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SunTrust Banks, Inc. (NYSE:STI)
Q4 2017 Earnings Conference Call
January 19, 2018, 8:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Ladies and gentlemen, thank you for standing by. Welcome to the SunTrust Fourth Quarter Earnings Call. At this time, all participant lines are in a listen-only mode. Later, there will be an opportunity for your questions. If you would like to ask a question, please press *1 on your telephone keypad. You may remove yourself from this queue by depressing #. As a reminder, today's conference call is being recorded. I would now like to turn the conference over to Ankur Vyas. Please go ahead.

Ankur Vyas -- Director of Investor Relations and Assistant Treasurer

Thanks, Leah. Good morning, everyone, and welcome to our Fourth Quarter 2017 Earnings Conference Call. Thank you for joining us. Today's press release, the presentation in detail, and the 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 Aleem Gillani, 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 risk 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.

William H. Rogers, Jr. -- Chairman and Chief Executive Officer

Thanks, Ankur, and good morning, everyone. I'll begin with an overview of the fourth quarter and full year, which we highlight on Slides 3 and 4, and then I'll turn it over to Aleem for some additional details. I'll conclude with some more strategic perspectives on our 2017 performance, our purpose, and thoughts headed into 2018. We reported $1.48 of earnings per share for the quarter, which includes $0.39 per share in net benefits associated with the actions we announced in our December 4th 8-K and the impact of tax reform, including actions we took as a result. The December 4th 8-K primarily highlighted the sale of our PAC business and associated gain, but also, important initiatives around organizational efficiency, technology enhancements, and real estate that will collectively better position the company for improved long-term success.

In addition, given our purpose of lighting the way to financial well-being, we thought it was important to invest a portion of the benefits of tax reform in our teammates and communities, each of which is foundational to our success. These contributions, which totaled $75 million in the fourth quarter, will support the financial confidence of our teammates and communities for years to come.

Aleem will provide more details on these items, but I'm going to focus on the adjusted earnings, which were $1.09 for the quarter and $4.09 for the full year. Overall, I'd characterize this quarter as a good conclusion to a very strong year for SunTrust. In 2017, we grew the core earnings of the company by 14%, improved our adjusted tangible efficiency ratio by 100 basis points, increased our dividend by 54% and our share repurchases by 38%. As owners, you certainly benefited from our strong performance. Our total shareholder return was 20%, which was more than 700 basis points higher than the median of our peer group.

While we benefited from a favorable operating environment, a key driver of our outperformance this year was our improved executional abilities. We have instilled a culture of continuous improvement across the company. We've raised the bar together and teammates have risen to the challenge. We're meeting more client needs, we're showing increased discipline on expenses and returns, but we're ultimately improving the long-term earnings power of the franchise.

So, to get into some of the specifics of the quarter, our net interest margin improved by 2 basis points sequentially, which drove a modest increase in net interest income. Fourth-quarter lending activity was not meaningfully different than all of 2017, with solid consumer lending growth offset by declines in C&I. Tax reform should begin to change the trajectory of C&I, though the timing and flow were difficult to predict at this juncture.

On the fee side, we had another great full year in capital markets, even after the fourth-quarter decline. Certain deal activity was pushed into 2018, and much of this decline was offset by strength in client-driven commercial real estate income, particularly structured real estate, where pipelines had been building nicely throughout the year and were realized in the fourth quarter. All in all, revenues were stable sequentially and up 5% compared to the fourth quarter of 2016.

On an adjusted basis, we showed continuous improvement in our efficiency with an adjusted tangible efficiency ratio of 59.9% in the fourth quarter and 61% for the full year. Looking to 2018, the impact of tax reform has on our FTE adjustments and compensation growth will be a bit of an efficiency headwind for us and the industry, but given the actions we took in the last two quarters in the year combined with our ongoing expense discipline, which had us on a path to be around 60% in 2018 before the FTE change, we still expect to improve our efficiency ratio this year. Aleem is going to talk more about this in a minute.

Credit quality continues to be a strength for us, and the full-year net charge-off ratio was 25 basis points, the fourth consecutive year of net charge-offs being below our through-the-cycle expectations. This reflects a strong economic environment, the diversity of our loan portfolio, and the conservative risk posture we've taken.

Even after an almost 90% total payout ratio in 2017, capital ratios ended the year higher than where they started, with a Basel III Common Equity Tier 1 Ratio of 9.6% on a fully phased-in basis giving us an incremental capacity to support strong growth for both our clients and our owners. So, with that as an overview, let me turn it over to Aleem.

Aleem Gillani -- Chief Financial Officer

Thanks, Bill. Good morning, everybody. Thank you for joining us this morning. As Bill mentioned, there are several discrete items in the quarter which we list on Slide 5. The first set of items relates to the actions we took in our December 4th 8-K, including the sale of our PAC business, which resulted in a $107 million pre-tax gain. Tax contributed approximately $55 million of revenue, $25 million of expense, and $20 million of net income over the last 12 months.

Much of the PAC gain was offset by several charges in the fourth quarter which allow us to accelerate certain efficiency initiatives. Specifically, we offered a voluntary retirement option to eligible teammates, consolidated operations centers, terminated additional branch leases, wrote down certain software assets, and prepared for the consolidation of our mortgage legal entity into the bank, the latter of which partially impacted the valuation allowance against DTAs within SunTrust Mortgage. The net impact of all these items was a $0.03 EPS benefit.

Separately, in connection to tax reform, our net deferred tax liability position was reduced by approximately $300 million, which resulted in an income tax benefit this quarter. We also took certain actions to enhance the company's future earnings potential, including a repositioning of our securities portfolio. Finally, as Bill mentioned, we announced important investments in the long-term financial well-being of our teammates and communities. The net impact of these items was a $0.36 EPS benefit. In 2018, we expect our effective tax rate to be approximately 20% on a reported basis and 21% to 22% if you model us on a fully taxable equivalent basis.

Moving to Slide 6, our net interest margin improved 2 basis points this quarter, in part due to some discrete benefits in the current quarter, including loan fees and non-accrual recoveries. When excluding these items, the net interest margin was relatively stable, as the benefit from lower premium amortization expense in the securities portfolio was largely offset by an increase in deposit costs.

Separately, as you know, we and many of our peers in the industry report our NIM and efficiency ratio on a fully taxable equivalent basis, or FTE, which means we gross up the interest income on tax-exempt loans by approximately 35% to reflect the equivalent yield they would earn if the interest income were taxable. This adjustment increases our net interest income by approximately $150 million per year, which positively impacts our NIM by 8 basis points. All things being equal, a lower corporate tax rate will reduce the FTE adjustment by about half and negatively impact our FTE NIM by 4 basis points and the FTE efficiency ratio by 50 basis points. From a bottom-line perspective, there's no impact, as these changes simply impact income statement geography.

During the quarter, we sold about $3 billion of securities and reinvested in a portfolio with similar mix and higher yields, which will increase interest income by approximately $20 million per year, all else equal. Looking to the first quarter, we expect the net interest margin to increase between 0 and 2 basis points, as the benefit of the December rate hike is mostly offset by the change in FTE calculation. Beyond that, NIM trends will depend on the rate environments, but we do expect NIM expansion in 2018 as the short end of the curve continues to rise.

Moving to Slide 7, you will see that noninterest income decreased by $13 million sequentially, largely due to the decline in capital markets-related income, given our strong performance in the first three quarters of the year, and the delay of certain client transactions into 2018. While capital markets-related income was down for one quarter, on a full-year basis, investment banking income was up 21%, which represents the tenth consecutive year of growth and was a key contributor to our overall revenue growth in 2017.

Much of the decline in capital markets was offset by a higher commercial real estate-related income, which increased $45 million sequentially due to structured real estate transactions and seasonality in both Pillar and SunTrust Community Capital, our affordable housing and community development business. Finally, the net impact of the discrete items I discussed on Slide 5 was a $7 million negative impact to noninterest income. Looking to the next quarter, we expect capital markets to rebound nicely while commercial real estate-related income will decline from that seasonally strong fourth-quarter level.

Expenses increased by $129 million sequentially, driven by the discrete items in the current quarter which we discussed on Slide 5 in addition to the net $14 million of discrete benefits recognized in the third quarter. We have now taken $80 million of efficiency-related charges in the past two quarters, which collectively have an approximate two-year payback. On a core basis, expenses were relatively stable compared to the prior quarter and prior year as a result of improved expense management and efficiency efforts. As a reminder, our core personnel expenses -- which exclude the $25 million increase in employee benefits in the fourth quarter -- should increase by approximately $75 million in the first quarter due to the typical seasonal increase in 401(k) and FICA expenses.

As you see on Slide 9, the adjusted tangible efficiency ratio for the quarter was 59.9% and 61% for the full year. It's clear that the efficiency initiatives we've been implementing for several years are driving consistent, positive operating leverage. Not only have the investments we've made in growth driven strong revenue, we're also demonstrating heightened vigor around expense management, which enables us to deliver a full-year efficiency ratio that was at the bottom of our guided range.

Looking to 2018, there will be certain headwinds to efficiency as a result of tax reform, both optical from FTE adjustments and actual from increased investments in our people and technology. Even after this, we're confident in our ability to improve the efficiency ratio in 2018 due to our heightened expense discipline, the actions we took in the last two quarters, and a positive economic and revenue outlook.

Moving to Slide 10, net charge-offs increased 8 basis points sequentially, primarily driven by the resolution of certain C&I credits that had been in our workout pipeline. Despite this, our asset quality metrics remain very strong and well below through-the-cycle expectations, evidenced by a full-year 25-basis-point net charge-off ratio and a 47-basis-point nonperforming loan ratio. The low level of net charge-offs reflects the relative strength we're seeing across our C&I portfolio, performance we're extremely pleased with, though we remain cognizant that there could be both variability and normalization going forward.

Provision expense declined as a result of the prior quarter reserve build related to the hurricanes. Overall, we expect to operate within a 25- to 35-basis-point net charge-off ratio in 2018 and expect a provision level that should approximate net charge-offs, though there may be some quarter-to-quarter variability.

Average loans were stable sequentially as growth in consumer lending offset declines in C&I. On a year-over-year basis, average-performing loans grew 1% with broad-based growth across most consumer lending products. Within C&I, lower revolver utilization and elevated paydowns continue to mask improving production numbers. Some of the decline is also due to our increased focus on returns, which has led us to exit certain lending relationships which don't meet our return hurdles. Looking ahead, we continue to have positive dialogue with our clients and we believe that tax reform is a catalyst for increased investment and growth. Further, we're well-positioned to meet their needs, whether via lending, capital markets, or other solutions.

Average client deposits were up 1% sequentially and 2% year-over-year, with growth across most products and both segments. Consistent with our previous commentary, the strong deposit growth we have produced over the past several years in addition to our access to low-cost funding enables us to prudently manage our funding base, and therefore more effectively manage our overall deposit beta. Our goal continues to be to maximize our value proposition outside of rate paid by meeting more of our clients' needs by strategic investments in talent and technology.

Let's move to Slide 13. Given the net gains this quarter, our estimated Basel III Common Equity Tier 1 Ratio on a fully phased-in basis was 9.6%, up slightly relative to the prior quarter. In addition, we issued $500 million of preferred stock in November, helping us to further optimize our capital stack and reduce our weighted-average cost of capital. At this point, our Non-Common Tier 1 and Tier 2 capital stacks are fairly optimized, and any other near-term issuance will be limited to refinancing existing issues and/or replacing maturities. Given our strong capital position combined with our improved earnings trajectory, we have incremental capacity to increase capital returns to our owners. The specifics of it will depend upon our rigorous capital planning process over the coming months.

Moving to the segment overviews, we'll begin with the consumer segment on Slide 14, where we continue to deliver healthy overall business and revenue momentum. One of our primary strategic priorities at SunTrust has been to improve our balance sheet diversity and enhance returns. As a result, we've invested consistently in LightStream and our credit card business. The investments we've made continue to yield positive results, which have more than offset the declines in home equity, evidenced by the 5% increase in average total loans in 2017. These efforts -- combined with our continued deposit growth -- were key drivers of the 7% full-year increase in net interest income.

Growth in net interest income helped offset the 17% decline in mortgage production volume. Noninterest income was also pressured by lower service charges given the posting order changes that were made in the fourth quarter of 2016. On the other hand, our wealth management business is beginning to show modest growth, a reversal of previous trends. We took significant actions in 2017 to improve our client coverage model and are seeing early results. We have also invested in new advisors, both within our existing markets and in new markets. Big picture, our value proposition for our targeted client segments is resonating in the marketplace, driving growth in new clients, greater wallet share with existing clients, and overall AUM growth.

Expenses were up $117 million relative to the prior quarter, driven primarily by the discrete items in the current quarter, including the discretionary 401(k) contribution and efficiency-related charges. The third quarter was also favorably impacted by the $58 million in legal accrual reversals. Expenses were stable relative to 2016 as a result of our continued expense management efforts, including continued reductions in our branch network and investments in self-serve channels, including mobile. Provision expense increased $196 million relative to 2016 as a result of the reserve build associated with the hurricanes in addition to strong loan growth.

Overall, we took significant actions in 2017 to improve the efficiency and effectiveness of the consumer segment, including the integration of mortgage into consumer. We're beginning to realize the benefits of this strategic change, which creates an enhanced client-centric approach by having all consumer products and services under one segment and improves scale. We are in the early stages of executing this strategy. We've got a great team in place and are confident about the potential this segment has to grow revenues and improve profitability.

Moving to wholesale banking on Slide 15, for this business, 2017 was a great year. We delivered record revenue of $4.1 billion and record net income of $1.4 billion, in part due to strong market condition and a benign credit environment, but also reflective of the continued strategic momentum we're having with our clients. Fourth-quarter revenue was inclusive of the $107 million gain on the sale of PAC. After excluding this, revenues were up 1% sequentially and 14% on a full-year basis. The sequential increase was driven primarily by higher net interest income and commercial real estate-related income, which offset the decline in capital markets.

Compared to 2016, the increase in revenue was primarily driven by net interest income and investment banking income, which was up by a full 21%. Investment banking's performance demonstrates the success we're having in increasing our strategic relevance with new and existing clients.

It is clear that we're continuing to take market share and become a more relevant capital markets provider. Specifically, our left-lead relationships are up 12%, M&A and equity both had record years, and our average fee per transaction was up 9%. Additionally, we're not just becoming more relevant with our CIB clients, we also continue to focus on bringing product and industry expertise to our commercial banking clients. We're making good progress here and earned a 10% increase in capital markets revenues from these clients in 2017. We have great momentum going into 2018 and we're very confident in our abilities to continue to grow capital markets revenues.

Noninterest expense was up 12% relative to 2016 as a result of the acquisition of Pillar, higher compensation tied to strong revenue growth, and ongoing investments in technology. Core revenue growth was a strong 14%, and as a result, wholesale's adjusted tangible efficiency ratio has improved by 130 basis points to 44.5%. Provision expense declined meaningfully in 2017 given the continued resolution of energy credits and overall strength within the C&I portfolio. These declines -- combined with the strong revenue growth and improved profitability -- drove meaningful improvements in net income, which was up 34% even after excluding the sale of PAC.

Looking ahead, while market conditions may create quarterly variability, our differentiated business model and strong executional abilities in wholesale banking deliver strong results for our clients and shareholders. We expect to see further growth in 2018, particularly as economic growth accelerates in response to tax reform. With that, let me turn the call back over to Bill.

William H. Rogers, Jr. -- Chairman and Chief Executive Officer

Thanks, Aleem. I'll point to Slide 16, which highlights how our long-term financial performance trajectory -- including 2017 -- aligns with our overall investment thesis. First, we have an attractive franchise with great diversity and growth opportunities. This diversity helped drive revenue growth and 14% core EPS growth compared to 2016, even after absorbing the 37% decline in mortgage production income. The growth we continue to see is largely the result of the consistent strategic investments we've made over the years. Specifically, within CIB, we've been particularly focused on our M&A and equity platforms to allow us to become the strategic advisor of choice. Both M&A and equity had record performance in 2017 and we have great momentum going into 2018.

Our competitive advantage continues to resonate with clients and is a key contributor to our continued market share gains. Within commercial banking, we're investing heavily in developing our industry and corporate finance expertise such that we can deliver increasingly sophisticated solutions to our clients. While we're in the early stages, our execution against this strategy was a contributor to wholesale's record performance this year and also a key part of our decision to expand our commercial banking presence outside of our Southeast and Mid-Atlantic footprint. Within consumer, the investments we've made in LightStream, credit card, and other consumer lending initiatives are providing top-notch experiences for our clients in addition to consistent and profitable growth.

Finally, across our company, we've made and continue to make meaningful investments in technology to modernize our infrastructure and deliver differentiated experiences which embody our purpose, meet evolving client needs, and position us for growth. Specifically, we continue to invest heavily in our mobile app. We've made it easier for clients to manage their financial well-being by adding advanced peer-to-peer payment capability Zelle and displaying FICO scores. We gave clients more control over their financial lives by providing the ability to lock and unlock credit cards in real time. Additionally, we introduced SunTrust Deals, which offers personalized rewards and discounts based on clients' preferences and spending habits.

We've also made good progress in developing an API and cloud-based framework for infrastructure and development, which allows us to more easily integrate with apps, services, and digital experiences across the ecosystem. Finally, we've significantly enhanced our core infrastructure by upgrading our loan origination platforms within wholesale and mortgage, transferring certain activities to the cloud, and began upgrading our core teller platform, which when combined with our introduction of Zelle, significantly enhances our broader payment capabilities.

So, looking to 2018, we'll continue to make significant investments in our technology platforms and have several items in the pipeline, including a new enterprise client portal, a fully digitized mortgage application, an increased use of various forms of automation to streamline end-to-end processes and improve efficiency. As you can tell, we remain highly focused on improving our efficiency, both to ensure we have significant capacity to make future investments in growth and technology and to improve the overall profitability of the company. We've made good progress this year, evidenced by the 100-basis-point improvement in our full-year adjusted tangible efficiency ratio.

We still have significant room for improvement and there are a few important actions we took in 2017 to ensure that we fully capitalize upon our opportunity set. We decided to consolidate mortgage, which historically had been a separate business segment, into consumer. This provided us with the opportunity to streamline operations and created greater alignment among all of our consumer-oriented channels. We also created an efficiency office, and the work they've done has enabled a heightened focus and rigor on driving and sustaining efficiency in order to position the company for long-term growth and success.

Finally, as Aleem highlighted, we took a total of $80 million in charges in the last two quarters, which allowed us to accelerate our progress against several key initiatives, primarily around organizational efficiency. These charges have relatively short payback, and further, the improvement in efficiency momentum we have going into 2018. Of note, as we improve the efficiency of the company, we're also enhancing our overall return profile. Specifically, when excluding the discrete benefits in the fourth quarter our return on tangible common equity in 2017 was 12.2%, a full 130-basis-point improvement over 2016.

Last but certainly not least, our strong capital position allowed us to increase our capital return by 47% in 2017. We reduced our share count by 3% and our dividend yield is now in the top third relative to our peers, such as you as owners now benefit from an attractive yield combined with a franchise that has strong growth opportunities.

While all these business accomplishments are impressive, what I'm equally proud of is the progress we've made in advancing our purpose of lighting the way to financial well-being. We launched Momentum On Up in June, which is the industry-leading workplace financial wellness program. We offered to our corporate and commercial clients to equip their employees with the tools they need for financial success. We had 70 companies sign up in 2017, and the early results are extremely encouraging. Participants walk away with a much better understanding of their net worth, the importance of a budget, an emergency savings plan, and ultimately, greater financial confidence. In fact. 99.5% of participants would recommend Momentum On Up to others.

We also celebrated the opening of SunTrust Park, which included the opening of the On Up Experience Center, which is a unique space that uses fun and interactive baseball activities to engage fans to learn more about gaining financial confidence while also strengthening our brand as a purpose-driven, client-first company. Clearly, the $75 million investment announced in the fourth quarter will be meaningful in improving the long-term financial well-being of our teammates and our communities.

Before I close, I wanted to tell you about a leadership appointment we'll be announcing after this call. Our Chief Information Officer, Anil Cheriyan, has decided to retire at the end of March. It seemed appropriate to mention it here as he's been a significant contributor to the results we've delivered. Scott Case, who was previously our Consumer Technology Officer, will become our new CIO and is perfectly suited to build upon the technology momentum I just outlined.

In conclusion, I'd like to say I'm incredibly proud of this company and the team that we have in place. For each of the past six years, we've grown the earnings of the company, we've improved our efficiency, and we've increased our capital return to owners. We've been able to do this because of the consistent strategy and discipline around financial performance and returns. Looking into 2018, I'm optimistic about the tailwinds the tax reform will provide to us and the broader economy. Further, given our position within the Southeast and Mid-Atlantic markets, we should see outsized benefits from increased economic growth.

While tax reform will provide benefits to our bottom line and increase capacity to invest in clients, teammates, communities, and owners, I continue to expect strong discipline and rigor in our balance sheet and investment prioritization process. We made great progress in recent years, and the momentum we've created should help 2018 be the seventh consecutive year of higher earnings per share, improved efficiency, and higher capital returns. Equally exciting, though, is my belief that we're just beginning to realize our long-term potential. I want to pause for a second and thank all of the great SunTrust teammates whose tireless dedication to our purpose makes all this possible. So, teammates, thank you. Now, with that, let me turn it back over to Ankur.

Questions and Answers:

Ankur Vyas -- Director of Investor Relations and Assistant Treasurer

Thanks, Bill. Leah, we are 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 yourselves to one primary question and one follow-up so that we can accommodate as many of you as possible today.

Operator

Ladies and gentlemen, once again, if you would like to ask a question, please press *1 on your telephone keypad. And, we will take a question from the line of Matt O'Connor with Deutsche Bank. Please go ahead.

Matt O'Connor -- Deutsche Bank -- Managing Director

Good morning. You guys bank a very wide spectrum of commercial corporate clients, obviously both on the lending side and helping to originate debt on the banking side, so I feel like you might have a good perspective on the potential for commercial loan demand to pick up, and how meaningful that could be, the timing of that, or this could still get siphoned away into the capital markets, which obviously benefit as well. I was trying to get a sense of -- could we see a little more balance between the loan demand and some of the banking demand with the tax reform and the timing of that?

William H. Rogers, Jr. -- Chairman and Chief Executive Officer

Matt, we spend a whole lot of time with our clients, and I clearly feel -- and, I think tax reform was a further accelerant growing an increasing confidence in their business prospects, and we see that in the surveys that we do. I would just look at ours and break it down, and I think maybe it'll actually help answer the question a little bit. If I think about the health metrics that I look and the core loan growth, as Aleem mentioned, our production has been really good. As a matter of fact, the last quarter was our second-best production quarter in the last eight quarters, so production as a health metric continues to be strong.

Then, if you look at our core company's middle-market lending, that's continued to grow at mid-single digits, so if that's a barometer of where the economy is, I think that's a pretty strong indication, and I think that should continue. So, really, the hanging chad, as you talked about, is how much of this paydown part will continue. I think what we're seeing is an opportunity to increase investments. I think overall, if I look into '18 and beyond, I'm thinking about loan growth as a GDP-plus kind of concept as realistic. The timing of that is a little hard to predict. That's probably a little more toward the latter part of this year and the first part of next year, but I just see that -- when I look at those health metrics, I see that core commercial basis continuing to grow.

Matt O'Connor -- Deutsche Bank -- Managing Director

Okay. And separately, you guys had a very early partnership with GreenSky on the consumer lending area, and I think you guys had a stake or have a stake in that, and I'm wondering if you can confirm that and if you've sized it. It's been in the press recently in terms of raising some private equity and a nice valuation on that, so I wanted to see if you could confirm your stake in that.

Aleem Gillani -- Chief Financial Officer

Absolutely. We can confirm that we do have a stake in GreenSky and that we expect that the partnership that we have with them will continue to get better over time. We really like the partnership that we have with GreenSky. We think we were one of the early investors and have helped them grow, and so, we think we have a special relationship with them and we expect that to continue to do better over time.

Matt O'Connor -- Deutsche Bank -- Managing Director

Okay, thank you.

Operator

And next, we have a question from the line of Ken Usdin. Please go ahead.

Ken Usdin -- Jefferies & Co. -- Managing Director

Thanks. Good morning, guys. I appreciate your opening comments about investing in the franchise with some of the benefits from tax, and still committing to operating leverage. Just wondering if you can help us understand the pacing and even the magnitude of the incremental spend that you're thinking about, and how you're balancing that against operating leverage. We obviously see it in the efficiency ratio guidance, but just wondering how you're balancing the two.

William H. Rogers, Jr. -- Chairman and Chief Executive Officer

Let me start with the punchline. I fundamentally believe the large majority -- and, I don't want to put a percent on it -- of the benefits of tax reform are going to fall to the bottom line. I think that's where we start, and I think that's particularly over the short term. Beyond that, it becomes a little harder to predict, and we base it on a lot of factors, including whatever the competitive environment may be.

That being said, might there be some incremental investments that we make that make more sense now given tax reform? That might be the case and we're going to look carefully at that, but that's going to go through our normal investment planning process, so I don't expect a big step-up function. As you know, we've been investing in our company for years and continue to do that, and a lot of the efficiency gains that we get we continue to make part of our investment strategy, so that's been part of the fuel that's been pumping our investment for a while and will continue to do so.

And then, I also don't see any sort of glaring gap that is going to require us to spend hundreds of millions of dollars that we didn't spend before to fix or put in place. And, as you noted, we're also making the commitment to continue to improve our efficiency ratio. If you did the math, what we're saying is we think we'll have another 100-basis-point improvement in our core efficiency ratio for this year.

Ken Usdin -- Jefferies & Co. -- Managing Director

Understood. As a follow-up on the lending side, you guys -- in the past -- have been relatively conservative and have talked about in the past that you'd like to stay on that side of things. Do you look at opportunity sets here -- especially given the potential, as you mentioned, for loan growth to hopefully improve -- and think about either opening up the credit box a little bit or reevaluating some of the places where you'd like to see incremental business generation?

William H. Rogers, Jr. -- Chairman and Chief Executive Officer

As you know, we have been conservative. That's part of our strategy. We think we want a capital base that reflects that conservatism. You see it in our CCAR results being at the lower decile or quartile of others in terms of capital degradation. That being said, post-tax reform, are there new deals that might hurdle that didn't hurdle before? Yeah, that might be the case, and we'll look at that on an individual basis. It'll go through the same rigorous process that we have, but it's not a case of opening the floodgates, it's a case of incrementally looking at opportunities given some different dynamics from a return perspective.

Ken Usdin -- Jefferies & Co. -- Managing Director

Got it. Okay, thanks, Bill.

Aleem Gillani -- Chief Financial Officer

Ken, let me come back to your first question for a moment on operating leverage and efficiency ratio. In '17 over '16, we delivered a full point of efficiency ratio improvement, from 62% to 61%, and in '18, we expect to do that again. We expect to get another full point of efficiency ratio improvement. But, just remember that optically, because of that FTE impact, that full point will look like half a point.

Ken Usdin -- Jefferies & Co. -- Managing Director

Right, the 50 basis points. Thank you.

Operator

And next, we go to the line of Saul Martinez with UBS. Please go ahead.

Saul Martinez -- UBS -- Managing Director

Hi, good morning. Thanks for taking my call. So, following up on reinvestment and positive operating leverage, your tax guide of 20% -- it's about a 10-percentage-point reduction, more or less, to where you were, and you're generating about $3 billion or so in pre-tax profits, so it looks like the windfall is about $300 million. Have you put parameters or quantified how much of that you think should be reinvested in the various initiatives you talked about? How should we think about that in the context of your cost guidance or your cost expectations?

William H. Rogers, Jr. -- Chairman and Chief Executive Officer

Back to the answer before, I think the large majority of that effect is going to inure to the shareholders. I think the discipline that we've had in the system, the constant trade for efficiency and investment, and that continued process that we've had in place -- that's just not going to change. As I said before, there's not a one-time thing that we're going to put in place, so I'm hesitant about putting percentages because I just don't think that's the way we think about it, and just take solace in what we think is the majority of that. Again, in the short term, it's going to fall to the bottom line.

Saul Martinez -- UBS -- Managing Director

Okay, that's helpful. Going back to the loan growth question, then, you'd mentioned, obviously, utilization rates and paydowns being elevated, and I know you don't manage the loan growth, but is there any way to put some numbers or some parameters around how much falling utilization rates and paydowns impacted your loan growth? If we had a more normalized level of paydowns, utilization rates were constant, how much would that have impacted loan balances? I'm trying to get at if those things do normalize, how much of a tailwind could that be going forward?

William H. Rogers, Jr. -- Chairman and Chief Executive Officer

Not to put direct math to it because those are constantly moving numbers, but if you just take C&I specifically, paydowns exceeded production, and we produce total loans somewhere in the $8 billion-plus category, so you can do your own math on that in terms of what that might be if paydowns were to normalize. I struggle with -- because I don't know what "normalize" means. I think we have to think about environments change, things are a different mode, but my earlier comments around overall loan growth going forward take into account that things do return to levels that we've seen before, and I think that's where I get back to a GDP-plus mentality as we think about loan growth. So, if we're looking at a 2.5% to 3% GDP, I think that's a reasonable expectation longer term toward the end of this year and into next year as we think about loan growth.

Saul Martinez -- UBS -- Managing Director

Okay, that's helpful. Thanks a lot.

Operator

And next, we have a question from the line of John Pancari from Evercore ISI. Please go ahead.

John Pancari -- Evercore ISI -- Managing Director

Good morning. On the commercial real estate-related income that you saw from Pillar and the other operations there, I think you alluded to some of that was impacted by tax-advantaged business. Would you say at all that a portion of that is inflated this year because of the pending tax reform, and accordingly, we can see a reversion next quarter? If so, by how much is that delta, so we can model it?

William H. Rogers, Jr. -- Chairman and Chief Executive Officer

The implication was that it was tax-reform related. I don't think that's an accurate representation. It does have seasonality toward the fourth quarter. That is just the natural flow of that business. So, all of that business is client-driven. It did have some seasonality, probably a little more beta on that seasonality than we normally have. As it relates to next year, we expect that business to continue to be positive. The first quarter will be lower than the fourth quarter because that's just a seasonality impact rather than a fundamental change or one-time aspect of the business. So, all client-driven, not one-time, not specific tax reform business -- just core good business in the fourth quarter.

John Pancari -- Evercore ISI -- Managing Director

All right, thanks. And then, on the margin, I wanted to see if you could quantify the amount of the loan fees -- or, the benefits of the margin from the higher loan fees and interest recoveries in the quarter, and then, your thoughts on the trajectory of the margin through 2018 as deposit betas start to build.

William H. Rogers, Jr. -- Chairman and Chief Executive Officer

The fees that we picked up in the fourth quarter I would think of in the context of 1 to 2 basis points, and then, as I look out into 2018, the first quarter is 0 to 2 basis points positive, and then, after that, it depends on the trajectory of rate hikes. Any quarter that we get a Fed hike or the quarter after it will typically pick up 3 or so basis points, and then, in a quarter where there isn't a Fed hike, we'll get a little bit of a grind downward.

John Pancari -- Evercore ISI -- Managing Director

Okay. Remind me what you're modeling in terms of the Fed actions for 2018?

William H. Rogers, Jr. -- Chairman and Chief Executive Officer

As you know, we're typically a little bit on the conservative side, so with the Fed suggesting that they'll hike three times this year, we're modeling two hikes.

John Pancari -- Evercore ISI -- Managing Director

Okay, great. Thank you.

Operator

And next, we go to the line of Mike Mayo with Wells Fargo Securities. Please go ahead.

Mike Mayo -- Wells Fargo -- Managing Director

Hi. My basic question is why can't you get to your 60% efficiency target in 2018 instead of 2019? You have additional tailwinds from rates, revenues, regulation, and not to take anything away from you, Bill -- since you've been there as CEO, efficiency ratio is down 10 percentage points. I heard what you said -- last year, that improved by a percentage point. This year, you expect it to improve by another percentage point. So, certainly all going in the right direction. It just seems like if you wanted to, you could be there. Maybe that's why you're getting so many questions on the reinvestment. The list of investments -- I counted ten different areas you're investing in based on just what was said on this call.

So, to ask an earlier question a little bit differently, how do you balance the trade-off between letting some of these benefits fall to the bottom line to shareholders today and reinvesting that for shareholders in the future? It seems like your pace of investing might have gone up, but if you could clarify that.

William H. Rogers, Jr. -- Chairman and Chief Executive Officer

Mike, first of all, these FTE adjustments are making this conversation a little more difficult. Let me make it really clear: We're going to get to 60% net of the FTE adjustments. Before, we said 60% was a longer-term trajectory, and net of FTE, actually, we would get to 60% in '18. That's exactly the place we want to be. So, challenge accepted and delivered. Of course, we've got to deliver it for the year, but challenge accepted.

As it relates to the continued level of investment, that's all in light of that efficiency target. We clearly have outlined things that we're investing in -- constantly, that's what we evaluate as a company -- but that's in light of the efficiencies that we create. We run this through a model that says a save-a-dollar, invest-a-dollar kind of process for our business leaders with the thought process that you've also got to continue to drive down the efficiency ratio. So, I think that intensity is in there.

The reason we talk so much about investment is we want to make sure that everyone understands from a shareholder's perspective that this is not a short-term gain for us. This is a long-term gain. So, as soon as we're hitting the efficiency targets, we're also not forgetting the fact that we're investing for the long term in the company. So, if we've over-calibrated in terms of how we talk about that, I think in fairness, we probably under-calibrated before; we didn't talk enough about investment and probably too much about expense saves. Really, the desire here is to calibrate and balance that dialogue because they are both equally important and this is a long-term deal for us.

Mike Mayo -- Wells Fargo -- Managing Director

And then, the follow-up relates to Slide 14. Compared to some peers, it's a disappointment compared to where you might want to go -- maybe it's an opportunity. You closed 100 branches -- that's 7% of the total -- yet the efficiency ratio in the consumer segment was flat '16 to '17. Now, I think there must be some noise in that '17 number, but even after eliminating some of that noise, it seems like the consumer efficiency probably isn't where you need it to be, and you did highlight the investments in LightStream, and digital banking, and automation, and cloud, and the mortgage restructuring to consumer. What are your expectations for the consumer segment efficiency, and did I characterize that correctly?

William H. Rogers, Jr. -- Chairman and Chief Executive Officer

You certainly characterized it correctly in terms of the opportunity. From a math perspective, if you assume consumer and wholesale -- just make it an easy 50%/50% of the business -- wholesale is pretty much at the efficiency ratio in terms of top quartile or top decile in terms of how we look at performance. Now, that's not to take Beau off the hook by any means. We want to continue to strive and do those kinds of things, but the bulk of the efficiency savings going forward are in the consumer segment, as you accurately pointed out.

The things like the mortgage consolidation with consumer create savings. That's why that's highlighted. The branch closures start to create more opportunity on an ongoing basis. The other efficiencies that we've taken in terms of transactional efficiencies and process improvements primarily rest on the consumer side.

Mike Mayo -- Wells Fargo -- Managing Director

All right, thanks.

Operator

And next, we have a question from the line of Marty Mosby with Vining Sparks. Please go ahead.

Marty Mosby -- Vining Sparks -- Director of Bank and Equity Strategies

Thanks. Maybe we can take a little different tilt on the investments and talk about the returns. You have restructuring the securities portfolio, which you say could generate $20 million. That's about a five-year payback. That's pretty conservative. I would think that could do a little bit better, even, than that. You've got $80 million which is going to turn into $40 million of annual benefit that you've talked about there. And then, you've been investing in your capital markets business, which you talked about the deal activity that had spiked, but you didn't even reap all the benefits of that as it comes in the first part of next year, so it looks like there's some returns that actually give you some momentum as you go into next year that you've been able to take from the investments you've been putting out there so far.

Aleem Gillani -- Chief Financial Officer

Marty, I think you're completely right. We've got a number of initiatives that we've put in place. We expect to be reaping the benefits of those initiatives over the course of the next several years. You're right about securities; you're right about the other things you've mentioned. There are a couple of efficiency ratio headwinds, as we've mentioned, but some of those are optical, and that's efficiency ratio as opposed to bottom line.

If you focus on bottom line, we're pretty optimistic about what we can deliver over the next couple of years, and if you think about what our shareholders really care about -- a return on capital -- we think that ROTCE over the next couple of years is going to be considerably higher than it has been over the last couple of years. As Bill mentioned earlier, this year, we did grow our ROTCE to 12.2%. We crossed that 12% barrier, and the next couple of years, we're looking for floors to ROTCE that would be even higher than that.

Marty Mosby -- Vining Sparks -- Director of Bank and Equity Strategies

To follow up, one of the backdrops of all your adjustments this particular quarter was a few nuggets that were also kind of hidden. One is your tangible book value was about 2% higher because you had the net gains from DTO versus a lot of other banks that were actually writing down their DTAs. So, you actually had a 2% increase in tangible book value, which is a nice base adjustment, and then your capital ratios went up because of that as well, which then gives you even more ammunition going into next year's CCAR and thinking about the acceleration of pulling some of that excess capital, so I just wanted to think about those two things as well.

William H. Rogers, Jr. -- Chairman and Chief Executive Officer

That's exactly right, Marty, and that's part of the reason we have the confidence in saying -- of the things that are continuing on the seventh year of improvement is continued increase in our return to shareholders. As you duly noted, we've got to get all the CCAR stuff and all those caveats, but we enter into this with a stronger capital base and more opportunity to return to shareholders.

Aleem Gillani -- Chief Financial Officer

Marty, I don't know if you've heard too many CFOs say this before, but I'm looking forward to seeing what the CCAR scenario is this year.

Marty Mosby -- Vining Sparks -- Director of Bank and Equity Strategies

I can imagine. If you'll humor me, one more question on credit. You have been building your allowance throughout the year, and in this quarter, you actually went the reverse. It looks like you're providing for the losses that you took this quarter through the first three quarters of the year, so this was just the natural offset of that as you got your provision down, but net charge-offs bounced up just because of the recognition of loss that you'd already provided for.

William H. Rogers, Jr. -- Chairman and Chief Executive Officer

Yeah, I'd say that our provision and allowance build was mostly in the third quarter, and that was for hurricanes, so we're expecting to see some of the hurricane charge-offs show up next year, and we provided for that early. Other than that, I'd say our allowance has been generally flat and maybe even slightly declining on a percentage basis.

Marty Mosby -- Vining Sparks -- Director of Bank and Equity Strategies

Got it. Thanks

Ankur Vyas -- Director of Investor Relations and Assistant Treasurer

Leah, we have time for one more question.

Operator

Very good. That's the line of Gerard Cassidy with RBC. Please go ahead.

Gerard Cassidy -- RBC Capital Markets -- Analyst

Thank you. Good morning, Bill and Aleem. A couple questions -- can you guys tell us -- we were talking about the commercial loan growth earlier -- what your utilization rates are in the C&I portfolio, and how do they compare in the past, and what do you think they could do over the next 12 to 18 months?

William H. Rogers, Jr. -- Chairman and Chief Executive Officer

They've been in the high 20s to low 30s, and they've been pretty consistent. That's a barometer that we all look at, but it moves in tectonic ways. It just doesn't move a lot in any one particular quarter. It's slightly down now, but that's reflecting some of the comments we've made. But, I think that's one of the levers, but I think that's the lever, quite frankly, that moves the slowest. I think the things we talked about in terms of production and paydowns have a bigger R-squared, so to speak, to low growth in the short term.

Gerard Cassidy -- RBC Capital Markets -- Analyst

Very good. And then, second, obviously, you guys put up a quarter. Like many of your peers, this year 2017 has been a very good year for the banks and the bank stocks. '18 looks real good as well. But, all of us know we have to look around corners for potential risks. What do you guys look at -- again, things are very good for you and for your peers. What are you worried about or what are you looking at on the horizon that you've got to keep your eye on?

William H. Rogers, Jr. -- Chairman and Chief Executive Officer

I think you clearly have to look around the corner and think about the things that are tail risk or that are pending risk. I think all the businesses that relate to leverage and higher rates, we have to factor in. So, whether that things on the credit card, whether that's leveraged lending in any shape or form, that's something that we have to look at. I don't see that as a near-term issue, in fairness, but as rates increase and leverage stays high, that's one thing we have to look at. Anything related to cyber is something that we have to be concerned about and think about. Those risks are risks that keep growing for us and the industry almost exponentially, so that's something that we have to be vigilant and concerned about.

Gerard Cassidy -- RBC Capital Markets -- Analyst

Great, thank you.

Ankur Vyas -- Director of Investor Relations and Assistant Treasurer

Leah, this concludes our call. Thank you to everyone for joining us today. If you have any further questions, please feel free to contact the Investor Relations department.

Operator

Thank you. Ladies and gentlemen, that does conclude our conference for today. You may now disconnect.

Duration: 60 minutes

Call participants:

William H. Rogers, Jr. -- Chairman and Chief Executive Officer

Aleem Gillani -- Chief Financial Officer

Ankur Vyas -- Director of Investor Relations and Assistant Treasurer

Matt O'Connor -- Deutsche Bank -- Managing Director

Ken Usdin -- Jefferies & Co. -- Managing Director

Saul Martinez -- UBS -- Managing Director

John Pancari -- Evercore ISI -- Managing Director

Mike Mayo -- Wells Fargo -- Managing Director

Marty Mosby -- Vining Sparks -- Director of Bank and Equity Strategies

Gerard Cassidy -- RBC Capital Markets -- Analyst

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