Regions Financial Corp (RF) 2010 Q2 法說會逐字稿

Good morning, and welcome to the Regions Financial Corporation's quarterly earnings call.

My name is Christie and will be your operator for today's call.

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

(Operator Instructions) I will now turn the call over to Mr.

List Underwood.

Please go ahead, Sir.

Thank you, operator and good morning, everyone.

We appreciate your participation.

Our presenters today are our President and Chief Executive Officer, Grayson Hall, and our Chief Financial Officer, David Turner.

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

Let me quickly touch on our presentation format.

We prepared a short slide presentation which will accompany David's comments.

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

For those of you in the investor community that dialed in by phone, once are you on the Investor Relations section of our website, just click on live phone player, and the slides will automatically advance in sync with the audio of the presentation.

A copy of the slides is available on our website.

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 and presentation, in today's Form 8K, in our Form 10-Q for the quarter ended March 31, 2010 and in our Form 10-K for the year ended December 31, 2009.

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 financial schedules.

Now I will turn it over to Grayson.

Good morning.

And thanks for taking the time to join our conference call.

As announced earlier today, Regions reported a second quarter loss of $0.28 per share which included a charge related to Morgan Keegan regulatory proceedings.

Concerning this charge as you may recall, administrative proceedings were brought against Morgan Keegan and Morgan Asset Management on April 7th by the SEC, FINRA and a joint state task force of security regulators.

Although we have not reached final settlement, based on the current status of negotiations, we recorded a nontax deductible $200 million charge representing the estimate of probable loss.

Excluding this charge, second quarter's loss was $0.11 per share, representing an improvement from first quarter's $0.21 per share loss, giving us additional confidence that we have the right strategy in place to return Regions to a sustainable level of profitability.

It just requires that we continue to focus on execution of our plans.

Although we are making progress and we are even slightly ahead of our own internal forecasts, we are clearly not satisfied.

The economic environment, while slowly improving, is challenging and fragile and it is too soon to know the ultimate impact of the Gulf oil spill and regulatory reform legislation.

But our focus is to improve our credit metrics while managing aggressively our expenses.

The slow nature of the economy requires that we remain cautious and prudent in our actions.

We are encouraged by second quarter's core improvement.

On a linked quarter basis, total adjusted revenues grew 3%, adjusted non-interest expenses declined 4% and our net interest margin and credit metrics both improved.

Balance sheet risk was further reduced, and we continue to see solid low cost deposit growth.

Credit related costs, while moderating, clearly remain elevated, with loan loss provision and OREO expenses having a $0.36 per share negative effect on second quarter's earnings.

However, we believe that the earnings [play a] burden from the elevated provision expense should begin to moderate going forward.

Our proactive efforts to recognize and resolve problem assets are providing a favorable impact.

We are not anticipating nor are we forecasting a double dip recession for the economy.

But the nature of the slow economic improvement has resulted in a much more conservative low growth forecast for our business and requires that we exercise extreme care in the management of our credit risk.

As many of you are aware, our focus on customers and cross-sell opportunities along with strong customer service has resulted in strong growth in new checking accounts and low cost deposits.

This continued in the second quarter.

Average low cost deposits rose 4% first to second quarter and we're on track to open approximately 1 million new business and consumer checking accounts again this year, matching or exceeding 2009's record level.

The ongoing positive shift in our deposit mix has resulted in a favorable improvement in funding costs, driving our net interest income and resulting margin even higher.

It should continue to do so.

Second quarter's margin increased 10 basis points and is very much on target to reach our goals.

Not surprisingly, there was a 3% decline in our loans outstanding during second quarter, and balances are expected to remain challenging for the remainder of the year.

We did experience an increase in loan production volumes in the second quarter but it was substantially below normalized levels.

Reduced demand from creditworthy borrowers, both consumers and businesses and deleveraging from loan payoffs and paydowns are all contributing factors.

Also, has been the case for several quarters now, average loan outstandings also reflect our disciplined efforts to reduce exposure to high risk portfolio segments, specifically investor commercial real estate.

The investor commercial real estate portfolio declined $1.5 billion in the second quarter, bringing our total outstandings to $19 billion.

This means that we've brought over the past 12 months a reduction of $4.7 billion to this portfolio.

Our small business and middle market bankers are trying to position ourselves to take advantage when loan demand returns.

We're actively calling on existing customers, and importantly, potentially new customers.

Our strategy leverages our extensive branch network to aggressively call on the targeted small business banking segment.

We're also active in the commercial middle market segment and we have recent success with specialized lending groups.

Commercial line of credit commitments remain strong but utilization rates have stabilized at historically low levels.

Commercial lending pipelines are showing signs of strength but have yet to materialize into increased outstandings.

On the consumer lending front we are aggressively working to improve consumer loan volume production, while maintaining pricing discipline.

Along those lines, we are increasing loan advertising, expanding direct mail programs and extending preapproved point of sale offers, and importantly, our sales plans are focused on properly priced and prudently underwritten loan production to drive these programs.

Our second quarter total consumer loan production was up by 40% over first quarter, with our year-to-date yield on new home equity production at 171 basis points above prime.

But our loan production volumes across consumer segments are far below normalized levels and we anticipate a slow growth economy with high unemployment and low interest rates.

Our customer demand has shifted from home equity to more direct loans and other consumer lending products.

As such, we've made the strategic decision to re-enter the indirect auto lending business with our activity in this business resuming in the third quarter.

With the increased demand for auto loans as well as loss rates in this sector performing better than expected during the economic downturn, this move will help us to diversify our consumer lending portfolio and improve our concentration mix and at the same time providing dealerships with an avenue for their customers to finance their auto lending needs.

With respect to mortgage lending, second quarter production was up 31% linked quarter, to $1.8 billion in originations.

We continue to increase our market share, providing outstanding customer service and enhanced speed and simplicity of the entire mortgage process.

Overall, consumer lending is showing signs of improvement, but demonstrating a net increase in outstandings is proving difficult.

Moving on to a couple of other issues, I am confident about the clear strategy we have in place and our leadership team's commitment to successfully executing this strategy.

However, two second quarter events, the Gulf oil spill and the financial regulatory reform legislation add to our challenges.

The Gulf oil spill is a tremendous environmental and economic challenge.

We are carefully evaluating the potential impact to our business and developing the necessary risk mitigation strategies to lessen the financial impact to our customers and our financial performance.

It is difficult, if not impossible for anyone to accurately estimate the environmental and economic impact at this particular point in time but it does appear that substantial progress has been made in stopping the flow of oil from the well into the Gulf.

We have confidence in the resilience of the individuals and the businesses located on the Gulf Coast as they have weathered a number of storms over the years.

But we are proactively contacting our customers along the Gulf to determine how they're being impacted and how we may help in being part of the effort to restore the economies of these markets.

Regions has a strong history in dealing with environmental disasters and how they impact our customers and the communities that we serve.

When Hurricane Katrina hit the Gulf, we were armed with a disaster response plan and went to work immediately.

We're following that same proven and disciplined process now with the oil spill.

And as the number one bank on the Gulf Coast, we are in a great position to assist many individuals and businesses.

We have set up a task force dedicated to collecting on the spot reports and updates from Regions team members and Regions customers who live and work in the affected markets.

And we are coordinating efforts to quickly, clearly and confidently communicate to local customers and businesses about Regions' ability to help as well as the availability of Small Business Administration direct programs, state programs, and BP assisted efforts.

With respect to potential exposure, we had to make a number of assumptions regarding the geographic impact area.

First, we reviewed businesses and consumer lending relationships in a geographic area ranging from Lake Charles, Louisiana, to just north of Tampa, Florida.

The exposure area totals for Regions $3.1 billion in loans outstanding and $8.4 billion in deposits.

We thoroughly analyzed exposures to high risk industries including tourism, commercial fishing, sport fishing, hospitality, restaurants and condominium.

Specific to consumer exposure, we stress tested all residential mortgages within 25 miles of the coastline.

We stress these loans using two stress scenarios.

One was a straightforward doubling of our highest historical loss rate and the other was even more adverse.

It included shocking the state employment levels for all impacted markets as well as reducing home prices, residential home prices a further 20% from already existing low levels, while also reflecting negative GDP in these specific markets.

Using this conservative methodology, we estimate total potential losses for Regions to be approximately $100 million in the most adverse case.

Let me point out that our loss estimate is conservative and assumes no benefit from private insurance payments, government support, or stimulus money that BP has committed, any of which would potentially reduce our forecasted losses.

As a historic reference, using essentially the same disciplined methodology, I'll note that we initially estimated our losses from Hurricane Katrina to be approximately $70 million.

And at the end of the day our actual losses turned out to be less than $10 million.

When we made that estimate we did not consider the amount of payment that we or our customers would receive from public or private sources.

As you can be assured, we will continue to closely monitor our portfolio and actively work with customers to mitigate any possible negative financial impact.

And furthermore, we anticipate that this financial impact will occur over an extended period of time.

Now let me speak directly to the other recent event, regulatory reform.

We are assessing the potential impacts on our revenue, expenses, capital and our business models.

And we're evaluating steps that we can take, adjustments that's we can make to our business models to mitigate the business impact.

We know for instance that the Durbin Amendment will put downward pressure on interchange revenues which in total for Regions is approximately $330 million annually.

But the extent of the interchange pricing reduction is not currently defined.

So before we can provide a valid estimate, we need to see clarity regarding exact rules regarding interchange price setting.

But we are promptly adjusting our business models in anticipation of these revenue challenges, to provide a substantial level of earnings impact mitigation, while still being committed to and providing products and services that our customers value.

In addition, our expense base will be pressured by many regulatory provisions included in this legislation.

Regardless, we will continue to consider and implement ways to improve our operating efficiency.

As to the capital implications of this reform, trust preferred stocks will be phased out as an allowed component of Tier 1 capital.

This change does not create a particularly challenging problem for Regions since trust preferreds only represent $846 million or 86 basis points of our Tier 1 capital, which was a strong 12% at the end of the quarter.

We, like all financial institutions, will face the challenge of a likely higher capital requirements once regulatory authorities work through the new guidelines.

We believe that we are well prepared to handle any new capital requirements in a timely fashion.

In summary, I am confident that Regions remains firmly on a path to return sustainable profitability.

We are forecasting a slow but improving economic environment, modestly higher net interest income and a continued improvement in expense management.

Our actions serve to offset the challenges posed to our revenue streams.

Our core business fundamentals are strong.

We have a solid franchise operating in good markets that will remain desirable over the long term.

Regions does have a potential for long-term success and we are focused on the disciplined execution of our business plans.

So with that, David, I'll now turn the discussion of our second quarter financial details.

Thank you and good morning.

Let's begin with a summary of our second quarter results on slide one.

As Grayson mentioned, our second quarter loss amounted to $0.28 per diluted share or $0.11 per share excluding the regulatory charge.

While we are not satisfied with the second quarter loss, we are pleased with another quarter of steady improvement in our core business highlighted by improvements in pretax, preprovision net revenue, or PPNR, and our improvements in asset quality metrics.

In summary, all three categories of our PPNR improved link quarter.

Net interest income increased $25 million, and the resulting net interest margin improved 10 basis points to 2.87%.

Non-interest income increased $22 million, or 3%, linked quarter excluding first quarter's securities and leverage lease termination gains.

And non-interest expenses declined $42 million, or 4% first to second quarter, excluding the Morgan Keegan regulatory charge and first quarter's loss on early extinguishment of debt and branch consolidation charges.

Regarding credit quality, non-performing assets, excluding loans held for sale, declined $297 million or 7% during the quarter, and is reflective of continued improvement in our credit quality trends.

Our provision for loan losses decreased to $651 million, from $770 million in the previous quarter, and was essentially equal to net charge-offs.

Now let's take a deeper look into the quarterly results, beginning with credit.

Slide two shows that net non-performing assets not only declined $297 million, but gross in-flows also declined, again led by investor real estate.

Our proactive sales program, coupled with aggressive marks and transfers to held for sale, have accelerated the decline in non-performing assets.

During the second quarter, we sold or transferred $779 million of loans and problem assets, bringing the total to over $4 billion over the last seven quarters.

Discounts on problem asset sales and loans that were mark-to-market were little changed at 24% on average this quarter, from first quarter's 23%, and fourth quarter 2009's 29%.

The decline in NPAs exceeded our earlier expectations and reflect the first improvement in several quarters.

While we are encouraged by this improvement, we remain cautious concerning the outlook for NPAs.

Although our internally risk rated problem loan trends remain favorable, the slow and fragile nature of the economic recovery requires that we remain cautious until we see clear signs of strength in this economy.

Net charge-offs declined $49 million to $651 million, for an annualized 2.99% of average loans, compared to first quarter's annualized 3.16%.

The decline in net charge-offs continued to reflect efforts to derisk our balance sheet and dispose of problem assets.

Given improving credit quality trends, provision costs declined in the quarter.

As you can see on slide three, our provision of $651 million essentially matched net charge-offs and declined $119 million in the second quarter, marking the second consecutive quarterly reduction.

Our loan loss allowance to loans ratio increased 10 basis points linked quarter to 3.71% at June 30 due to a lower level of loans outstanding.

As I stated earlier, we are being cautious and our actual level of NPAs and provision expense will be dependent on our asset quality metrics which will reflect economic conditions especially unemployment and housing data.

Further, while the Gulf oil spill will be a challenge, we believe it will be financially manageable.

Having said that, we will be closely monitoring the situation and our provisioning will incorporate any deterioration in affected portfolios to the extent necessary.

Let me give you some detail on troubled debt restructurings, or TDRs, and why, despite the relatively large balance, they are not expected to translate into substantial losses.

Keep in mind that nearly all of our consumer TDRs, which comprise about 89% of total TDRs, are a function of our proactive customer assistance program and very importantly, 95% of consumer TDRs are accruing interest.

Through our customer assistance program, we proactively contact consumer borrowers even before they become delinquent, often making modifications to loan terms such as deferring a payment, or reducing an interest rate, any such concession to a borrower experiencing financial difficulty requires a loan to be classified as a TDR.

While these concessions may not be significant, they have proven very helpful to borrowers in need.

Importantly, the redefault rate has been very low as has our foreclosure rate, which is less than half the national average.

These metrics and the monthly conversations we have with each and every borrower give us confidence that our program will continue to benefit borrowers and Regions alike over the long term.

Turning to the balance sheet, slide five breaks down this quarter's change in loans and deposits.

Note that $1.5 billion of the $2.2 billion decrease in loans reflects our efforts to reduce investor real estate loans.

However, new commercial lending remains challenging with utilization rates that were largely unchanged versus the previous quarter.

Most commercial customers are still waiting on confidence in the sustainability of the economic recovery before drawing down lines.

In any case, we remain positioned to grow balances as the economy improves, and customers begin to rebuild inventories, make new capital investments, and start expanding their businesses.

However, we are encouraged by the increases we have recently seen in June and July commitments.

On the liability side of the balance sheet, low cost deposit growth, mostly money market and interest free balances, was strong.

Average balances were up $2.7 billion quarter-over-quarter.

This reflects outstanding customer acquisition and retention, bolstered by service and satisfaction levels that are higher today than at any point in our history.

Average low cost deposit growth allowed us to reduce higher cost time deposits by $2.8 billion in the second quarter and as noted earlier, resulted in lower funding costs for the quarter.

Importantly, opportunities exist for further improvement in our deposit mix and cost over the coming quarters.

Slide six provides a quick view of the relationship between growing low cost deposits and improving total deposit cost.

Average timed deposits as a percentage of total deposits declined from 30.3% in the first quarter, to 27.5% in the second quarter.

Coupled with our deposit pricing efforts, we lowered deposit cost 21 basis points this quarter, to 0.79%.

Looking closer at the top line, net interest margin and net interest income are significantly benefiting from the positively changing mix and cost of our deposit base.

As noted on slide seven, fully taxable equivalent net interest income of $863 million was up nearly 3% linked quarter, despite a lower earning asset base.

Our resulting net interest margin expanded 10 basis points to 2.87%.Our emphasis on improving both deposit mix and cost will be a primary driver of the margin improvement.

As a reminder, we have approximately $8 billion of CDs maturing over the remainder of this year, which will be repriced to market rates as they mature.

These CDs currently carry an average 1.71% interest rate, implying a meaningful positive benefit to our overall deposit cost.

Pricing momentum will carry into next year too when we have another $4.1 billion of first quarter maturities, about $1.5 billion of which carry a 4.55% interest rate.

Before moving on, I want to make it clear, we currently expect interest rates to remain low until well into 2011.

All else being equal, a persistently low rate environment will put pressure on the margin.

In consideration of that, we have extended our short-term hedge position to help maintain the margin and net interest income in the event that rates do remain low well into next year.

These hedges now mature in the fourth quarter of 2011, reflecting a nine month extension of the hedge periods since our last Earnings Release.

Turning to slide eight, we were able to grow adjusted non-interest revenues 3%, while reducing adjusted non-interest expenses 4%.

The main non-interest income driver was an $18 million increase in brokerage revenues, owing largely to strong fixed income business, higher private client revenue, as well as strong investment banking activity.

Non-interest income also reflects a 5% increase in service charges, primarily from higher interchange transaction activity.

Note that NSF/OD policy changes related to the dollar limit and daily occurrence caps took effect on April 1st.

However, while these did reduce service charges, the effect was offset by an increase in customer transaction activity.

Policy changes associated with Regulation E began in the second quarter and will be fully implemented during the third quarter.

The results of our program to educate customers on the impacts of them regarding Regulation E are continuing.

To date, we have successfully reached approximately half of the users of our standard overdraft service, with 90% deciding to opt in, or participate in our overdraft protection program, while 10% have opted out.

As you may remember, we originally estimated the impact of this legislative change would be a net reduction of service charge revenue of $72 million in 2010.

And we continue to believe this is our best estimate.

Mortgage income declined $4 million linked quarter, primarily due to a reduction in benefits from hedging mortgage servicing rights.

However, origination volume of $1.8 billion was up versus the prior quarter's $1.4 billion, with June representing the highest monthly volume this year.

The pipeline remains strong as well.

End of the second quarter, unclosed loans were up 40% versus the March 31 level.

Also of note, 59% of second quarter volume represented purchases compared to 45% last quarter, and just 24% a year ago.

As mentioned earlier, the decline in adjusted non-interest expenses was largely due to lower salaries and benefits cost, as we remain focused on fine-tuning staffing models and improving personnel efficiency.

In fact, we have reduced headcount by nearly 2,000, or 6.5% in the last year alone, and approximately 300 since the end of the last quarter.

Lower payroll taxes were also a factor, declining from first quarter's seasonally high level.

We have an intense focus on expense management and we will continue to control discretionary expenses and improve operating efficiency.

However, certain headwinds including higher FDIC premiums and credit related costs will continue to impact the bottom line for the foreseeable future.

Having said that, given that many of these costs are tied to other real estate and work-out costs, we believe that decline in non-performing assets serves as a leading indicator of an eventual decline in credit related costs.

Let's finish up with capital.

As you can see, capital ratios remain strong at quarter end with a Tier 1 capital ratio that now stands at an estimated 12% and a Tier 1 common ratio estimated at a very solid 7.7%.

In addition, we have provided a pro forma capital estimate which excludes trust preferred securities from our capital.

As Grayson mentioned earlier, and as illustrated here, we do not have much trust preferred in our capital and are not as impacted by this legislation as others will be in the industry.

To sum up, we are pleased with Regions' second quarter progress thanks to the effort of our hard working team.

And while we have a lot of hard work ahead of us, you can be assured that everyone at Regions remains firmly focused on returning the Company to a sustainable level of profitability as promptly as possible while continuing to improve our risk profile.

We have a strong franchise with solid underlying business fundamentals as evidence by this quarters core results.

We have high expectations for Regions and are committed to delivering for our shareholders, customers, and associates.

With that, Operator, we will now take questions.

Thank you.

(Operator Instructions) Your first question comes from the line of Brian Foran with Goldman Sachs.

Hi.

I apologize if I missed this but your share count up about 5% on an end of period basis and then also your Tier 1 common up 60 bips.

Both were a little higher than I had modeled and just wondering what drove them and were they related?

Yes, Brian, this is David.

What we did is we elected to early convert our mandatory convertible preferred which by its term would have converted into the common stock in December.

And we chose to do that based on the economics that are embedded in the agreement.

And so we added 63 million -- roughly 63 million shares in total.

Some of which on an average basis would have come through in the quarter.

And we did that towards the end of the second quarter.

So you don't have the full weighting of that yet but that was really the difference probably in your model.

And understanding the averaging effect, is that now fully in the end of period or is there more to come at some point in the future?

No, it's fully in the end of period.

Got it.

Thank you.

Your next question comes from the line of Paul Miller with FBR Capital.

Tell me a little bit about your experience in your loan sales, in other words, I believe, correct me if I'm wrong, that you said you have your NPAs marked down roughly $0.25 on the dollar.

Are you selling them at those prices or what prices are you moving some of those assets off the books?

Paul, this is Grayson.

Listen, I'll answer it and then I'll ask the folks in our credit team to comment a little bit further.

First of all, we're still continuing to see strong demand for our stressed credits.

We sold approximately $620 million in stressed credits in the quarter.

As David mentioned, we wound up with a discount of roughly 24% off of those and in fact the loans that we are selling out of OREO, the property we're selling out of OREO are the loans we're selling out of held for sale, are coming in very close to our marks and in fact in some cases we're realizing gains on those sales.

So still strong demand, strong sales and we're continuing with that strategy.

I'll stop and let the credit team add to that.

This is Bill Wells.

Again, we had a very good quarter in sales and as Grayson mentioned, our marks held pretty true to what we thought.

Not only did we have a good quarter of sales, problem loans, but out of OREO I think we sold a little bit over 1600 properties and then we had a good bit of sales out of our held for sale.

So we believe our marks have been holding pretty true.

And we continue to see active interest going into this quarter also.

We've had about $50 million in sales and we've got another about $50 million in pending contracts.

So we continue to see good progress.

Paul, one other point is that we are -- if you look at our charge-off number this quarter of 651, there still is a fairly substantial number related to valuation charges.

That being said, we are seeing some stabilization in our markets and the valuation charges on our OREO held for sale and NBLs is starting to decline due to that stabilization.

Thank you very much, gentlemen.

Thank you.

Your next question comes from the line of Craig Siegenthaler with Credit Suisse.

Thanks.

Good morning, everyone.

Good morning.

Just looking at the trend in your non-interest expenses, I'm wondering was the biggest driver down there a little less than the OREO side?

That was not the biggest contributor but that was one of the contributors.

The first quarter from a salaries and benefits standpoint is you have seasonally high payroll tax expense in that first quarter.

And that was a piece of the pick up as well, with the remainder being the reduction in staffing as I mentioned earlier, continuing to benefit the [SMB] line.

And that all flows to actually other, not compensations?

I thought that was higher up in the income statement.

In the other, we would have also the held for sale.

We had some held for sale gains that were in that other line that you're looking at.

Got it.

Okay.

And then just on Regulation E, looks like you implemented some of your changes this quarter.

Was there any positive revenue from these implementations?

Any higher checking account maintenance fees?

When we think about the run rate, anything unusually positive which will stay there?

But I'm trying to compare the second quarter from the first quarter run rate.

When you look at the Reg E changes we put in in the first and second quarter, really at the end of the day, sort of a net negative, minor, but net negative but minimal impact.

Where the impact really starts to hit is in the third quarter.

We really do have a number of changes that we've made to existing product --checking account product offerings that will start to mitigate some of that impact.

And we are pleased so far with our success in talking to customers.

If you look at roughly our 4 million checking accounts, 30% of those accounts would have had an NSF in the last 12 months.

So that 30% of those customers, of that 30%, half of them have made a decision and as David had indicated earlier, 90% of them are either opting in to our standard overdraft process, are signing up for overdraft protection and only 10% are electing to go without either product.

And so we're encouraged by that.

But we still think that $70 million estimate is a good estimate for the balance of the year.

I think full year next year is a bigger question.

How much of that can we mitigate and offset with changes in our product offerings and changes in our customer behavior.

All right.

Great.

Your next question comes from the line of Betsy Graseck with Morgan Stanley.

Good morning, Betsy.

Good morning.

One follow-up to that question, which is that therefore we should assume a $35 million hit to each of -- well, to 3Q that carries through to 4Q?

Is that what you're saying?

Yes, the $72 million actually gets -- is a little higher in the third quarter, in the $40 million range, with the fourth quarter being in the $40 million range.

So I think that we still have mitigation that we have to put in place and that's why it's getting -- it's a little more difficult to predict for the next year in terms of just leveraging off the run rate.

But I think, Betsy, what you're seeing is that when you look at that $72 million, when you annualize that over next year, obviously it's not a full impact for full third quarter.

There's going to be part of third quarter not impacted by that.

If you didn't have any mitigating factors, it could be slightly more than twice that number next year.

But we do have mitigating actions that we're taking and we will be prepared at come juncture to share with you what we think the 2011 number will be.

But it will be better than what the annualized effect of this year.

Okay.

Is that because the opt-in, the people who have opted in to your new products that don't start to pay for that until next year?

A couple things.

One is that the people who have opted in either to overdraft protection or our standard overdraft process, that is one set of customers.

The other set of customers are new accounts we're opening and what decisions are they making.

And as customers are impacted by this change, we're reaching out to those customers and giving them a second opportunity to make a decision.

And when we do that, many are coming back that had previously opted out and opting back in once they really fully understand the implications of their decision.

I think -- this is David.

Betsy, as people learn what it really means to not have opt-in and they've had that first experience that's disappointing to them.

And they call the call center, we think we'll have another opportunity to give them another option, so-to-speak.

Got it.

Thank you.

Thank you.

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

Hi, Grayson, David.

Two unrelated questions.

First, it seems like your regulatory capital benefited at a pretty meaningful way from disallowed deferred tax assets coming down.

Seems like there was a $500 million boost from that.

I guess I'm wondering what drove that and you still have a bunch of disallowed DTA, how quickly can the remaining amount come back?

Let me talk about all the capital.

As I mentioned earlier, we convert -- early converted the mandatory convertible that picked up about 26 basis points in the Tier 1 common.

Second component of our capital change was a decline in our risk weighted assets of approximately $2 billion.

And then the final piece, Matt, that you mentioned on disallowed deferred tax assets was reduced about half this quarter.

And it's important to note that this calculation is defined by regulatory rules and it differs from GAAP, from the view of GAAP when you're talking about realizing DTAs.

So what we do is we look at over the next 12 months of taxable income as defined by the regulatory rules to determine how much of our DTA is allowed versus disallowed.

As our PPNR and credit metrics have improved, we make adjustments to that projection and we will continue to do so each and every quarter.

The pace at which that comes in is hard to determine because it's dependent on our credit metrics and while we, as you heard our prepared comments, felt good about where they're going, we do remain cautious there and would hate to forecast that the timing of the return of the DTA into capital.

It is important to note, though, that that is temporary.

That ultimately, as we show a return to profitability, that that remaining DTA of a little over $400 million will come into capital.

So is it fair to say then you're outlook for the next 12 months in terms of return to profitability has increased meaningfully versus last quarter?

Because that's the biggest driver, it sounds like, then.

I think that if you were to look at our expectations of return to profitability have changed from one quarter to the next.

And clearly, you could look at our major components of PPNR, our improvement in credit metrics as being the indicators as to why we feel that way.

Okay.

And then just separately, the reentry into the indirect auto business, it's interesting, the past month I've had a bank tell me that spreads are too thin so they're getting out of it.

I've had a bank tell me that spreads are pretty goods so they're ramping up production.

And I'm just wondering if you can give us a sense of what pricing is out there for you guys and how much volume you expect from here?

When you look at our history, we were in the indirect auto financing business for years.

And at the beginning of this credit cycle we made the decision to exit that business and we only exited that business in terms of origination.

We have still been servicing a portfolio throughout this cycle.

It's obviously a declining portfolio as customers have paid down and paid off but we're still servicing that portfolio, still very cognizant of what the credit performance in that portfolio has been.

We still have many of the people on our team who had participated in that business for a number of years and getting back in it is not a particularly difficult feat for us, since we still have the platform and we still have a lot of the leadership and so we are going to re-enter this quarter, we believe, from what we've seen some of the businesses, the dealerships we've spoken to, that there's a need for this product.

In fact, what drove this decision more than anything else was consumers returning to our branches asking for auto loans.

Now, we had not seen that for years.

It's a strong indication that there is a need for financing for autos.

We believe we know how to price it.

We believe we've got the discipline to price it.

I think the bigger question, an important question you ask is, how much volume can we generate?

We're not ready to predict that yet.

But if we didn't think we could generate some decent volume, we wouldn't be getting back in it.

Thank you.

Your next question comes from the line of Marty Mosby with Guggenhiem Partners.

Good morning.

Good morning.

David, given the comments you made about the net interest margin and extending out the hedging that you have, you're obviously thinking that rates are going to stay low as we all kind of do for a long period of time.

Are we getting any more, maybe not anxious is the right word, but kind of looking forward to trying to lengthen the assets as well, to try to use some of the yield curve since we are so asset sensitive and it looks like the benefit of that is going to be delayed so far?

Marty, we think our duration on our portfolio is fairly consistent with our peer group.

We're probably on our investment portfolio in the two and-a-half year range, two and-a-half maybe up to three.

We have discussed whether or not we want to go out and take more duration to pick that up and that certainly is one thing we consider.

But we have not done so at this time and I'll tell you, we will have ongoing dialogue in our ALCO process that will ultimately determine that.

If you look at our investment portfolio in particular, we derisked that portfolio when this cycle started by selling off any CMBS and municipal securities and so we're about 99% agency guaranteed in the investment portfolio today.

But as loans have come down and we start reassessing the risk that we're taking in totality and so we actually from a risk weighted asset position are pretty low on our risk weights and it gives us an opportunity to perhaps take some additional risk, whether it be credit or duration.

And we are going to be start about how we use that opportunity so that we don't lock ourselves into a problem for the long haul.

We are all about what is the best interest for us in the long term.

There are things we can do in the short term to generate profitability that we think works against us in the long term.

And one of those is including our -- we have about 800 -- at quarter end, about $800 million of unrealized gains in our investment portfolio that we did not take.

We didn't take security gains because we don't think that's the long-term best interest of this franchise.

And so to your point, we will continue to look at duration and other matters as we go to the next quarter.

Marty, this is Grayson.

I just want to emphasize the point David just made.

There is a number of things we could do to demonstrate stronger earnings, short-term, but would be -- would not be particularly wise decisions over the long-term.

And we are trying to build a franchise with strength for the long-term and if you look at our quarterly earnings, you'll see there a lot of things we do not do that we could have to have demonstrated stronger earnings.

But we, again, believe that we ought to stay the course in trying to build the franchise for the long term.

We did not take any security gains to offset any of the other expenses we had.

We continue to carry a large unrealized gain in that portfolio.

But those assets provide a tremendous benefit for us and will do so for quarters to come and we're keeping the duration relatively short compared to peer.

There are peers with much longer duration in their investment portfolio.

But we do not want to take any undue risk at this point in the cycle.

Thank you.

Your next question comes from the line of Jason Goldberg with Barclay Capital.

Hi.

This is [Ryan Ash] from Jason Goldberg's office.

Grayson, I think you talked about, in prior guidance about both NPAs and NCOs peaking at the end of the second quarter.

And now with both coming in better than expectations and NPA formation declining, combined with that your outlook seems a bit cautious, with the Gulf economy and other macro events.

But then on the flip side your DTA is down substantially due to an improved outlook.

How should we think about reserves for the back half of the year?

I know in the past you talked about not adding any more.

But should we start to think about you guys either potentially releasing reserves?

Well, I think the best way to look at that is you ask yourself, what's changed since last quarter?

Certainly our credit metrics have improved substantially.

But our economic outlook has been tempered since then with all the events that occurred on a macro basis.

Our long-term economic forecast is a very slow growth forecast and we're adjusting our business expectations for that.

The trends, the credit trends are favorable but we're going to stay very disciplined on our allowance reserve methodology and let the numbers speak for themselves.

We're going to -- if you look at our reserve today, the allowance to loans is a strong 3.71%, and our coverage ratio is about 92% which puts us relatively in the middle of peer.

We feel that our reserve is sufficient today and we feel good about where we're at.

In terms of how that might change between now and the end of the year in large part I believe is going to be driven by the level of economic improvement.

That at this point for us, is you've heard the word encouraged but cautious.

That's sort of where we're at today.

Okay.

Just one other question.

You made reference that you expect to continue to reach your goals on the margin.

I know in the past quarter you talked about potential 3% by the end of the year.

Are you guys still expecting to reach that or is there something maybe impacting the margin that now could change your outlook?

No, we set that target several months ago and we still remain confident in our ability to reach that target.

And know of nothing at this juncture that stand in the way of us achieving that.

Thank you.

Your next question comes from the line of Heather Wolf with UBS.

Hi.

Good morning.

Just a quick follow-up on the margin question.

As you look into 2011, I'm wondering if you can quantify the additive impact of the hedge extension and whether or not you think that's enough to offset asset yields [grinding] lower without taking incremental interest rate and credit risk in your securities portfolio.

Yes, we think, Heather, this is David.

We think that the impact of that hedge really as things level off, that the hedge will protect us from the down side.

To the extent rates stay low longer, we did not want to run the risk that our margin actually dips down below that 3% level that we've talked about.

And to the extent that we're all wrong and things are that much better, and GDP's improving and everybody's feeling better then the interest rate environment may go up and we'll ride with that.

That's a very different environment than the protection on the low side and that's what the hedge is intended to do.

Perfect.

Thank you.

And just one quick follow-up on commercial real estate.

Looks like you had some upward pressure on non-accruals in the term mortgage buckets.

Could you talk a little bit about what you're seeing there?

Yes, on commercial real estate I think you may have been talking a little bit about some of our valuation charges that we did see on that.

What I would say is that there was one particular credit that we've been watching for a particular time, over a period of time.

We got some new information in and we took a charge on that.

Other than that, we've continued to derisk the portfolio.

Our balances are coming down.

Everything that we've seen has been going as we thought that it would, as far as investor real estate.

Bill, why don't you comment just briefly on the construction book and where that stands today?

One of the things that we have been watching very closely, as a Company, is our construction book.

At the time of the merger it was almost $12 billion.

Over the past year, couple years, we have worked that down to about $3.8 billion so we've taken a good bit of risk out of that investor real estate portfolio and our non-performings in that construction book has been about 20%.

That's held pretty much true over the last several quarters.

Thank you.

Thank you.

Your next question comes from the line of Christopher Marinac with FIG Partners.

Hey, Chris, good morning.

Good morning, Grayson.

I wanted to ask about TDRs on the commercial side and why you haven't used more of those and do you think that might change in future quarters?

Well, Christopher, what we've tried to do is to really focus early on of trying to dispose of stressed assets on the commercial side.

We've tried to work with a number of customers on restructuring which was what would wind up in the TDRs.

Quite honestly, the market was deteriorating at such a pace that the opportunity to do that has been somewhat limited.

We're having more success with that recently, but that continues to be a challenge for us and I'll ask Bill to speak about that a little more.

Well, I mean, it is that, that our focus has been recently over the last several quarters on the disposition effort.

We're continuing to look at that.

We think we're going to have another good quarter of sales.

But as Grayson mentioned, we're looking at particular credits that we can restructure and that's one of our goals this quarter to do is to do -- or if our customers are available to do it is to do more of the restructuring.

Thank you.

Your next question comes from the line of Chris Mutascio with Stifel Nicholas.

Good morning.

My question regarding the -- a bit more cautious tone on the credit outlook, I think has been asked.

And Grayson, I thought you did a nice job answering it.

I have no further questions.

Thank you.

Thank you.

Your next question comes from the line of Kevin Fitzsimmons with Sandler O'Neill.

Good morning, Kevin.

Good morning, everyone.

Most of my questions have been asked already too.

The one thing I would just throw in, Grayson, is most of the conference calls you've mentioned how you feel about TARP repayment.

I would guess, given just your comments about the economy and then the uncertainty in the Gulf, you're not going to be in any hurry to do that.

Just if you had any other comments on that.

No, I mean, really no update, no change in guidance on how we're viewing TARP repayment.

We continue to be patient in that regard.

We continue to believe that our focus ought to be on credit improvement and returning to profitability and that issue will resolve itself.

Okay.

Thank you.

Thank you.

Our final question will come from the line of Al Savastano with Macquarie.

Good morning, Al.

Just on the Gulf exposure, can you just confirm that you didn't take any reserve this quarter?

Al, what we've done is we take no specific reserve on the Gulf exposure itself.

If you look at our loan loss allowance methodology, we do go in and adjust our allocation factors based off of environmental issues as we see them or in changes in our loss forecast for particular segments of our portfolio.

And -- but we do not have a specific allocation for Gulf oil spill.

It's embedded in our methodology.

Great.

Thank you.

Thank you.

I will now turn the call back over to Mr.

Hall for closing remarks.

Well, in closing let me say thank you for your time and attention.

We appreciate you being here and your thoughtful questions were helpful and appreciated as well.

So thank you and have a good day.

Thank you.

This concludes today's conference call.

You may now disconnect.