Oct 15, 2010
Executives
Aarti Bowman – Investor Relations Bryan Jordan – CEO BJ Losch – CFO Greg Jardine – Chief Credit Officer
Analysts
Craig Siegenthaler – Credit Suisse Steven Alexopoulos – J.P. Morgan Matt O'Connor - Deutsche Bank Bob Patten – Morgan Keegan Jon Arfstrom - RBC Capital Jefferson Harralson - Keefe, Bruyette & Woods Ken Zerbe – Morgan Stanley Kevin Fitzsimmons – Sandler O'Neill Jason Goldberg - Barclays Capital Kevin Reynolds - Wunderlich Securities Marty Mosby - Guggenheim Heather Wolf - UBS Matt Burnell - Wells Fargo Mac Hodgson – SunTrust Robinson Humphrey
Operator
Good day, ladies and gentlemen and welcome to the First Horizon National Corporation third-quarter 2010 earnings conference call. At this time, all participants are in a listen-only mode.
Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator instructions.]
As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Aarti Bowman.
Aarti Bowman
Thank you, operator. Please note that our press release and financial supplement as well as the slide presentation we'll use this morning are posted on the Investor Relations section of our website at www.fhnc.com.
Before we begin, we need to inform you that this conference call contains forward-looking statements which may include guidance involving significant risks and uncertainties. A number of factors could cause actual results to differ materially from those in forward-looking information.
Those factors are outlined in the recent earnings press release and more details are provided in the most current 10-Q and 10-K. First Horizon National Corporation disclaims any obligation to update any forward-looking statements that are made from time to time to reflect future events or developments.
In addition, non-GAAP financial information may be noted in this conference call. A reconciliation of that non-GAAP information to comparable GAAP information will be provided, as needed, in a footnote or appendix of the slide presentation available in the Investor Relations area of our website.
Listeners are encouraged to review any such reconciliations after this call. Also, please remember that this webcast on our website is the only authorized record of this call.
This morning's speakers include our CEO, Bryan Jordan; our CFO, BJ Losch; and our Chief Credit Officer, Greg Jardine. With that, I will turn it over to Bryan.
Bryan Jordan
Thank you, Aarti. Good morning and thank you for joining the call.
We view third-quarter results as another step forward in executing our strategic plan. Net income available to common shareholders was $16 million, a $13 million improvement over the second quarter.
Actions taken to refocus on our core businesses, restructure our balance sheet, and proactively deal with problem credits are paying off. Third quarter's improved results reflect lower credit-related costs as well as better performance from our core businesses in regional banking and capital markets.
Our core businesses give us a competitive advantage in our markets. The regional bank's pre-tax income rose 63% linked quarter to $48 million, driven by a lower provision, improved net interest income, and relatively stable [unintelligible].
Capital markets pre-tax income grew $15 million second to third quarter, or 56%, due to stronger revenue driven by depository customers' increased activity. We saw positive results from our focus on growing our middle-Tennessee market share.
According to the recent FDIC deposit market share survey, our deposit in Nashville increased 16% year-over-year, twice the rate of overall market growth. Low loan demand, coupled with runoff in our non-strategic portfolio, resulted in a small decline in period-end loans.
We're encouraged by the third quarter's solid pipeline of corporate, asset-based, and commercial real estate loans. There is some C&I pricing competition, but in general we're seeing better pricing in our loan portfolio as yields were up 6 basis points from last quarter and up 28 basis points year-over-year.
Third quarter's bottom line was also helped by a $20 million linked quarter reduction in our credit provision. Continued reductions in higher-risk loan portfolios, along with generally stable credit quality, enabled us to reduce provisioning for the sixth consecutive quarter.
Even so, our loan loss reserve is at 4.22%. Net charge-offs declined for the fifth consecutive quarter.
Non-performing assets, although down 25% below a year ago, increased 2% second to third quarter due to fewer resolutions and lower paydowns. The total inflow of new NPAs steadied, despite a couple of larger commercial credits going on non-accrual.
Greg will give you more details later in the call. It is important to keep in mind that with the winding down of our non-strategic loans, we may experience a little more quarterly fluctuation in credit quality metrics given the size of our C&I and commercial real estate credits and the cyclicality of commercial portfolios.
Overall, we believe that our credit quality trend will be improving. I'm pleased with our third-quarter progress, but a slow-growth economy, low interest rates, elevated environmental expenses, and implementation of the Dodd-Frank bill are likely to present challenges for the financial services industry and [us].
We believe we're well positioned to meet the challenges ahead as well as take advantage of the opportunities that will ultimately arise. On the regulatory front, it's too early to know the full impact of reforms on revenue or expenses, but we believe that they will be manageable for us.
We will continue to focus on improving our efficiency and productivity to help offset the impact of reform. Additionally, we will prudently revisit pricing of effective products and services as circumstances warrant.
Let me take a minute to address some of the industry issues around the mortgage foreclosure process. We deal with foreclosures in residential mortgages and in home equity loans.
As a reminder, we sold our national residential mortgage servicing and origination platform to MetLife Bank in August 2008 and have a servicing agreement with them for the servicing rights that we still own. We are working with MetLife and rely on them and the terms of the subservicing agreement to ensure that proper policies and procedures are being followed.
Through September 2010 MetLife has foreclosed roughly 4500 loans year to date, with approximately another 8200 loans currently in the foreclosure process. MetLife is currently reviewing its overall foreclosure process and working with outside foreclosure counsel and agencies as appropriate.
On the home equity side, our portfolio is mostly second liens, and thus the number of foreclosures remains relatively small. Currently, there are roughly 200 foreclosures in process on home equity loans.
We believe that our risk with this issue should be manageable. Foreclosures are an unfortunate and less-than-desirable outcome for everyone involved: investors, servicers, and especially home owners.
For that reason, like others, we believe that it is important that foreclosures, when necessary, be handled properly. Finally, we've built a strong balance sheet with a solid capital base, another advantage for us and our footprint.
At September 30, tangible common equity and tangible assets was 8%, and our tier 1 common ratio was over 10%. We believe that we will be well-positioned for the newly issued Basel III requirements as they become the new standards.
Now, BJ will take you through the financial results and then Greg will discuss credit quality, and I will be back for some final comments. BJ?
BJ Losch
Great, thanks Bryan. Good morning to everybody.
If you flip to slide five, it shows our consolidated financial results for the third quarter. EPS was $0.07, up from last quarter's $0.01.
You'll find all of our key highlights on this slide, but I'll talk about them in more detail on the following pages. So if you take a look at slide six, we'll look at our overall and business segment trends.
Our consolidated pre-tax income increased $19 million linked quarter, to $37 million. Regional bank, capital markets, and our corporate segments, which we call our core businesses, produced combined pre-tax income of $77 million, up 50% from second quarter's levels.
Linked quarter, the regional bank's pre-tax income was up 63% at $48 million, driven by an $18 million decline in provision. Revenues rose 1% at NII and the bank was up 4%, reflecting higher spreads in our loan portfolio.
Fees were down a couple percent, as we saw continued negative impact from Reg E, which was somewhat offset by other income. On the capital markets side, we booked another strong quarter, as pre-tax income climbed $15 million to $43 million linked quarter.
Fixed income's average daily revenue improved to $1.7 million from the prior period's $1.5 million. The improvement in what is historically a soft quarter was driven by increased activity from depository customers.
Now our corporate segment made a pre-tax - the pre-tax loss widened to $14 million, primarily due to higher expenses and lower NII. On the expense side, linked quarter, the expenses were up $8 million, with the variance primarily driven by the inclusion of a $5 million benefit related to a Visa litigation liability reversal in the second quarter.
And on the NII side, our securities portfolio remains stable at about $2.6 billion. However, reinvestment rates are lower, pressuring yields, which dropped about 26 basis points in the third quarter.
In the non-strategic segment we posted a 15% decline in revenue as servicing income declined, 29% to $44 million in the quarter, reflecting lower net hedging results, the full effect to second quarter servicing sales, and the reduced size of our servicing portfolio to approximately $30 billion Net hedging results decreased 28% to $32 million through mostly the interest rate movements and credit marks. On the expense side, mortgage repurchase provision expense decreased from $56 million to $49 million in the third quarter.
And I'll go into more detail on this on the next slide. So if we flip there, to slide seven, if you look at the bottom left chart, in the third quarter the active pipeline grew to $469 million.
New requests were fairly stable from last quarter's levels, that's the dark blue bar, with the vast majority continuing to come from the TSEs. If you look at the light blue bar, resolutions nearly doubled to $146 million from second quarter's $74 million, and are reflected in higher net realized losses of $36 million.
As you can see on the bottom right chart, requests are still concentrated in the 2007 vintage. Our rescission rates have held steady at 40% to 50%, and our loss severity remains at approximately 55%.
Going forward, we will have continued emphasis on increasing resolutions. And a note: Though we've seen negligible put-back activity from private securitizations, we know there has been increased industry discussion on this topic and we here continue to review and monitor this very closely.
As you know, the standards for reps and warranties somewhat differ between GSEs and private labels, and as such may cause differing trends in both request activity and the resolution process. As a point of reference on our historical put-backs, which again is largely GSEs, out of the roughly $60 billion of our GSE originations from 2005 to 2008, our total repurchase requests to date have been approximately $800 million, or roughly 1% of originations.
And we have successfully resolved in our favor 40% to 50% of those requests. Moving on to slide eight, you'll see margin in the balance sheet trends.
Our consolidated NIM increased 4 basis points to 3.23%. Core business NIM - regional bank, capital markets, and our corporate segment - remained solid at 357.
Third quarter's consolidated margin benefitted from better loan pricing, lower deposit costs, and less drag from our non-accruals. These positives were somewhat offset by the negative impact of our excess Fed balances that we carried during the quarter, as well as those lower reinvestment rates in the securities portfolio.
But looking at all of these factors in aggregate, we do believe that the NIM could modestly benefit in the short term as we reduce the excess balances that we carry at the Fed and continue to improve our loan pricing. But we generally expect little opportunity for meaningful improvement in our consolidated margin until interest rates increase.
As Bryan discussed earlier, we view our balance sheet as well-positioned. Core deposits were relatively stable.
Linked quarter we saw non-strategic loans decline 6% as expected, but going forward we expect the rate of runoff to slow as the shorter duration construction portfolios are eliminated. Overall, we're pleased with our progress and positioning for this environment.
We're focused financially on further strengthening our balance sheet, improving our pricing and our margins, as well as our productivity and efficiency. Now I'll turn it over to Greg to discuss some of our asset quality trends.
Greg Jardine
Thanks BJ. Good morning everyone.
I'll start with slide 10. Overall, third quarter showed continued stabilization and credit quality, although not surprisingly there was some volatility.
Charge-offs decreased 16% to $111 million, from last quarter. Aggregate reserve declined 8% to $720 million, due to lower loan balances from runoff, pay-downs, and charge-offs.
Now moving to slide 11. We saw some lumpiness in our non-performers, which was 2% from last quarter.
But we're nonetheless down 25% year-over-year. Inflows stayed steady and the percent of NPLs was basically flat from last quarter at 4.31%.
The linked quarter increase was driven by a handful of large credits and two repayments and resolutions in the NPA portfolio. We're seeing a reduction in resolutions, as the compositions of non-performers is changing from more dated, non-strategic assets to commercial loans.
Additionally, commercial TDRs increased, reflecting efforts to mitigate loss potential by working with our distressed borrowers and adjusting as the industry moves forward more consistent practices I'll now discuss key trends by portfolio, starting with income CRE, on slide 12. Income CRE balances were $1.5 billion, or 9% of our loan portfolio.
Linked quarter, net charge-off declined $22 million to $11 million. Non-performers were up at 10.1% and as we progress through the maturity cycle of commercial real estate we expect continued deterioration in 2011.
At third quarter, reserves in our income CRE portfolio were at 9.5%, and the reserves have been above 8% for seven quarters now. Moving on to the C&I portfolio on slide 13, ending balances were at $7.3 billion, up 5% from Q2 '10.
Linked quarter charge-offs increased from $20 million to $24 million. This included an $11 million fraud-related credit that we charged off in the third quarter.
As you can see on slide 14, the C&I portfolio also includes approximately $700 million of trusts, bank holding companies, and other bank-related loans. About $300 million are bank trusts, including seven loans on interest referral at quarter end.
Insurance trusts comprised $164 million, $136 million were loans to bank holding companies, and $96 million were other loans secured by bank stock. Financial institutions remain stressed, and we will continue to monitor this portion of the C&I portfolio very carefully.
I'll talk about our home equity portfolio on slide 15. Home equity balances were at $5.8 billion at the end of the third quarter.
30-day delinquencies were 2.33%, up 14 basis points, or $5 million, linked quarter, which was driven by more borrowers in the foreclosure review process. Non-performers in the home equity portfolio were up 11 basis points to 0.46%, reflecting our ongoing efforts to work with borrowers on modifications.
Net charge-offs were up $40 million in the second quarter to $46 million in the third quarter. This increase includes $9 million of charge-offs related to accelerating loss recognition of charge-offs for clients who are non-responsive for 60 days.
Due to the vintage mix and strong borrower characteristics, we expect relative stability in the home equity portfolio over the near term, noting the consumer delinquency and loss rates remain highly correlated with unemployment trends. We continue to assume the economic recovery and employment gains will remain slow.
I'll wrap up on slide 16. Third quarter demonstrated generally positive credit metrics, including lower provision expense and a decline in charge-offs.
There was some fluctuation in non-performers, as we are at a stage in the credit cycle when some commercial loans are experiencing greater stress. And given their size, this can lead to lumpiness in charge-offs and NPAs.
Also, as our nonstrategic portfolios wind down, the magnitude of reserve decreases is likely to lessen, especially in our consumer and construction portfolios. As Bryan noted earlier, we believe that our overall credit quality trends will remain improving.
I'll now turn it over to Bryan for some closing comments.
Bryan Jordan
Thank you Greg. I'll end on slide 17.
Our proactive approach to credit has allowed us to get on our [unintelligible]. We're able to concentrate on new customer acquisition and retention, we've improved underwriting, better pricing, and continued great service.
We know that we have additional work to do in improving productivity and efficiency, and we're focused on doing it. Thank you to the First Horizon team, who takes care of our customers and continues to take the actions necessary to refocus our company.
We're taking steps toward our goal of achieving sustainable profitability that drives consistently attractive returns for our shareholders. Operator, we'd now like to open the call for questions please.
Operator
Thank you. [Operator instructions.]
And our first question comes from Craig Siegenthaler from Credit Suisse.
Craig Siegenthaler – Credit Suisse
Just two questions on the private-label mortgage business. The first one - put-backs from the private label side still are quite small.
I'm just wondering if you could help us in evaluating the risk that there's a material increase in this area in the next few quarters.
BJ Losch
I'll take a crack at that. We continue to monitor this very closely as I said, and as I said we've seen negligible put-backs to date.
So for us to monitor something that we haven't yet seen is tough. So how we do that is we just monitor the same types of things that you do: discussion activities, where trends are, and some of the different industry views.
As we see those start to come in, which we do expect, we will be as proactive as we have been on the GSE put-backs. So as I said in my remarks, the refs and warranties somewhat differ between the GSEs and the private labels, and maybe that's causing some timing issues in activity.
We'll just be prepared for it as it comes.
Bryan Jordan
Let me add to that. We've got about $15.5 billion, $16 billion that are still outstanding.
I think it's important to understand what that product is and the credit quality in it. About 55%, or $8.5 billion, is what we would define as [unintelligible] adjustable, [unintelligible] etc.
It had going in a FICO score of over 700 with roughly an 80% combined loan to value. The remainder, about 45%, or $7 billion, is jumbo product - had a 735 or so FICO score going in and a 60% original combined loan to value.
Of the jumbo, say $7 billion, roughly $6 billion of that was full-[unintelligible] products, so we think the credit quality of the product is a good product and so as BJ said, it's something where we've seen very limited requests at this point. It's something that we're aware of and focused on, and we will continue to monitor it.
Craig Siegenthaler
And then just to your point, if the credit quality is quite strong here, even if there is a modest risk of put-back, there won't be a put-back if the loan is still at par and still paying. So is your view the credit quality is strong and that could help offset it?
Bryan Jordan
Clearly the credit quality, the strength of the borrower, will have a big impact on the default. The default leads to repurchase requests.
So we think credit quality clearly has an impact on it. And as BJ said, the requirements for repurchase the rep and warranty risk is different in these portfolios.
So given the limited activity it's difficult to estimate at this point.
Operator
Our next question comes from Steven Alexopoulos from JP Morgan.
Steven Alexopoulos – J.P. Morgan
Bryan, could you just go into - do you have any liability at this point with the foreclosure process that MetLife is conducting?
Bryan Jordan
Given the unfolding nature of this that's a question I don't know the answer to at this point. As I said in my prepared comments, we're very focused on working with MetLife in understanding the processes that have been applied and as it unfolds we'll have a better sense of that.
I do think that any liability if it does exist is reasonably manageable.
Steven Alexopoulos
But you don't have any control at this point as to the actual foreclosure process there?
Bryan Jordan
Well, as I said earlier, we control the foreclosure process on the home equity side. That's been fairly small.
We've got roughly 200 loans in the foreclosure process now. The reason it's been small in the past is loss severities have been very very high and it didn't make sense to foreclose.
With respect to the first mortgage business, the 4500 loans that have been foreclosed, we rely on MetLife and the subservicing agreement to lay out the terms of that. So it's something we're working with them and their teams to understand and I know that they're working very hard on this issue as well.
Operator
Our next question comes from the line of Matt O'Connor from Deutsche Bank.
Matt O'Connor - Deutsche Bank
I do have to ask a question on the put-back, but I also have an unrelated question. So just first, on the repurchase risk, has there been any change on either the rescission rate or the severity in the last couple quarters.
Have you noticed anything materially different there?
BJ Losch
No, there hasn't. It's been consistent, precision rates 40 to 50 and the loss severity around 55.
Matt O'Connor
And then separately, I've thought one positive this quarter was some of the commercial growth that you had - about 5% period end on annualized - and just wanted to get a little more color on what's going on there and how sustainable you think that growth is.
Greg Jardine
Couple things. One is balances increased quarter-over-quarter from two things.
One, driven by our mortgage warehouse funding - not more, that's been fairly well-utilized. And second is as we've indicated the beginning of growth due to the pipeline that we have had.
And as we [unintelligible] on through that pipeline. But the majority of the quarter-over-quarter balance growth was mortgage warehouse.
Operator
Our next question comes from the line of Bob Patten from Morgan Keegan.
Bob Patten – Morgan Keegan
Most of my questions on the repurchases have been asked. Can we jump over to TDRs for a second?
Obviously a little jump in the TDRs. Is that accruing?
Is it non-accruing? What's your thoughts on where that goes, Greg, over the next several quarters?
Greg Jardine
The TDRs include accruing and non-accruing. I would expect TDRs to continue to increase as we work with borrowers, and obviously it takes some time to - as everything's performing - for a TDR to then remove that flag.
So it's just where we're at in the cycle, and working with them as we've got the non-strategic portfolio lessening and we're working with our core franchise customers and working through problems with them in the cycle. I would expect that TDRs would continue to increase some.
I think the other thing I'd comment on TDRs, I think we're all expecting that between the OCC and FASB that we'll have some clearer views of how the industry is to treat TDRs. Because it's a little bit opaque to everyone right now.
Bob Patten
Yeah, the new draft just came out earlier this week. What's the breakdown of accruing and non-accruing?
Is it all -
Greg Jardine
I was going to add that. It's really determined based on where the loan is at the time of restructure.
So if it's on non-accrual, until it performs for a period under the restructure terms, it gets reported as non-accruing. But it's about 50% or so that is accruing today.
The other would be non-accruing largely.
Bob Patten
Is that total number in the NPA number?
Greg Jardine
Yes. The accruing is included in the NPA.
Bob Patten
And then just a question to go back on this because everybody's trying to figure out you guys are obviously making progress on the fundamentals on this mortgage overhang, and [unintelligible] something everybody's trying to quantify. Can you guys talk about the differences in the reps and warranties in your portfolio?
BJ Losch
I'll just give you a couple of examples between the GSEs and privates. One has to do with the ownership requirements in a private securitization.
You have to have a certain level of ownership in the securities to then get the master servicer or the trustee to make claims requests on behalf of the investor. The second relates to the reps and warranties of what you're actually repping to on private securitizations.
It's more to the tapes, whereas in the GSEs it's a little bit more to the actual loans. And so those are very broad, high-level differences.
So we'll see where those go.
Bob Patten
And last question, Greg, you talked about the reserve for release beginning to slow. We've been doing 30 basis points a quarter or thereabouts.
Are you going to keep up this pace over the next three or four quarters, and where do you stop?
Greg Jardine
I'll answer that more broadly. I think the point is there was rapid reserve releases as we were working through non-strategic.
That hit's behind us and expecting that the portfolios continue to stabilize I think that we would look potentially for some continued reserve releases, not at the rate that we've seen before. That's going to be driven by the economy and by the individual portfolios, but much of the reserve releases are coming out of some of the non-strategic portfolios as well as stabilization of the home equity book as well.
Bryan Jordan
If you just put it in order of magnitudes, we've said in the past we expect a normalized reserve would probably run under current accounting 1.5% to 2%. Today we're at 4.22% I think.
So there's a significant amount of reserves that we think come down as the credit picture improves over the next couple of years.
Operator
Our next question comes from the line of Jon Arfstrom with RBC Capital
Jon Arfstrom - RBC Capital
Can you give us an idea what utilization rates look like in the commercial business?
BJ Losch
Utilization rates have not significantly changed. I’m trying to go off the top of my head.
I don't have that number. I think it's about high 40s I guess.
It's not moving a tremendous amount.
Jon Arfstrom
Any observations you can share on Reg E, maybe percentage opt-in and any changes in behavior at all?
Bryan Jordan
We've had I think it's something like 60% or so of our customers who have made a decision. About half or more have opted in.
It had some impact on fees this quarter. I think NSFOD charges were down in the $3.5 million to $4 million range.
We still see customers opting in. As we've said in the past, we expect that net net that when you work through an annual cycle it's probably going to have something in the $10 million annualized impact on our revenue.
So as I said we're still seeing customers making decisions. We still see customers opting in.
The pace has slowed a little bit here, late third quarter moving into the fourth quarter.
Jon Arfstrom
And then just one last question. You've got a couple of quarters of profitability back to back, and you have some clarity on capital ratios.
Just curious what your thinking is today on TARP and does that capital clarity change things at all for you?
Bryan Jordan
Well, yeah. I would say that our thinking has not changed an awful lot.
As I've said for the last several quarters we'd like to make progress working with our regulators to repay the TARP in a practical and sensible way. We would expect to continue our efforts in that regard, and I'm hopeful that we can continue to make progress in that and repay it as that works through the process.
Operator
Our next question comes from Jefferson Harralson with Keefe, Bruyette & Woods
Jefferson Harralson - Keefe, Bruyette & Woods
The GSE put-backs, what's the most typical rep and warranty cause of conflict as these are coming through?
BJ Losch
I'd say that there's three. There's appraisal questions, there's owner-occupancy questions, and there's undisclosed debt questions.
Jefferson Harralson
So they're questioning the actual legitimacy of the appraisal or just there's not one there?
BJ Losch
They're questioning how the appraisal was made, and what value was assigned, which then leads to what the loan to value was. That's one of the main reasons for put-backs.
Jefferson Harralson
And secondly, you guys had really large C&I growth this quarter. Can you talk about the types of businesses that you're lending to and what drove that $300 million of growth?
BJ Losch
Again, part of the growth in balances was mortgage warehouse lending. We're seeing significant utilization in that.
In terms of other, we're seeing some good progress in the medical space and obviously some in the CRE income property space as well, which is also an area where we're seeing it. So generally, in terms of new opportunities it's the medical space and growth in the warehouse.
Bryan Jordan
As we look at our pipeline we're pretty encouraged by what we see in the pipeline. It's broad-based, it's everything from commercial to commercial real estate.
We see opportunities continuing to exist in asset-based lending. We saw probably outsized growth in warehouse lending, but the lending activity we saw this quarter was fairly broad-based and we're reasonably encouraged with the opportunities we see in front of us.
Greg Jardine
The pipeline's over a $1 billion.
Bryan Jordan
And that's a pipeline that is not just everything that we're looking at. This is where we think there's a pretty high probability or have a verbal commitment that we'll close the deal.
Operator
Our next question comes from the line of Ken Zerbe with Morgan Stanley
Ken Zerbe – Morgan Stanley
When you think about non-performing assets, you mentioned it's moving to commercial as opposed to the legacy business. When you think about how that change is affecting the NPA balances, should we be expecting more of a flattening in NPA balances going forward as the non-strategic stuff just becomes less of a portion and you have longer commercial NPAs in there?
BJ Losch
Yeah, I think generally. There's a couple things.
I think we're at a fulcrum point, so as the non-strategic's winding down, we're working with the commercial ones. One thing that will begin to happen is the upgrade process.
So I think at this point in time what you're seeing within our portfolio is generally the portfolio grades improving. What happens is those that are in the criticized category are either healing or they're getting a little worse.
And that's part of what we see and would expect in this part of the cycle. So as we look forward I would see NPAs kind of be around this level and then as we continue to work with them and as we can restructure as appropriate, then we will see some upgrades out of that.
Ken Zerbe
It sounds like that's also a driver for more of that stabilization to some extent in the reserve ratio as well, in terms of why it might not be coming down as fast as we would have seen otherwise?
BJ Losch
I think what you have seen is decent releases out of the commercial side as well and I think that continues. I see this as a couple of quarters as we work through this, that the NPAs will be level and then down at the end to improve.
Operator
Our next question comes from the line of Kevin Fitzsimmons with Sandler O'Neill
Kevin Fitzsimmons – Sandler O'Neill
Most of my questions have been asked. Just wondering if you could comment on the sustainability of the capital markets revenues.
That was a line item that we've seen coming down the past few quarters and it had a nice spike up this quarter. And then I just wanted to clarify on that earlier question about TDRs.
Is the accruing part of the TDRs, so the 50% of that $300 million, just want to make sure I heard you right. Is that included in your non-performing loans, or is it not?
BJ Losch
Yes. That accruing is in our non-performing loans for TDRs.
Bryan Jordan
As we've said in the past, capital markets will have some fluctuation around the level of their revenues. We feel pretty optimistic about the activity we see in the business for the next several quarters and we think that it could ebb or flow a little bit, but we think we're going to see pretty good activity flows, particularly in the fixed-income business, over the next several quarters.
I can't tell you whether it's $1.7 million on an average day or $1.5 million, but we think we're very optimistic as we look out and think about the next several quarters.
Operator
Our next question comes from the line of Kevin Reynolds with Wunderlich Securities.
Kevin Reynolds - Wunderlich Securities
As you look forward, moving beyond this mortgage foreclosure issue, what is your position on TARP repayment and I apologize, I've been trying to keep up with you, so if you've already addressed this a little bit, but what's your position on TARP repayment? And also, how do you feel about the acquisition environment today?
I know we've seen in the general neighborhood down here a couple of interesting announcements with a small bank that was acquired at a pretty deep discounted price. Where do you stand on that today?
Bryan Jordan
Let me start with the TARP, and they're really closely related in some sense. As I've pointed out, as we went through the prepared remarks, we've got a very strong capital base, tier one common north of 10%, I think 10.4%, 8% tangible common to tangible assets and we think that we've got a very strong capital base, which really enables us to do things.
One, to work with our regulators as we think about how we repay the TARP, to do it in a reasonable fashion, and a reasonable time frame. And we would expect to continue to work with our regulators in that regard.
With respect to the M&A environment, we think that's an opportunity for us to put capital to work. We're going to be very focused and measured in how and when we execute on that.
We want to make sure that we have the right kind of opportunity and the right kind of market and it helps us build the franchise for the long term. And we think there will be opportunities there.
We don't feel any particular urgency around the M&A environment right now, simply because we see ourselves making very good progress on the things that we're focused on day to day: growing customers, getting more productive in the way we produce revenue and more efficient in the way that we produce that revenue. And so we think we've got a lot of opportunities in a number of different avenues, and so we're very encouraged about what we think the next several quarters and several years hold in terms of our ability to grow the business.
Operator
Our next question comes from the line of Marty Mosby with Guggenheim
Marty Mosby - Guggenheim
I wanted to ask about asset quality improvement and given what we're being able to see on that front in trends, are we beginning to be able to pull any of the expenses down related to work-out or the analysis on the asset quality side?
BJ Losch
Yes. That continues to run down, to the degree even from the number of people in rehab is reducing substantially as we work through that.
And then our more environmental costs are also decreasing as well.
Marty Mosby
And then BJ, when we talked about the reinvestment risk in the securities portfolio, how are we trying to combat that given that we do have the low interest rate environment that's going to be around for a while? And then kind of a tag on to that is how do we think about the pre-payment risk in the mortgage side if you go from what is an inflated level, but not really where we should be given where interest rates are at.
And if we were to lose some of the servicing possibility as well as some of the national HELOC volume and also more reinvestment risk in the investment portfolio. How do we handle that kind of [unintelligible] as well?
BJ Losch
On the reinvestment risk I think I talked about that. Our yields declined about 26 basis points there.
What we're trying to do with our securities portfolio is make sure that the structure's right of what we're buying as opposed to looking for yield. So our durations are staying very short and probably in the 2.5 year range and we want to make sure that we don't get caught upside down on a carry trade if rates suddenly move up.
So our reinvestment rates right now are right in the 2.5% range, and if you look at our maturity stats going forward into next year and next few years they're certainly going to be a drag if interest rates stay where they are and our reinvestment rates stay where they are. But as you know our securities portfolio as a percentage of our assets is relatively small versus peers.
So we think that that drag is manageable and we would rather not reach for yield there. We do think with the pipeline that we have on the loan side we'd much rather put some money to work there and try to get some loan yields, which we think could happen over the next several quarters.
So like I said on the NIM, overall we think it can modestly improve over the near term and then it will take some interest rates in general to make it move up meaningfully. In terms of the pre-payment risk on MSR, I think our CPR this quarter was 13%, so it's still very very low.
You're exactly right. If that started to increase we'd have it running down, but as we sit here today we think that servicing portfolio is very manageable at this size.
We very much like how we're able to hedge it and the knowledge and expertise that we have around hedging it, and so we think it's a good asset for us to help us somewhat offset some of the mortgage repurchase expense that we have. So as we sit here today we're pretty comfortable with it.
Operator
Our next question comes from the line of Heather Wolf with UBS.
Heather Wolf - UBS
Just one quick question on the put-backs. Do you get the sense that put-backs on non-delinquent mortgages will be higher under private label securities relative to what we've seen for Fannie and Freddie?
BJ Losch
My guess would be no, that it would be more on delinquents or where there's actually been losses. The experience that we've seen on GSEs is the vast majority of what comes back is delinquent.
So I can't sit here right now and think of a reason why that would be different on privates.
Bryan Jordan
I'm just trying to think through it. Delinquency and default have been the trigger in the past.
I can't come up with what I think would be a good reason why you would see current mortgages be a significantly different proportion out of private securities as it would be in the agency servicing business, or agency sales.
Heather Wolf
I had read a quick headline and I have no idea if this is valid, but something about how the documentation surrounding the entire trusts were being investigated, whether or not there was a risk of full trusts being put back due to weak documentation.
BJ Losch
Well, good question. Don't know the answer to that.
As I understand it right now the reps and warranties somewhat differ on the privates and so on security [unintelligible] you're going to have prospectuses, which clearly lay out the risks, and we'll look through and have defenses for what we think is something that we need to repurchase, and things that we don't we'll put back.
Operator
Our next question comes from the line of Matt Burnell with Wells Fargo.
Matt Burnell - Wells Fargo
Most of my questions have been asked and answered, but just a couple of quick questions. I guess I would like to get a little more color on your net interest margin guidance.
BJ, I think you said that essentially you're expecting, at least in the near term, relatively flat net interest margin. What was the benefit in the quarter from the fairly large, or what was the magnitude of the benefit, from the fairly large increase in the net interest margin in capital markets on the overall net interest margin in Q3?
Greg Jardine
It was just a few basis points.
BJ Losch
Capital markets was actually down a little bit in the quarter. The big increase came from the loan portfolio.
Greg Jardine
Yeah, the loan portfolio had a much bigger impact. There was a little bit of an impact on lesser drag from non-accruals - I think a few basis points.
The securities portfolio, as I talked about, was a net drag, and I mentioned excess balances at the Fed. We probably averaged about $600 million of excess balances at the fed during the quarter and so we think that comes down going into the fourth quarter pretty substantially.
So we think over the near term the margin could modestly improve just because of that, but longer term it's going to be hard to move up until interest rates rise.
Bryan Jordan
Aarti pointed out that I was wrong, the margin in capital markets was up.
Matt Burnell
Right, okay. Bryan, you mentioned a couple of times the commercial lending pipeline is starting to build and you're obviously enthusiastic about that.
If you've got a billion dollars in the pipeline right now and you're pretty comfortable that most of that is going to turn into actual loan growth, what's the timing over which that billion dollars would flow through into actual loans?
Bryan Jordan
Maybe I misspoke. I didn't intend to signal that we expected most of that to turn into loan growth.
We sort of look at the pipeline based on probabilities or where we have a commitment, so we think there's a good chance to close a loan, but we understand that there are competitive deals and we may or may not win it. But the pipeline has been stable to steady, maybe declined a little bit later in the third quarter, but we expect that most of that pipeline will work itself through over the next two or three quarters maximum and we're optimistic that it will replenish as those credits work through.
Operator
Our next question comes from the line of Mac Hodgson with SunTrust Robinson Humphrey.
Mac Hodgson – SunTrust Robinson Humphrey
Just a couple of questions. Bryan, do you think this mortgage repurchase risk has delayed the company's desire to exit TARP at all?
Has it pushed back your timeline there?
Bryan Jordan
No. We looked at, and as we work with the regulators, we're thinking about all of the risks in our capital position in totality.
This mortgage repurchase is something that as you know we've been very focused on for many quarters now and it hasn't had any impact on our desire to try to work with the regulators to come up with a way to deal with our TARP, our CPT, and appropriate repayment timeframe.
Mac Hodgson
And what about M&A? Do you feel like you need to exit TARP in order to participate in a regular way M&A?
Or do you feel like you can do that while still holding TARP?
Bryan Jordan
I don't know that it's an inhibitor, but my instincts tell me that having TARP be paid first is definitely an advantage and probably preferable.
Operator
At this time I'd like to turn the call back over to Bryan Jordan for any closing remarks.
Bryan Jordan
Thank you for joining the call this morning. We appreciate your interest.
Please let Aarti or any of us know if you have any additional follow up questions, and I hope you all have a great weekend. Thank you.
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