Regions Financial Corp (RF) 2009 Q3 法說會逐字稿

Good morning.

Welcome to the Regions Financial Corporation's quarterly earnings conference call.

My name is Wes, and I will be your operator for today's call.

I would like to remind everyone that all participant phone lines have been placed on listen only.

At the end of the call, there will be a question and answer session.

(Operator Instructions).

I will now turn the call over to Mr.

List Underwood, before Mr.

Ritter begins the conference call.

Thank you, operator.

Good morning, everyone.

We appreciate very much your participation today.

Our presenters are Chairman and Chief Executive Officer, Dowd Ritter and Chief Financial Officer, Irene Esteves.

Also joining us and available to answer questions are Bill Wells, our Chief Risk Officer, Tom Neely, Director of Risk Analytics, and Barb Godin, our Head of Consumer Credit.

Here with us also is our recently appointed Chief Credit Officer, Tim Laney.

Let me quickly touch on our presentation format.

We have prepared a short slide presentation to accompany Irene's comments.

It's available under the Investor Relations section of Regions.com.

For those of you in the investment community that dialed in by phone, once you are on the investor relations section of our web site, just click on Live Phone Player and the slides will automatically advance in sync with the audio of Irene's presentation.

A copy of the slides will be available on our web site shortly after the call.

Our presentation this morning will discuss Regions' business outlook and includes forward-looking statements.

These statements may include descriptions of management's plans, objectives or goals for future operations, products or services, forecasts of financial or other performance measures, statements about the expected quality, performance or collectability of loans and statements about Regions' general outlook for economic and business conditions.

We also may make other forward-looking statements in the question and answer period following the discussion.

These forward-looking statements are subject to a number of risks and uncertainties, and actual results may differ materially.

Information on the risk factors that could cause actual results to differ is available from today's earnings press release in today's Form 8-K, our 10-Qs for the quarters ended March 31 and June 30, 2009 and in our Form 10-K for the year ended December 31, 2008.

As a reminder, forward-looking statements are effective only as of the date they are made, and we assume no obligation to update information concerning our expectations.

Let me also mention that our discussions may include the use of non-GAAP financial measures.

A reconciliation of these to the same measures on a GAAP basis can be found in our earnings release and related supplemental filings.

Now I'll turn it over to Dowd.

Thank you, List.

Good morning, everyone.

We appreciate you joining Regions' third quarter earnings conference call this morning.

Before I begin discussing the quarterly results, I want to mention one other item of importance to this Company and its future performance.

Last week, I'm sure most of you saw we announced that Grayson Hall was named President and Chief Operating Officer of the Company.

This is the logical next step in establishing a clear management succession plan as well as further strengthening our corporate governance and, most importantly, positioning Regions well for growth in the years ahead.

This appointment is recognition of Grayson's tremendous leadership ability and accomplishments over his 29 years with the Company in ever increasing roles of responsibility as well as our Board's future expectations.

Under Grayson's leadership, for example, customer satisfaction at Regions has reached an all-time high and consistently ranks in the top quartile versus other banks as measured by Gallup surveys.

Finally, I'd say that the economic environment remains difficult, and I am committed to working with Grayson and the other senior members of our management team over the coming years to continue to manage the company for the long-term benefit of our shareholders.

By the way, I should add that Grayson is here with us today and available to answer questions as well.

Let me turn now to the quarter.

Regions' third quarter loss of $0.37 per fully diluted share was driven by our ongoing efforts to proactively identify, deal with and reserve for credit-related problems as we further improve the risk profile of our balance sheet.

Additionally, noninterest expenses were inflated by costs associated with our branch consolidation initiative, and other rising costs reflective of the current recessionary environment.

Examples of these would include FDIC insurance, further real estate costs and professional fees.

These items more than offset the benefits of strong, low-cost customer deposit growth, an improving net interest margin and solid core fee-based revenue and good core operating expense containment.

Let's first talk about credit quality and the third quarter's loan loss provision and OREO costs, which total nearly $1.1 billion or $0.56 per share, which were up $150 million on a linked quarter basis.

As Irene will detail for you, both nonperforming assets and net loan charge-offs continued to rise during the third quarter.

Therefore, we increased the allowance for credit losses to 2.90% of loans.

The good news is that the gross inflows of nonperforming loans appears to be stabilizing.

Also of note, related to our7.3 billion shared national credit portfolio, we recorded just $37 million of net charge-offs, and we placed an additional $109 million on nonaccrual status in the current quarter.

While manageable, the effects of the economic downturn are to a greater degree extending beyond our problematic home builder, Florida Home Equity second lien and condominium portfolios.

These assets still account for a sizable element of overall nonperformers; however, other commercial real estate credit such as loans secured by income-producing properties explain the bulk of the third quarter's NPL inflow.

Keep in mind, there is greater cash flow associated with loans on income producing property, which improves our ability to restructure the credit and return it to performing status.

We continue to take a proactive stance in recognizing those problem credits.

Importantly, approximately $335 million of our commercial real estate loans, including $226 million backed by income-producing properties, are carried as nonperforming and are actually paying currently.

Meanwhile, we continue to reduce our home builder and condominium portfolios, which declined another $498 million in the aggregate during the quarter.

Given the lower levels of these portfolios and the significant charge-offs that we've already booked, this source of losses will decline as we move through 2010.

At the same time we are managing through this period of fee pressure and elevated credit costs, we are continuously looking for ways to enhance the long-term profit potential.

Our most recent action relates to our branch network, where we believe there are opportunities for us optimize the efficiency.

In our extensive analysis, we've decided to consolidate 121 branches into other branches over the next two quarters.

Our results this quarter include valuation related expenses and other costs of $41 million and the net savings resulting from these actions are expected to total $21 million on an annual basis going forward.

These closings will have very minimal customer impact.

We have a number of other expense initiatives aimed at eliminating nonessential costs and constraining discretionary expenses.

In particular, we are closely managing our headcount, and of course, we drastically reduced staffing, as a result of the merger, but we've gone far beyond that.

Since this time last year, we've eliminated nearly 1700 positions across all areas of the company and with the branch consolidations and other personnel related measures, we'll become even more efficient through the remainder of this year and see the full run rate in 2010.

In addition, we've made great strides improving our net interest income.

Drivers include enhanced risk adjusted loans and deposit pricing as well as business development initiatives such as continued emphasis on growth in low cost deposits.

A main focus has been building our customer base and expanding customer relationships.

For example, we opened a record 270,000 new retail and business checking accounts during the third quarter, up 29% versus the same quarter last year, taking new account openings for the first nine months of this year to 762,000 new accounts.

And we've grown average customer deposits over $10 billion since this time last year.

In the third quarter alone we increased average interest free deposits $701 million or 3.4%, which is notably benefiting our funding mix.

Further strong confirmation of our efforts came late last week as the FDIC deposit market share data showed that we gained share in all but one of our state markets and after you adjust for acquisitions and brokered deposits during the last year.

At the same time, our deposit market share rankings improved in six of our 16 states.

These are very good results, especially considering this current operating environment.

Similar to this quarter, however, at least in the intermediate term, the benefits of these initiatives is somewhat overshadowed.

Escalating costs related to the current economic environment, such costs as OREO and other credit-related expenses along with the higher FDIC expenses will largely offset the efficiency and revenue initiative benefits that we're achieving.

But as the economic credit environment normalizes, we should see substantial improvement in our earnings power.

To sum up, the operating environment remains challenging but the economy appears to have bottomed, and should start to recover, although at a potentially much slower pace.

Throughout this period of recovery, Regions will continue to prudently manage its capital and other resources and further strengthen our core business on all fronts.

We are confident that once credit costs normalize, and they will, Regions will be set to deliver solid bottom line profits.

Let me now turn it over to Irene to discuss third quarter results in greater detail.

Thank you, Dowd.

Let's begin with the summary of results for the quarter.

Despite third quarter's credit-driven bottom line loss, results showed strength in several areas.

As shown in slide one, low-cost deposits rose an average $1.3 billion linked quarter.

An approximate 3% gain in noninterest bearing deposits and a 4% increase in money market funds more than offset a drop in higher cost certificates of deposit.

Reflective of lower demand, average loans were down across most categories.

The ongoing positive shift in funding mix combined with improved loan and deposit pricing helped lift the net interest margins 11 basis points.

As a result, we were able to grow net interest income about 2%, even though average earning assets declined nearly 4%, due primarily to a $2.8 billion reduction in cash balances and a $1 billion decrease in loans.

As Dowd said, noninterest income was solid.

Adjusting for several unusual second quarter items, it was little changed linked quarter.

Higher service charges and mortgage income were partially offset by lower brokerage revenues.

Noninterest expenses included the $41 million of branch consolidation and valuation related costs, as well as higher professional fees and other real-estate owned expenses.

Our capital position remains strong, with tier one capital an estimated 12.1% and tier one common at 7.8%.

As expected, credit quality remains challenging during the quarter.

As a result, we booked a $1 billion loan loss provision that more than covered net charge-offs, providing a 46 basis point increase in the period end allowance for loan loss.

Net charge-offs rose to an annualized 2.86% of average loans from second quarter's 2.06%, with the change driven by value-related write-downs and problem asset dispositions.

Non-performing assets, excluding loans held for sale, increased $662 million, well below second quarter's $1.1 billion jump.

CRE was the most notable contributor to the NPL and charge-off increases.

Let's take a few minutes to delve deeper into credit-quality trends and related costs, given their importance to Regions' bottom line results.

This slide shows the total loan loss provision, including net charge-offs and provision above net charge-off, rose to just over $1 billion in the third quarter from second quarter's $912 million.

As you can see, while consumer real estate remained a major source of credit costs, they did decline versus last quarter.

Most notably, the quarter over quarter home equity loss rate improved 48 basis points.

We attribute this to the fact we are through most of our investor type loan issues, well through the second home issues, and are now working more with customers on loans secured by their primary residence.

More than offsetting these, however, commercial real estate costs increased as we aggressively revalued properties which resulted in write-downs.

Note the increase in CRE valuation charges, which rose from $129 million to $191 million in the current quarter.

NPAs, excluding loans held for sale, totaled $3.7 billion or 3.99% of loans in OREO at quarter end, an 82 basis point rise linked quarter.

Gross NPA migration steadied at $1.7 billion, $91 million lower than second quarter inflows.

Third quarter inflows included $225 million of currently paying loans as well as $109 million of shared national credits.

As I mentioned earlier, on a net basis, ending NPAs excluding loans held for sale increased at a much slower quarter to quarter rate, $662 million this quarter versus $1.1 billion last quarter.

We are seeing a shift in the inflow mix, with homebuilders and condos slowing significantly, and income producing commercial real estate inflows picking up.

Income-producing CRE accounted for 33% of third quarter's gross inflow, driven by retail and multi-family property.

Again, it's important to remember that many of our CRE loans are on income-producing properties with some level of cash flows.

This suggests loss severity should be less than what we have seen in our home builder and condo portfolios and that we'll have greater ability to restructure and to more quickly return some of these loans to performing status.

Problem assets disposition remains a focus for us.

In fact, during this quarter, we sold $353 million of assets, more than twice the amount sold in the second quarter, plus we transferred an additional $201 million to loans held for sale, taking an average 37% charge-off in the process.

The fourth quarter is off to a quick start, too.

Shortly after the third quarter ended, we closed sales on $27 million, which were in the held for sale portfolio.

Looking now at specific loan categories, we've talked a lot about our closely managed home builder portfolio for the last several quarters.

Over that time, we've made significant progress in reducing our exposure through a combination of sales, paydowns and loss recognitions.

Outstandings have declined to now total $3.4 billion, down 53% from their peak of 7.2 billion.

These assets now equal 15% of our non-owner occupied CRE portfolio or 4% of total loans.

Condos are quickly becoming a nonissue, as these loans totaled just $647 million at September 30, down from just under $2 billion two years ago.

These loans have been on our moratorium list for some time now, and we expect this portfolio to be even smaller by year-end.

Lastly, let me touch on commercial real-estate loans secured by income-producing retail or multifamily properties.

These loans totaled about $9.4 billion at quarter end with a nonperforming content of $448 million.

Of this nonperforming portion, $226 million is paying currently.

We expect income-producing properties to present greater opportunity to restructure and return to accrual status at a later date.

On the consumer side, our home equity portfolio is performing much better than the industry, largely because of our disciplined approval process and the fact it was originated in our branch network.

The most stressed portion continues to be second liens in Florida, which account for $3.6 billion, or 4% of total loans.

Losses here were actually down versus last quarter, owing largely to the fact that we have a very active customer assistance and outreach program where customers come into the collection process on average at six days past due, and in Florida at three days past due.

Wrapping up on credit quality, let me mention a couple of important points regarding our allowance coverage.

First, we have taken appropriate write-downs on our non-performing loan portfolios at the time of their migration into non-performing status.

Beyond those marks, our loan loss allowance covers additional losses inherent in our total loan book.

The coverage of non-performing loans was at 0.82 times at quarter end.

Further, as you know, this allowance consists of both specific or FAS 114 reserves allocable to certain non-performing loans and with the remaining allowance applying to the remainder of the portfolio.

Breaking NPLs down in similar fashion, between the portion for which the FAS 114 reserves exists, and the remaining portion, you see that specific reserves amount to just under 20% of related NPLs, and recalculating the coverage ratio on the remainder of NPLs, our coverage is approximately 1.9 times.

Now, let's take a closer look at third quarter balance sheet changes.

As I previously mentioned, both commercial and consumer loan demand was sluggish.

However, you will notice an increase in both non-owner occupied and owner occupied commercial real estate.

But note, too, that these increases were essentially offset by declines in the construction categories, with the shift being driven by construction loans upon project completion migrating to mini-perm status.

On the consumer side, residential first mortgage production declined as refinance activity slowed as a result of increasing mortgage rates.

Most of our other consumer loan portfolios, mainly consisting of indirect auto lending, are in runoff mode, so they will continue to decline with normal amortization.

Let me now turn to our deposit growth.

Our growth in low-cost funding continues to be robust on all fronts, including consumer, small business and commercial.

Slide 12 shows a positive change in our deposit funding base since last quarter, driven by continued strong low-cost deposit growth, especially interest free and money market accounts.

Much of the success is being driven by our strong new consumer and business checking account openings, which totaled $270,000 in the third quarter alone.

We've also improved our customer attrition with household retention at historical highs.

Annualized retention rates have improved 89% for consumer checking from a year ago's 88%, while business services retention rate is now 87% versus 85% last year.

Also helping our funding mix, higher cost certificates of deposit balances declined $889 million this quarter versus last.

We've had the opportunity to reprice a meaningful amount of the remaining balances recently.

This solid, low-cost deposit growth has been a catalyst to our improving net interest margin, and should continue to benefit the margin as we move to 2010.

We're also beginning to reap rewards on the pricing front, where deposit costs continue to decline, and loan spreads have improved significantly.

But keep in mind that over the next several quarters, drag from rising nonperforming loans as well as the impact of maturing interest rate swaps could mitigate the positive effect on our margin.

The bottom line, we expect the margins remain relatively stable in the near term.

However, looking further out, we believe our asset-sensitive balance sheet is positioned well for the eventual rising rate environment.

On our noninterest revenues, we are significantly lower than second quarter, which had benefited from sizable gains related to a trust preferred exchange, Visa shares, and other security sales and leverage lease terminations.

Excluding these items, noninterest revenues were essentially unchanged linked quarter.

A highlight in the quarter, service charge revenue was up $12 million or 4%, benefiting from a high level of customer transactions and new account growth.

An $11 million decline in brokerage revenues largely offset, as investment banking and fixed income capital market results were down slightly.

Mortgage revenue was solid, increasing $12 million, primarily the result of favorable MSR and related hedge performance.

The mortgage interest rate environment trended higher during the quarter, driving down origination volume of $1.8 billion compared to second quarter's $3.1 billion.

Refinance activity represented 54% of origination, down from the first quarter level of 76%.

Importantly, our service quality has been outstanding.

We were recently ranked highest in customer satisfaction among primary mortgage servicing companies by JD Power and Associates.

Now let's take a look at Morgan Keegan's third quarter results.

Overall, Morgan Keegan had a very solid quarter.

While slightly behind the second quarter, fixed income continued its record-setting pace, driven by institutional customers' demand for government, mortgage-backed and municipal securities.

Private client revenues increased 6% versus the prior quarter, reflecting incremental improvement in the equity markets as well as the addition of new financial advisors.

Both trust and asset management revenues improved linked quarter, benefiting from strong markets, which drove customer and trust assets up 6% and 4% respectively.

Lastly, new account openings continued to rise with the addition of 16,200 in the current quarter, bringing year-to-date new account additions to 64,500.

Our progress in reining in noninterest expenses continues to be masked by higher credit-related and unusual charges.

Third quarter reported expenses increased 1% linked quarter.

Adjusting for unusual items such as second quarter's FDIC special assessment, second and third quarter's securities related impairment charges, and third quarter's $41 million of branch consolidation charges, expenses were up 9%.

This increase was tied to three areas.

First, OREO costs were $37 million higher than last quarter, driven by marks to updated appraisal value.

Professional and FDIC fees also rose, driven by higher credit-related and other legal costs.

Partially offsetting these increases were lower incentive compensation as well as meaningful incremental head count reduction, driving $8 million or 1% improvement in salaries and benefits.

Let me give you some specifics regarding our branch consolidation plans.

We've got one of the most geographically diverse branch networks in the industry, which provides us with many opportunities for efficiency improvements.

Based largely on profitability and proximity measures, we have identified 121 branches for consolidation.

These branches, which are spread throughout our footprint, will be closed in early 2010.

In total, we recorded costs of $41 million this quarter, and we expect to realize net cost savings of $21 million annually.

In addition to this $21 million, we have identified other core expense reductions of over $200 million.

This includes personnel, occupancy, technology, and other discretionary spending.

Unfortunately, these won't be evident until credit-related expenses subside.

But these measures are making us more efficient and more effective.

On the next slide, we show the quarter to quarter decline in core PPNR, which largely reflects the just described higher OREO and professional fee expenses.

While these costs are certainly something we'll have with us over the near term, they will moderate at some point in coming quarters, leaving a PPNR base driven higher by strengthening net interest income, solid non-interest revenues, and efficiency initiatives.

Turning now to the comparison to the SCAP results, if we straight lined the SCAP results one-eighth per quarter, we would compare favorably to their stress case by just under $1.2 billion through the first three quarters.

And looking at net charge-offs alone versus the SCAP straight line, you see that this quarter's net charge-offs were near the upper end of our range, but still far below the SCAP stress case.

Switching to capital, this slide shows our strong ratios, our tier one capital ratio now stands at 12.1%, far in excess of the regulatory minimum, while tier one common ratio is a very solid 7.8%.

In conclusion, while we certainly don't want to gloss over the reported loss, it's important to recognize that beneath credit driven factors, we are transforming Regions into a more efficient organization with good core earnings power.

We're profitably growing our customer base and deepening our ties to existing customers.

We've stabilized our net interest margin and we're implementing initiatives that will further enhance operating efficiency and profit potential.

As a result, we believe that when credit costs return to more normal levels, Regions is poised for a significant profit rebound that will translate into attractive return for shareholders.

At this time, operator, I'd like to open it up for questions.

(Operator Instructions).

We'll pause for just a moment to compile the Q&A roster.

Your first question comes from Betsy Graseck of Morgan Stanley.

Good morning.

Thanks.

A couple questions.

One is on the asset sensitivity.

If you could just help us understand the duration that you have for the loan book and securities book and then just walk us through the NIM impact you're anticipating from the front end of the curve going up versus the front end of the curve potentially steepening.

I'm just wondering what's more important for you?

We are expecting that our NIM is going to be about flat.

That has to do with our expectation that interest rates will not be increasing until the latter part of next year, but we do expect with that increase that our NIM will rise substantially, and you can see that in our 10-Q.

Disclosure, yes.

Okay.

What we have said is our deposit pricing and loan spread improvement was beyond expectations which drove the 11 basis point increase this quarter, the rolloff of our derivative portfolio, which was about seven basis points next quarter.

It will be about 14 basis points next quarter.

But our progress on deposit pricing and loan spreads has offset that.

Okay.

Is there anything that you would do as we're approaching that second half next year as interest rates rise to position yourself even more for rate hikes in the securities book?

We're still very asset sensitive compared to our peers, but we think we're well positioned.

Then just another question on as we look out to what normalized earnings should be, could you give us a sense as to where you think the organization can get to on a normalized ROA?

Betsy that's a difficult question, as you know, with the various moving parts, and what timeframe we're looking at, it would be difficult for me to answer that.

I guess a different way of asking the question is we hear a lot about what's going on with regard to pricing for different types of products in particular the consumer space on insufficient funds and there's other kinds of regulatory changes that are going to be coming with capital, et cetera.

What I'm asking is, when you look at your business model and when you look at how your customer base is responding to what you're doing, do you feel that you're going forward, normalized ROA would be materially different from what you had been experiencing pre-crisis?

One thing to point out and if our history is quite different from the bank we are today, given the history of legacy Regions alone versus a combined and south Regions bank that we are today and new Regions.

It's difficult to compare to the past but we certainly believe that there's tremendous upside as we roll off these credit-related expenses both in our loan loss provision as well as credit-related expenses buried in PCNR.

Obviously with the recession, our fee income is down significantly, consumers are not transacting as much as they have in the past.

There's great upside there as well as at our Morgan Keegan franchise as we mentioned earlier, the net interest income has upside as interest rates go back to more normal levels.

There's certainly quite a bit of upside potential in that normalized number.

Lastly, on TARP repayment, could you give us an update on your views as to what kind of time frame you're thinking about there?

Obviously, we're going to do what's prudent and shareholder friendly.

There isn't any direct information on what it will take and when it will be positioned to pay back TARP.

But we are taking every action necessary to be prepared for that.

Are you holding excess liquidity as a function of being prepared for that?

We have at quarter end, we had, I think, $6 billion.

That's now about $2 billion.

We had significant liquidity in our investment portfolio that we're able to pledge at any moment.

Thank you.

Sure.

Your next question comes from Matt O'Connor of Deutsche Bank.

Good morning.

I was wondering if you could elaborate on the $200 million of cost savings that you expect to get over time, in terms of what's on the current run rate, when you expect to realize them and a little more color on what's going to drive those savings?

This is Grayson Hall.

As Irene said earlier, we've had an initiative underway literally for several months in terms of trying to generate expense reductions, and as Irene mentioned, we've got a run rate that will exceed $200 million in 2009 and will actually go north of that in 2010.

It is largely in staff reductions, which is as Dowd had mentioned earlier since the first of the year we're down 1700 positions.

We continue to trend downward in staffing levels.

We have disposed of a little over $ 800 million square feet of excess space.

We'll continue to reduce our space requirements probably by another 800,000 square feet.

My apologies.

We have roughly, as we mentioned, 121 branches that will consolidate if you'll recall.

We consolidated a little over 200 branches at merger.

We consolidated 12 already this year.

We'll do 121 first quarter.

We've literally looked at every single discretionary spending category from legal to travel and entertainment to telecommunications, and we have reduced our discretionary spending in many categories in excess of 30%.

Okay.

And just separately with the tightening of credit spreads in 3Q your OCI is now a positive.

What's the outlook for potential security gains in the fourth quarter?

We're not planning any major are sales of those securities in the fourth quarter.

Okay.

All right.

Thank you very much.

Your next question comes from Craig Siegenthaler of Credit Suisse.

Thanks and good morning.

Good morning.

First, just on the residential mortgage and home equity, it looks like some of the credit quality metrics like delinquencies, NPLs in these two portfolios were down.

They improved while -- excuse me, the credit quality in these portfolios got worse but on the other hand losses got better.

I'm wondering should you expect losses to reverse and go higher in those two books specifically or can you relate those two trends?

Yes, Craig.

This is Barb Godin on the consumer side.

As we mentioned last quarter, if you recall, in the earnings call, we had noted that we had anticipated that our delinquencies would indeed be down in our 90 plus.

The reason for that was because of things like income tax returns and stimulus checks.

And we anticipated it would go back closer to first quarter levels which they have moved up but certainly haven't even hit the first quarter levels.

Of course, with the 90 plus delinquency going down last quarter, one would anticipate some of that, as I mentioned, would roll back into delinquency and another portion of course didn't roll back at all and in fact, cured.

That's the reason for the lower net chargeoffs.

Purely seasonal?

Seasonal, and of course the other comment would I make, though, is as we think about the consumer book time be sensitive to unemployment.

So we anticipate there will be pressure, depending on what the economy does.

Barb, talk a little about what we've already been through, the portfolio and losses and going to the investor piece in the second home.

Yes, as Dowd mentioned or Irene mentioned in their comments, we started off during the cycle with investors, some of them known to us, some of them not known to us.

What I mean by investors is consumers who came in and said they wanted to purchase a property and turn around and use it as a rental property as an example.

Those are underwritten differently.

They're priced differently.

We also had others who did not tell us that who actually in turn did rent their properties out.

Those first that came through in terms of a wave of losses and a wave of delinquencies.

That was then followed by consumers who had second homes who hung on as long as they could but indeed turned around and said I need to keep my first home and therefore I need to return the second home to you or return the keys to you or at least let me do a short sale.

And now what we're working with, generally, we still have some of the other two left but generally it's consumers in their primary homes that really want to stay in their homes.

We're much more able to work with those consumers.

Got it.

Thanks.

Just one question on really the NIM guidance in the fourth quarter.

I'm wondering what moving pieces on the balance sheet is this dependent on?

Is this dependent on further expense or deposit shrinking?

I'm just wondering that.

A lot of it has to do with the deposit, continuous decline and deposit costs.

Also as we have loans coming up for renewal, we are improving the loan spreads, and also our mix of deposits is improving with much more in low-cost deposits.

Great.

Thank you for taking my questions.

Sure.

Your next question comes from [Peter Volkner] of Sanford Capital.

Hi, guys.

Hi, Peter.

I have two questions.

On the gross NPA inflows, I'm kind of eyeballing it off the slide, but it looks like income-producing CRE was around 650, roughly double the Q2 level, and maybe you could just give me a little bit of an indication as to whether that's being driven by regulators or how uniform the standards are in terms of when you move a cash flowing loan into NPA.

Also, if you could just let us know what the marks are moving that into NPA.

In terms of overall migration into NPA we were giving us 50% mark in Q4 then it went to 35, 25.

Where are we in this quarter?

And also, you talked about restructuring these loans being a little bit easier because of the cash flow.

What about disposing of them ?

Are you seeing liquidity for that type of NPA.

My second question is on operating expenses.

It was at about $1.24 billion in the quarter.

Even when I back out, the restructuring costs and I back out some of the higher OREO, which at some point is not going to be recurring, I still come up with about a 1.15 operating expense level, which is kind of where you were trending in the first half of the year.

Maybe you can take a stab at what the recurring level is.

If I use that $200 million of cost saves going into next year and the year beyond that gets me to like a $900 million to a $950 million operating expense level.

Is that the right way to be thinking about it or if not, you know what's the right way to be thinking

Peter, let me first start on the credit.

On the gross NPAs, what I would tell you first,our nonperforming gross migration was down a little bit slightly this quarter.

It was higher than expected really because of three things.

Shared national downgrades of $109 million that Dowd and Irene mentioned.

When you look back that was a very good story.

And as you pointed out, there is a deterioration of the multifamily that happened a little quicker than expected.

And then we are still working.

Kind of gets back to your question to the issue of the loan that is currently paying as agreed that goes on nonperforming.

That goes on $225 million versus $169 million.

So when we're looking at it, you are seeing more deterioration in a multifamily portfolio.

When I look at the gross NPAs what I'm seeing is more positive efforts are bringing down our condo and home builder books.

So you're seeing that.

As far as the marks are going, when we did our first big disposition, the number you referred to was about 50%.

Remember that was some of our worst credits we dealt with in the fourth quarter of 2008.

First quarter was roughly in that 30, 33%.

Then last quarter we saw about 25% discount.

The reason for that liquidity had not come really back in the market first month of, I guess, first part of the quarter.

We just didn't see a lot of liquidity there.

We saw it pick up at the end of second quarter.

As you can see from our sales, it's continued in the third quarter.

So our marks are about 33% for this quarter.

So they're up a little bit.

Part of that is just our ability to move some more product.

So that's more liquidity coming back in.

We are dealing with strategic buyers instead of doing bulk sales.

I think that's why our marks have been holding very, very well.

As far as restructuring, what I would tell you is that 18 months ago, when this company was facing land and condo and home builder book, that was tough to deal with.

You didn't have that much restructuring opportunities, although we did some.

With the multifamily, any time you have cash flow, you have a better ability to restructure.

I feel better about looking what's ahead of us, while we still can't see what deterioration our pace would be.

When I'm looking at loss severity, that gets into our ability to be able to restructure credit.

Peter, what I would also say about asset disposition.

Since 2008, we've disposed of over $2.2 billion, and we've had a very active market in our sales this quarter.

We did see the market improve a little bit.

Bill mentioned the overall discount.

We're also seeing more in the way of short sales, which is an indicator that certain markets we're seeing values on properties begin to level out.

Barb, I think you've seen that on the consumer side as well.

Absolutely.

Okay.

And on maybe Irene on the recurring operating expense line?

On the operating expenses, besides the OREO, just looking at the quarter to quarter change, you also have to look at the professional fees, including FDIC.

And as far as ongoing, as I mentioned, we have a number of head winds where you are not going to see that $200 million right away because we have these other credit-related costs like OREO, professional fees and reserving for unfunded commitments that are also in that line that you're not going to see it immediately.

It's the underlying improvement and the efficiencies that you will see once credit related costs come back down.

We can all make our guess as to when credit stabilizes and starts to improve.

I guess my question was because I know there's a lot of moving parts in there, at that point, whether it's next year or sometime there after, we're going to be in the sub-$1 billion operating expense run rate if I'm hearing you properly.

Just want to make sure I'm hearing you properly.

Yes, you are.

Okay.

Thank you.

Your next question comes from Chris Mutascio of Stifel Nicolaus.

Good morning.

Thanks for taking my question.

Irene, I was looking at slide 22, the chargeoffs, below the stress test level.

Should I take more comfort in that or not?

Does it look like you're going to blow through your own stress test chargeoffs by next quarter?

This is Bill.

What we're trying to do is in recognizing when you do a presentation like this it's not linear.

What you're starting to see is our still forecasting I believe last quarter we said would be about in the middle between the green and the blue line.

As we've gone through more and see a little bit more of the deterioration and multifamily, you're probably moving up a little bit.

But well below where we see the blue line ending up.

So I think you have to look that in some part it'll peak and start to trend down.

Okay.

That deals with the credit cycle.

So I don't think you could see it just going straight up quarter after quarter.

You have to recognize, one, that we've dealt with some of our most troubled credits earlier.

You were dealing with land, condo and home builder.

Now you're dealing with a little bit of a multifamily portfolio, but it is more geographically dispersed than what we dealt with, with home builder and condo.

So when I look at submarkets, I start to see about multifamily that yes, a stressed portfolio and you're seeing issues in it, but you're able to one, restructure it.

Two, it has loss severity and more geographically diverse.

If I could ask one follow-up.

At the Analyst Day over the summer, we were seeing stabilization in credit quality.

Did you all envision greater than 20% increases in nonperforming loans, 90 days past due and restructured loans this quarter, is that within the realm of stabilization, or did things deteriorate more than you thought at your analyst day over the summer?

First, you know, I think you have to break down the 90 days.

I talked about that.

In the business services side, actually our 90 days are down.

We've worked very hard quarter over quarter to get that number down, and that gets into how our ability to restructure.

What you're seeing in the increase of 90 days came out of the consumer services side.

I believe we're also talking about trouble debt restructuring a little bit, too.

I'll let Barb speak to that.

I'll go back and I won't repeat my comments relative to the seasonality of the book.

That's the reason that was up second quarter over third quarter.

And again, as we had noted previously, we thought it would go back up to first quarter levels.

We were pleasantly surprised that it wouldn't.

The other comment I would make would be about trouble debt restructures.

You're correct and moved up to $1.178 billion in the second quarter to $1.416 this quarter.

Anything we do on the consumer side to modify or change any of the terms of the loan we actually call that loan a trouble debt restructure.

We have not, as of yet, moved any of those trouble debt restructures back into our current portfolio.

Also on the TDRs, remember, as Barb's very active customer assistance program we have underway so you're taking a customer and you may change the interest rate, which is still a pretty good interest rate and they're paying.

So it's again, working with that customer to put them on so it doesn't have the same feel of a TDR I used to sigh back in the 1990s on the business services side.

In general, did credit quality play out like you thought earlier in the summer or did it get worse in the quarter than you anticipated back in your analyst day?

I would say that we always thought this our nonperformings would be up.

I mean, we've talked about that.

Probably I saw a little more this quarter than anything was the pace of the multifamily coming in than what I had anticipated.

Thank you so much.

Hey, Chris.

This is Tim Laney.

When you look at land condo and home builder and the rate of deterioration and the fact that that deterioration has declined it's very consistent with our internal forecasts, and our confidence in estimating future deterioration and losses of this particular portfolio only continues to strengthen.

Thanks.

Appreciate it.

Your next question comes from Jefferson Harralson of KBW.

Operator, this is List Underwood.

I need to interject something.

We've got a number of questioners remaining and to be able to get everybody in, if we could limit each questioner to just one question, please.

I can do that.

Let me ask you guys about the pace ever disposition.

Do you expect the pace of dispositions to continue at this $1 billion pace or do you think it's going to decline from here?

We're seeing more liquidity come back in right now.

As Irene mentioned, we've already sold about $27 million since quarter end.

We just had our sales managers in to work on selling putting a program in to continue to dispose of problem assets.

I'll let Tom speak to what he's seeing already.

Again, as Irene mentioned, we had $27 million worth of sales in the first week after the quarter end.

We stay focused, and I certainly believe that our strategy signifies our overall approach to deal with these problems through very aggressive dispositions and sales programs.

So I see that activity staying about the same or picking up.

All right.

Thanks, guys.

Your next question comes from Philip Gutfleish of Elm Ridge Capital.

Hi.

I actually didn't have a question.

Your next question comes from Al Savastano of Fox-Pitt Kelton.

Hi, guys.

How are you.

Good morning.

Just wondering on NPL formation in the income portfolio, is any of that driven by the $3.3 billion in nonprofessionally underwritten portfolio?

Is there any noticeable difference in that portfolio versus the remaining in terms of performance?

Could you say that one more time?

The NPL formation in the income Crete portfolio, is any of that driven by the nonprofessionally underwritten portfolio and then the second part of that,there any difference in performance between that nonprofessionally underwritten portfolio and the rest of the income crete portfolio?

Our business banking portfolio has been centrally underwritten and again, when you say professionally, I mean it is not a specialist in commercial real estate.

But the book has overall been holding up fairly well.

I go back by looking at our past dues in general.

I really see it's coming through on the income producing some of the larger credits that really deal with lease up phase or whatever.

So I would -- Tim could speak to it.

Al, as you would expect, we are monitoring our income property portfolios very closely with the primary focus on multifamily and retail.

When you bifurcate the small business and small commercial real estate portfolio from the professionally underwritten, what you see is a pretty decent granularity in both cases.

In the business banking, you're talking about loans typically less than $1 million.

In fact in the commercial real estate book, you're talking about loans with an average size that ranges from 3 to $3.5 million.

So would emphasize the granularity.

As Bill mentioned earlier in both cases, obviously when you're talking about loans contrasted with securities, in most of the cases here, we have recourse and some cases takeouts and greater flexibility and working with our direct borrowers.

And it goes back to what Bill also said was centralized underwriting.

That smaller book and what Tim said about granularity.

If you look at the loan portfolio risk view and supplement story on page 23, you can see where the nonowner occupied and community and business bankings actually performing very well.

Excuse me it's page 15.

Okay.

Thank you.

Your next question comes from Ed Groshans of Ladenburg.

Excuse me, I misdialed.

Your next question comes from Kevin Fitzsimmons of Sandler O'Neil.

Good morning, everyone.

Given what you announced this morning in terms of the branch consolidation plan, can you give us a sense, is this the end of a long process in terms of scrutinizing the franchise?

And we could say this is it for a while or are there further opportunities out there, and this is an ongoing process?

I guess what I'm specifically getting at, there's always a little bit of speculation around whether you might do something with the midwest part of the franchise where you're not a market share leader there?

Does it make sense to keep it or is it more something you would be looking to do something with?

Thanks.

This is Dowd.

Let me start off by saying it is an ongoing process.

If we're doing our jobs properly it'll never end.

It wasn't that long ago that we brought the two companies together to form this new Regions.

If you remember, the head count at that time was almost 38,000 people.

We said we'd get $400 million in cost saves as the financial justification for the merger.

You fast forward ahead about 15 to 18 months and we'd gotten almost $800 million in cost saves.

You come forward today without these branch consolidations and we're down almost 9,000 employees in the company, 23%.

Productivity is up at an all-time high.

Customer service and quality metrics are at all-time highs.

The answer is, it's something we'll never stop doing, trying to compare ourselves and find better ways to work smarter.

The midwest part of that question in particular, it does come up time to time.

It is a small franchise for us.

It generates very good profitability.

So as we look at what would we do with it, always comes the question with how would you replace that revenue?

So we'll never stop right sizing sizing, if you will, the franchise.

As we look at that it made no sense from a shareholder standpoint to exit that.

Okay.

Great.

Thank you.

Your next question comes from Todd Hagerman of Collins Stewart.

Good morning, everybody.

Irene, the question for you in terms of pre-provision profitability numbers.

How should we think about in terms of the outlook there?

You've talked about kind of a run rate of 450 to $500 million or so?

How do I think about that given kind of the record results that are being posted in mortgage and Morgan Keegan as I started to think about 2010?

Obviously, we've got some benefit coming into the Morgan Keegan and our fee revenue as the economy comes out of its slump as I mentioned earlier, we also have headwinds.

We do expect to have more foreclosures which will create more OREO expense.

We've continued to have growth in our professional fees as we litigate and continue to go after getting our money back.

So there are pluses and minuses as we look out, and we think that we are going to continue our efficiency and effectiveness considerations, but we do have head winds in front us.

Again.

Aside from the credit cost issue, more specifically talking about the revenue side.

You believe with an improving economy that you're going to continue to see an increase year-over-year in terms of mortgage and Morgan Keegan fixed income capital markets?

The tough thing with mortgage is we've had a very strong 2009, right, with the rates coming down as much as they have?

So while we might expect it to be a strong mortgage year it may not be as strong as 2009 was.

With Morgan Keegan, we're continuing to see increased financial advisors come to Morgan Keegan.

We're picking up new accounts all the time.

We're hoping that that overshadows any drag on the economy.

Still in this environment, adding even though when I talk about productivity and you ask about efficiencies, we are adding head count for mortgage loan originators because we feel in a lot of our footprint, we aren't capturing the share that we should be, so we're still adding there.

As Irene just alluded, we are still adding producers on the Morgan Keegan side.

So we'll continue to do that.

Thanks very much.

Your next question comes from Heather Wolf of UBS.

Hi, good morning.

Just a quick follow-up question on the commercial real estate nonaccruals.

Of the roughly $350 million increase in the business services non-owner occupied nonaccruals, how much of that comes from well-established projects versus new projects.

Most of it comes from projects are coming out construction are in the lease-up mode.

Okay.

That's very helpful.

Thank you.

Your next question comes from Christopher Marinac of FIG Partners.

Yes, good morning.

Could you clarify the point you made about the TDRs, not being moved to current.

Does that mean that the net interest income and net interest margin did not approve accruals from the TDRs?

They do include it.

What I meant by being moved to current is we'll continue to capture them and show them as trouble debt restructures.

We do not simply move them to the current portfolio without that attached TDR assignment against it.

But they're included as part of the margin in NI?

Yes, they are.

Great.

Thank you very much.

Your next question comes from Marty Mosby of FTN.

Good morning.

Irene, I wanted to ask you about the net interest margin improvement to make sure, we had loan and deposit pricing that we're hanging our hat on in the sense of producing the improvement.

Have we done any of the incremental things or strategies to kind of extend out and take advantage of some of the yield curve or any other strategies to help the net interest margin at this point?

Yes, we have.

We've taken some measures to improve the short term where we feel that the interest rates are going to stay flat for the next several quarters, so we've become less asset sensitive for the next few quarters but still leaving the upside potential in the back half.

So we have taken measures there.

How much of the 11 basis points would you equate to the asset liability versus pricing?

It's almost all pricing.

Okay.

All right.

Thank you.

Thank you.

Your next question comes from Jason Goldberg of Barclays Capital.

Thank you.

I guess while down, I guess the $1.7 billion addition to NPs is still a big number and I guess while I appreciate you were kind of, I guess, seeing a slowdown from land construction mitigated by you saw an uplift in multifamily.

Is there kind of a concern next quarter we're talking office and retail and hotels to get you rolling kind of CRE inflows?

Then just secondly, I think in our conference last month you alluded to the belief that you thought NPAs would decline in the back part of this year or early next year, is that still your view?

Jason, I'll take the second part and let someone else take your first part.

Our view has still not changed.

The economy, while everybody talks about green shoots, unemployment still increases.

Who knows what the outlook will bring, but from what we see sitting here today, our best guess is that our gross level of NPAs will indeed peak the end of this year, early first quarter.

We still see that.

Jason, to your first question, we should note that we only have $3.1 billion in office exposure.

$1.6 billion in industrial and $1.1billion in hotel.

So we already talked about our focus on multifamily and retail, and the three numbers I just shared with you may help you draw your own conclusions on the other three.

But the message is low exposure in all three categories.

And Jason, too.

Tim is exactly right.

When you go down through and look at our problem long list and even our forecasting, just seeing a few office here and there, not any particularly any market when we've gone through there.

A couple of hotels, but they've been more isolated than that.

I think what Tim said is actually about exposure.

What happened this quarter probably from where we were when we were with you not long ago was a little bit more of the pace in the multifamily portfolio that we saw.

What we've done on that is aggressively got our hands around it, dealing with it, much as we did with the land, the condo, and the home builder.

And I've got to tell you, I said this earlier, when we go back 18 months ago, I'd rather be dealing with the multifamily portfolio where I have one that's more geographic diverse, two, I've got a loss severity when I'm looking at that portfolio.

Three, I've got cash flow, which means I can restructure.

So, you know, things that you're seeing are starting to trend through, but we're in a much better position to deal with it, and that's been a lot of things, talking about the company but I'd go back and look at the 18 months how we dealt with problems, identified early, put action plans in place, put the right resources towards it and deal with our issues as they come before us.

Someone asked earlier,that playing out as I thought?

Yes it is.

The parts might move out a little bit but it's working out as we thought we'd see the portfolio.

Thank you.

Your next question comes from Scott Valentin of FBR Capital Markets.

Thanks for taking my questions.

You mentioned the marks are improving on asset sales.

I was curious one, how much was that mix shift, meaning less construction and higher severity and more lower severity multifamily and income-producing commercial real estate.

Maybe you could give us an idea of the $27 million you sold this quarter, how much that is the income producing commercial real estate and where you are seeing marks there.

This is Tom Neely.

We sold a lot of income producing impaired assets this quarter.

We had $120 million of sales, and I would say the majority of that is in the income-producing.

The marks are improving.

Bill mentioned, that if you have cash flow tied to impaired asset, it's, A, easier to sell and B, you get a better price for it.

I would say going forward, you're still going to see us because we're seeing more of the inflow coming in.

We're going to be selling some of our income producing.

And that's continuing this quarter as we exalt $27 million in the first week.

And we go back and we're still saying that we've got four identified sales executives that are out there strategically meeting with strategic investors.

We believe we'll continue to push forward and do as well as we did last quarter in sales.

That's correct.

And so the 25% in the second quarter, I guess the marks would be lower going forward as the mix of CRE increases?

Is that correct implication?

That's correct.

We mark each asset on its own merits, so we are seeing improved marks.

If you compare it in particular with the home builder and condo marks that we were talking about at the beginning of the year.

Thanks very much.

Your last question comes from Carole Berger with Soleil Securities.

I was just wondering, could you talk a little about your slide on appropriate reserve coverage?

I'm not sure whether this slide makes me feel better or worse, specifically, it looks like you have only 0.2 times reserves to nonperformance for the larger loans, and all other you seem to have almost twice loans.

Am I supposed to -- I don't know whether to think about, you've already charged down the specific loan so much that that's an adequate coverage or you are losing so much more on other loans that you need a much higher ratio?

I will let Bill Wells answer you but the purpose of the slides is to make you feel better.

I know, that's why I asked the question.

You had a great point because you know our initial when we bring a credit into a nonperforming, we take that initial charge.

One thing we haven't said is when we welcome at our valuation charges for the quarter, about 85% are first-time valuation charges.

When I look at that specific analysis on the loans, that's talking about a group of loans we've taken the charge in, and we've gone through an individual reserve analysis what we call a FASB 114 analysis, and you're saying this is the amount of reserves that you had allocated toward it.

What it shows is a pretty good amount of number against that reserve.

And then when you look at all other loans when you see what you have, you are starting to see you have a high coverage of our reserve dedicated to that portfolio.

Remember we talked about our shared national credit portfolio, our business banking, community banking, centrally underwritten.

Barb's talked about consumer.

When you look at that other number, we see that's a very good number and we have a very good reserve.

Just to add to that, the specific specific analysis that I think you mentioned, we take a significant mark on those loans as they come in to NPLs.

over the last several quarters it's been around 30, 31%.

So when you first initiated the loan, you had some equity in the deal.

Then you've marked it down 30%.

Now you have reserved another 20%.

So we feel quite good about that reserve.

So what does that leave for everything else?

That's our point.

There's a lot this for everything else.

So you're not suggesting that you need a lot more for the others because you lose more on them?

I don't understand your question.

Well, you have a very big reserve for all of the smaller loans so the question is, are you having much higher losses, or do you not write them down when they go into nonperforming?

I'm sort of not --

The other coverage covers all loans.

The other $90 billion of loans.

That's the entire rest of the company's loan portfolio was the point Irene was making on that slide.

Okay.

Thank you.

Okay.

Operator, if this are no other questions, let me thank everyone for joining us this morning.

We will stand adjourned.

Ladies and gentlemen, that concludes the Regions Financial Corporation's quarterly conference call.

We appreciate your time.

You may now disconnect.