business. I think as those markets start to fall probably later in the quarter and later in the year, we continue to think those will be strong parts of what we do. And then as Allison and I both mentioned, just the core underpinning of our non-CIB clients and our ability to be really relevant to those clients as they think about the future and the structures of their companies. That's going to continue to be an increasing part of what we do in capital markets.

And I think you asked about CRE at the end there as well. And we expect CRE growth to continue to be good in 2019. As noted, we are no longer tied just to construction fundings and with the addition of our permanent financing products and the ability to really participate in a life cycle. of a project we can now expect CRE balances to maintain through the year, and we see good growth in our pipelines there.

All right, thank you.

And we'll go to Mike Mayo with Wells Fargo Securities. Please go ahead.

Hi. Hey, Mike. More on the efficiency. Just want to recognize, you know, seven years of better efficiency. The efficiency ratio went from 72% 60% under your time, Bill, and you got your efficiency target a year earlier, so all noted.

I feel like there's a buck coming.

But you only now got to your target from the 1985 merger. There you go. You weren't there. But, look, I mean, you've made a lot of progress, but three to four years for your next efficiency target just feels far off. So, you know, two-part question. One is you talked about the tradeoff between revenues. It seems like you're shifting some. So is the emphasis now on generating more revenues at lower marginal cost? As you said, your goal is efficiency is a means to an end, and the end is returns and growth. And second, what are the gaps at SunTrust to best in class?

Yeah, I think first of all, Mike, in terms of setting the medium-term target, I think given our business mix, I think this is aspirational. and it's all assumed to be organic. So this has no dilutive impact into it. This is all organic improvement in our efficiency and not rate dependent. So we've sort of said let's take a lot of those factors out of it in terms we think of the medium. And the tradeoff really isn't so much around revenue. I mean clearly we're making sure that we're investing the revenue. The tradeoff is more long term making sure that we've got the and the right forethought to make sure that we're long-term thinking about what clients need. So we're constantly making that trade-off. So I'm probably more proud of the investments we've made in technology than I am in the efficiency that we've achieved. So we've been balancing those continuously. So that medium-term target, I think, toggles both of those effectively. I can assure you that the culture of continuous improvement, daily grind on all the things related to efficiency are there. I don't know that I see, you know, you asked what's the sort of a big gap or the place at SunTrust. I don't think it's one particular thing. I mean, our business model, I think, given the way we're structured, We're not going to be a low 50s efficiency ratio company. That's not our business model. So I think it's just continuing to do the things we're doing, blocking and tackling, investing long term, and taking advantage of things that we've already invested in.

One follow-up then. Again, efficiency is a means to an end. You mentioned returns and growth. Any thoughts about where you'd like returns to be? They're certainly higher now.

Yeah, I mean, they're higher now. I mean, if we talk about sort of returns on the asset liability part of the balance sheet, you know, we have an extreme discipline around what comes on our balance sheet, what we expect from our teams to deliver in overall returns and meeting client needs. You know, the last seven years, that discipline continues to increase and I think is very acute. If we look at sort of total ROA and total ROTCE, I mean, clearly we're at a pretty high point just relative to, you know, where we are in the credit cycle. So, you know, we're going to be pushing as hard as we can push. We're going to be focused on the returns. But over time, you know, pick your timeline. The credit part of that will normalize.

All right. Thank you.

Thanks, Mike.

I'll go to John Pantari with EverCorp. Please go ahead.

Morning. Morning, John. I want to see if you can just give us a little more color on the operating losses. You mentioned the legal and fraud-related costs, you know, it was a pretty big increase for the quarter. So what is actually behind the, I know on the legal side you may not be able to specifically talk about it, but on the fraud-related, is there something that's impacting that and can that continue? Thanks.

Yes, John, there's no one particular thing there. You're going to see variability quarter to quarter, so nothing specific to point out necessarily. I don't think, I don't expect to see operating losses in the first quarter at this kind of $40 million level. At the same time, I don't know that they'll be as low as the $20 million or so where we were running in the first half of last year. So there's going to be some variability quarter to quarter just given our business model, and some of the puts and takes there, something between 20, 40 million is probably a reasonable expectation, but you should expect variability.

Okay. All right. And then also on the expense side, I heard your answer, Bill, regarding your efficiency ratio outlook, but when you look at it versus where your peers are, it still implies that You're operating and you expect to operate at a higher efficiency ratio than a good number of your larger super regional peers. Are you saying that you structurally believe that that will always be the case?

Well, let's go back to ours is organic. So this is an organic growth given our business model. We look at every line of business and we look at where it can produce both growth, return, and efficiency. We try to target all those in terms of being top quartile, then add all those up relative to how our company looks. We've got to try to balance all those together. Some will have different emphasis relative to that piece. So I think the 56 to 58, as we sit here structurally, is an appropriately ambitious goal that allows us to continue to invest and continue to grow.

Okay. All right. Thank you.

We'll go to Marty Mosby with Finding Sparks. Please go ahead.

Thanks. I wanted to ask you a little bit about this loan growth and then kind of take that to the liquidity coverage ratio. As we've had the regulatory threshold where you're still below, I think you're getting some relief from liquidity coverage ratio and the way it was calculated. Wanted to make sure that as we're pushing towards 100% loan to deposit ratio, just wanted to have a better feel for how you manage the liquidity coverage ratio and how you think about that.

On the LCR, if we do get some relief there at the margin, it gives us a little bit of an opportunity. It's not significant, and it's not going to significantly change the way we manage our balance sheet or the way we think about loan growth. It does give us, again, benefit at the margin, but we still have our own internal liquidity standard, and those are always going to dominate how we think about the balance sheet.

And then when you look at the commercial real estate, you've been, as a concentration, that's been a product that you've avoided or just have not had as much as many other super regional banks. It's creating a lot of the momentum that you have now. How do you think about, as a percent of your loan portfolio, where that kind of gets to and how you think about that from a credit quality concentration risk?

Yeah, Marty, as you noted, it has been a smaller relative part of our portfolio. I don't think it's going to have abnormal growth. I mean, we're not sort of leaning into headwinds. Part of what we've seen today and the offset of what the runoff is in construction, in 2017, we put a permanent financing product in place that really just allows us to be with stabilized, high-quality loan-to-values that are actually lower, so better, and 60% plus of that is refinancing our existing portfolio. So these are clients we know, projects we understand, we finance, they're highly stabilized, and we're doing them at lower loan-to-values. So in many ways, we're and the other is an agency bridge product and the acquisition of Pillar and our knowledge about what is agency eligible allows us to really work with existing multi-family that's going through some type of rehab or ownership change and we do all that to underwrite the agency eligible position. It's really in a strong position. The other part of the growth is really, I think, reflected in just what's happening in our core markets. I mean, we've got some build-a-suit office for regional and national headquarters that are moving to our business. And then on the other side, construction is down pretty significantly. So I don't think CRE is going to be an abnormal part of our growth prospect. It's that our strategies are working. and our overall credit experience currently and what we're putting on the books we feel really good about.

I'd just add our CRE strategy is relationship based. So participating in the full life cycle of the project allows us to grow full relationships with these clients which actually helps fuel capital markets activity like derivatives as well as deposit growth. So it's not just a product, it's really a relationship driven business overall.

and those are relationships you've already had which was a nice leveraging point that you could really use that you just kind of left on the table in the past.

I think that's a good way to say it.

The last thing is on efficiency. I want to take a whole other take because comparing to 20 years ago and a goal it just isn't going to, it doesn't work because this is a totally different environment when you talk about compliance and the things that you're required to do. I want to really look at it from a sense of and I know how hard it is to generate these efficiency gains. You got there a year early. What actually worked better? Was it just revenues or were there other things that you got into and those projects got to be a little bit more productive a lot faster?

It's a combination of both, Marty. The revenue environment both in terms of return discipline and an executional excellence environment probably exceeded our expectations, you know, several years ago. So our ability to acquire, retain, and expand relationships is, you know, continues to perform at a higher, higher level and has got more discipline around it. And then on the efficiency side, I wouldn't say it was one thing. I mean, clearly early the credit environment changed and we were able to take advantage of that. but it's dozens of things. It's opportunities that we see in terms of streamlining the chassis. Probably the opportunities in technology were better than we thought they were five years ago or we didn't know what they were five years ago so being able to take advantage of those. Thanks.

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

Good morning.

Good morning.

Question on credit quality. I know the numbers are small, but if we look at the losses in the other direct book year over year, I guess to account for the seasonality, they ticked up a little bit. Again, the dollars are small, but is that just seasoning? And then the follow-up question would just be, you know, how are you feeling about the online lending platforms, given some of the concerns about being late cycle and just this has been kind of a hot area and somewhat untested in downturns? Thanks.

Yeah, to the first question, it's a little more seasonal, so that you see that pop, so that's not anything in seasonality, so that's not anything in seasonine and seasonal, I should say it that way, maybe to get them both out there. So that's not something that we're, you know, have a particular concern about at this point. If we look at, you know, the online channels and the partnership channels, You know, we now have a chance that that book has got some good turns in it. So, you know, I think it's time tested. And what we're putting on is, you know, high quality, you know, 770 plus in Lightstream, 750 plus in Green Sky. You know, our loss experience has been low. Our 30 plus day experience has been low. fraud losses have been almost nothing. So we feel good about that portfolio. We continue to stay at the high end of the risk spectrum there, and that's not going to change dramatically. And as I said before, it's had a chance to have a couple of turns. So we've had several at-bats on the learning of that portfolio.

Okay, thank you. Thank you. We have time for one more question.

Thank you. We'll go to Gerard Cassidy with RBC. Please go ahead.

Thank you. Good morning. Good morning. Alison, you mentioned, I think, the Lightstream originations last year were just over $2 billion. What percentage do they represent of the consumer originations in 2018, excluding mortgages from that number?

Let's think about that.

Okay, we can get back to that. Maybe, Bill, I've got a quick question on consolidation. And if I want to just build the background for you on the question. Obviously the industry has had a great run here. Four years of consecutive record profitability if we adjust last year's numbers for the tax changes. Credit quality has been spectacular. Funding, low cost, core deposits have been great until very recently. Now we're starting to see some issues there. Digital banking making massive inroads. At what point is there an environment that you would consider that because maybe things start to become less good that it makes sense to join forces with another large regional bank?

Well, we're not going to speculate on any of that. I would say for SunTrust, we just continue to see a lot of good opportunity within our own business.

And Gerard, the answer to your question on Lightstream Originations as a percent of Consumer Originations ex-mortgage, it was about 25% in 2018. Appreciate that.

Thank you. Thank you.

All right. Thank you, everyone, for joining us today. If you have any further questions, please feel free to contact the IR department.

Thank you ladies and gentlemen. That does conclude our conference for today. You may now disconnect.