Regions Financial Corp (RF) 2013 Q2 法說會逐字稿

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

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

I would like to remind everyone that all participants on lines have them 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 to begin.

Good morning everyone and welcome to Regions Financial second quarter 2013 earnings conference call.

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

Other members of Management are present as well and available to answer questions as appropriate.

Also, as part of our earnings call, we will be referencing a slide presentation that is available under the investor relations selection of regions.com.

Finally, let me remind you that in this call and potentially in the Q&A that follows, we may make forward-looking statements which reflect our current views with respect to future events and financial performance.

For further details, please reference our forward-looking statement as located in the appendix of the presentation.

With that, I'll turn it over to Grayson.

Thank you and good morning, everyone.

We appreciate your interest in Regions and participation in our second quarter 2013 earnings call.

Regions positive momentum continued in the second quarter, with results meeting or exceeding our expectations as we remain focused on executing our strategic priorities and our business plans.

Let me highlight a few of our accomplishments in this quarter.

Loan production increased and, more importantly, we grew loan balances outstanding.

We expanded our customer base and grew core checking accounts.

We invested in improved technology and experienced bankers to enhance our revenue-producing capabilities.

We continued our discipline focus on expense management.

And we completed several actions that improve our debt and capital structure, as well as reduce our future funding costs.

We raised our common stock cash dividend.

And finally, we began executing a common stock share repurchase program.

I am encouraged by our accomplishments in the first half of 2013, and believe that we are better positioned for continued progress in the second half of the year.

Overall, our balance sheet is positioned to benefit from an increase in both short and long-term rates.

Moreover, rising rates indicate an improving economy, which should ultimately lead to greater demand among our customers for products and services that translate into additional business opportunities.

In addition, we are encouraged by the outlook for the southeastern US, where the majority of our franchises are located.

According to the recent research report on Moody's, the Southeast continues to lead the nation in job creation and hiring rates.

Furthermore, the Southeast is at the forefront of the national recovery in residential construction.

Its housing starts have risen by 84% since May 2011, versus the national average of 62%.

We have experienced similar trends as the mix of mortgage applications is shifting more towards new home purchases and away from re-finances.

This quarter, 53% of mortgage originations were for new home purchases, compared to 35% in the previous quarter.

Our success this quarter was driven by loan growth, which is broad-based across our markets.

Importantly, 70% of the markets we serve experienced loan growth in the second quarter.

Commercial industrial loan growth was a primary contributor to the improvement, but we also experienced strong growth in indirect auto lending, and a modest pickup in credit card balances.

In addition, we observed a slowdown in the pace of decline in the investor real estate portfolio, and moderating declines in residential mortgage loans.

Further, new loan production remained strong at $8 billion, up 23% from prior quarter as all local categories experienced an increase in production.

Additionally, we made progress through the second quarter in growing our customer base, which includes business customers as well as consumer and wealth management customers.

Growth of this essential measurement should, over time, provide additional revenue opportunities.

Over the past several months, we hired close to 100 financial consultants and placed them in our branch offices.

These financial consultants have generated approximately twice the amount of business that we had initially forecasted, and we plan to further expand and enhance this activity.

Our continued focus on prudent expense management is also paying off.

Excluding debt extinguishment costs, second quarter's decline in operating expenses drove a late-quarter improvement in our adjusted efficiency ratio of approximately 180 basis points.

We have done this while continuing to make appropriate investments in people, in products, and in technology.

To illustrate, this year we have hired over 500 net new Associates, many in revenue-generating roles.

Finally, regarding Basel III final ruling, recently approved by the regulators, we are pleased that our capital position will be less impacted than our previous estimate.

And we have greater clarity in our capital planning process going forward.

I will now turn the call over to David, who will provide you greater detail about second quarter financial trends.

David?

Thank you and good morning everyone.

Let's begin with the balance sheet on slide 3.

So we were very pleased with our loan growth this quarter.

At quarter end, balances stood at $75 billion, which is an increase of $1.1 billion or 1.4% from the first quarter.

Starting with business lending, which includes our commercial and investor real estate portfolios, these loans increased 2% from the end of the prior quarter.

This growth was broad-based geographically, and continues to be led by our commercial and industrial category, as ending the loans in this portfolio grew 5% versus the prior quarter.

Areas that experienced growth included Regions business capital, real estate corporate banking, as well as healthcare, transportation, and technology lending.

Meanwhile, total new C&I production increased 36% over the prior quarter.

And pipelines remain strong, and we are beginning to see a pickup in loan production extending beyond middle market into the small business segment, which is encouraging.

Notably, line utilization increased 30 basis points from last year to 44.7%.

The second quarter is usually a seasonally strong quarter for commercial growth, and while we expect growth in commercial and industrial loans to continue, we do not expect the pace of growth to remain at this level during the seasonally slower third quarter.

We were encouraged that we experienced a more modest pace of decline in the investor real estate portfolio.

This portfolio declined 4% linked quarter, compared to the previous quarter's decline of 5%.

At quarter end, investor real estate ending balances stood at $7 billion, down 26% or $2.4 billion from one year ago.

Notably, new and renewed production in the investor real estate portfolio has continued to improve, as we see more opportunities to make loans to qualified borrowers consistent with our risk appetite.

In fact, we've seen a variety of new lending opportunities within home builder finance, which was 28% of total investor real estate production in the second quarter compared to 17% this time last year.

Overall balances in the investor real estate portfolio may fluctuate, depending on productivity levels, de-risking and payoff activity.

And turning to consumer lending, this portfolio totaled $28.9 billion and was steady linked quarter as consumer deleveraging began to subside.

Importantly, our mortgage portfolio was relatively stable linked quarter, due to the retention of $222 million of 15-year fixed-rate conforming residential mortgages in the second quarter.

Declines in our home equity portfolio, which includes lines and loans, continued as customers take advantage of opportunities to refinance.

However, we are encouraged by recent results, as loan production increased 47% linked quarter due to an improvement in residential home valuations and customers taking advantage of our home equity loan product.

This production is expected to continue to reduce the pace of decline in our overall home equity portfolio.

Indirect auto loans increased 8% quarter-over-quarter and total loan product -- total production was up 21%, as we continue to expand our dealer network.

At quarter end, we had almost 2,100 dealers and plan to increase the number of dealers by another 10% by the end of the year.

There are currently approximately 8,000 dealers located in our footprint, further illustrating the opportunity we have to increase our dealer network.

Credit card balances were also up this quarter, as our number of cardholders increased 2%.

And we remained focused on increasing our penetration rate of our credit cards into our current base of 4 million households.

We believe that, over time, this will result in a substantial increase in the number of customers that carry our Regions credit card.

Overall, we are pleased with the determined efforts of our bankers, which have translated into improved loan production and growth in balances this quarter.

Historically, the summer months have been typically slower production months for the industry, but we will continue to stay focused on growing our business.

Let's move to the liability side of the balance sheet.

Deposit mix and cost continued to improve in the second quarter.

Total average low-cost deposits increased $230 million linked quarter and timed deposits fell to just 12% of total deposits.

This positive repricing and mix shift resulted in deposit costs declining 3 basis points down to 15 basis points.

While the opportunities for continued reduction in deposit costs is now more limited, we have an additional $3.6 billion of CDs maturing in the second half of 2013 at an average rate of 43 basis points.

And this compares to our current average going on rates produce CDs of approximately 21 basis points.

Let's take a look at how all this has impacted our net interest income and the resulting margin.

Debt interest income on a fully taxable equivalent basis was $821 million, up $10 million or 1% linked quarter.

The increase was driven in part by an additional day in the quarter, incremental loan growth, continued declines in deposit costs, and liability management activity.

The resulting net interest margin was 3.16%, up 3 basis points linked quarter.

Again, the reductions of deposit and borrowing costs were principal drivers, although our net interest margin was also impacted by a decline in excess average cash balances.

As we have previously stated, rising interest rates are beneficial to our net interest margin, as our asset-sensitive balance sheet reacts favorably to increases in both short-term and long-term interest rates.

Despite the outlook for short-term rates being stable for the foreseeable future, the recent rise in long-term interest rates has increased our expectations for future net interest margin.

If rates remain at current levels, or increase further, we expect modest margin expansion over time.

As long-term rates rise, we experienced higher reinvestment yields in our investment portfolio.

And as mortgage prepayments slowed, we experienced less premium amortization, which amounted to $73 million in the second quarter, down from $77 million in the first quarter.

At the end in the second quarter, mortgage-backed securities were represented 84% of our investment portfolio.

So as long-term interest rates rise, we continue to see a benefit to our portfolio yield.

Let's move onto the next slide, where we illustrate this point.

We estimate that if short-term rates increase an additional 100 basis points, our net interest income would increase approximately $81 million over the next year.

And separately, if longer-term interest rates were to increase an additional 100 basis points, our net interest income would increase an additional $132 million.

Each of these scenarios would be additive to our base scenario, which assumes increases in longer-term interest rates over the next 12 months.

Considering that the recent changes in interest rates occurred during the latter part of the quarter, it was not a significant factor affecting the second quarter's net interest income.

It takes time for rate increases to impact net interest income by way of reinvestment yields, prepayments, and other customer behaviors.

However, these recent increases negatively impacted the change in the unrealized gain in the securities portfolio.

So I want to provide you a more color on some adjustments we made to the investment portfolio during the quarter.

The overall size of the portfolio declined $2.7 billion linked quarter, and we also moved $2.4 billion in securities to held to maturity.

These actions will allow us to reduce wholesale borrowings, reduce the overall balance sheet size, reduce tangible common equity of volatility, and increase flexibility in asset liability management.

In connection with these actions, we offset portfolio sales with derivatives in order to maintain our sensitivity profile.

We will consider additional strategies as loan growth continues and we get more clarity on fiscal and monetary policies.

Including the assets move to held to maturity at quarter end, the securities portfolio was $24.4 billion or 24% of earning assets, compared to 26% in the previous quarter.

Let's take a look at non-interest revenue on the next slide.

Second-quarter non-interest revenue declined 1% linked quarter, primarily related to a decline in mortgage and service charge income.

As expected, mortgage banking revenue was down in the second quarter.

Mortgage loan production was $1.9 billion, an increase of 6% over the prior quarter.

This production was offset by changes in market rates that affected mortgage servicing rights hedges, and gains on sale, which ultimately lowered mortgage revenue.

And as mentioned earlier, the retention to 15-year production on our balance sheet also impacted mortgage income.

However, in order to generate additional mortgage revenue, we are also focused on cross sell opportunities, as only 13% of Regions' banking households have a Regions mortgage.

Service charges during the quarter were impacted by a couple of factors.

In viewing service charges during the quarter, we determined that we needed to make $12 million in additional reimbursements to customers related to our non-sufficient funds policy change that we made last year.

Excluding this charge, service charges would've been up over the prior quarter, due primarily to household growth that we experienced.

Additionally, we continue to focus on other revenue-generating products and services, like our Now Banking suite of products.

During the quarter, the number of households using these products increased 4% and the number of active Now Banking debit cards increased 6%.

Of note, almost 60% of these customers are new to Regions, providing us with additional opportunities for revenue growth.

Moving on to expenses, non-interest expenses totaled $884 million.

However, excluding debt extinguishment costs related to the early termination of certain debt and preferred securities, non-interest expenses declined 2% linked quarter.

Credit-related costs continued to decline, as well as professional and legal fees.

Salaries and benefits increased slightly this quarter, due to additional staffing in income-producing areas, as well as increases for merit and incentive compensation.

However, we continue to expect that 2013 expenses will be lower than 2012 expenses, illustrating our commitment to prudent expense management.

Our tax rate for the quarter was 31% and was impacted by the debt extinguishment costs associated with the early termination of certain debt preferred securities.

Approximately $24 million of the $56 million was not deductible for tax purposes.

That added about 2 percentage points to the effective rate.

So if you exclude that impact, the tax rate would've been closer to 29%.

Let's move to asset quality.

We continue to make progress with respect to asset quality.

The provision for loan losses was $31 million or $113 million less than net charge-offs.

Total net charge-offs were down $36 million linked quarter, and net charge-offs as a percent of total average loans was 77 basis points, which is the lowest level since the first quarter of 2008.

Both non-performing loans and nonperforming assets declined 5% linked quarter.

In addition, total delinquencies declined 7% from first to second quarter.

Inflows of non-performing loans amounted to $328 million, which was within our range of $250 million to $350 million that we have previously discussed.

While this represents an increase from the prior quarter, it's important to note that the increase represents a small number of large credits, which create volatility in migration from time to time.

Notably, criticized and classified loans, which is one of the best and earliest indicators of asset quality, continued to decline, with commercial and investor real estate criticized loans down 4% from the first quarter.

Our coverage ratios remained solid.

At quarter end, our loan loss allowance for non-performing loans stood at 109%.

Meanwhile, our loan loss allowance to loans was 2.18% at the end of the second quarter.

And based on what we know today, we expect continued improvement in asset quality going forward.

So let's take a look at capital and liquidity.

We have successfully completed several actions in the second quarter that served to improve the efficiency of our capital structure while reducing funding costs.

Specifically, we called virtually all of our remaining trust-preferred securities, tendered for higher cost senior debt, and issued lower cost debt.

As a result of these actions, along with scheduled debt maturities, our overall funding costs improved 5 basis points to 40 basis points, and our run rate will improve going forward.

These actions have been included in our margin guidance that we have provided.

We also have increased capital returns to shareholders by raising the corporate dividend and repurchasing shares.

For additional information related to the early termination of debt preferred securities, refer to the index, which is at the end of the earnings presentation.

Our capital position remains strong as our Tier 1 ratio at the end of the quarter stood at 11.7% and our estimated Tier 1 common ratio was 11.2%.

We continue to analyze the final Basel III capital rule issued on July 2, and we are pleased that many aspects of the proposal were modified or removed from the final rule.

Based on our interpretation, we estimate our pro forma Basel III Tier 1 common ratio will be approximately 10.4%, a significant improvement from our original estimate under the proposed rule.

Liquidity at both the bank and holding company remains solid, with a loan-to-deposit ratio of 81%.

Lastly, based on our understanding of the new amendments, Regions remains well-positioned to be fully compliant with respect to the liquidity coverage ratio.

So in summary, we continue to be confident in our ability to maintain positive momentum as we strive to prudently capitalize on Regions' opportunities and deliver consistently positive returns for shareholders.

I'll now turn it back to List for instructions on the Q&A portion on the call.

List?

Thank you, David.

We are ready to begin the Q&A session of our call.

And in order to accommodate as many participants as possible this morning, I would like to ask each caller to please limit yourself to one primary question and one related follow-up question.

Operator, now let's open up the lines for your questions.

(Operator Instructions)

Ken Usdin, Jefferies.

I was wondering if you could talk a little bit about the progression for earning asset growth.

It's great to see the loan progression moving the right way, and you talked about the -- shrinking the portfolio a little bit on the security side.

So with period-end earnings assets lower than the averages, I'm just wondering, are we at the point where we get to that bottom of average earning assets?

And what you expect to see as far as that trajectory?

Yes, Ken, this is David.

We had, as I mentioned in the prepared comments, taken some actions with regards to our securities portfolio and deleveraged.

You don't see all that coming through.

There's a little piece and other assets that will settle, and you'll see reductions there.

But our earning asset number, in general, if you look at it over a longer term, we think we're pretty close to where we can get net growth from here.

We may have some minor adjustments, depending on what we do from a deleveraging standpoint, but I think the -- it really comes down to us is the loan growth, which we see as continuing to be positive.

All right.

And then my follow-up is just, any update with regards to ordering around NSFs?

And any potential changes you might have to make as far -- affecting revenue in that regard?

No.

We continued to review and challenge ourselves on policies, continue to try to make our policies very customer-friendly, very transparent.

Continue to make adjustments here as guidance comes out, but no news to disclose is forthcoming at this juncture.

Okay.

Betsy Graseck, Morgan Stanley

I just wanted to ask about your NIM guidance.

You indicated that you could see some positive platform moving.

Could you just give us a sense as to how much you were expecting from the funding costs and the asset repricing versus the mix shift?

And part of the reason for asking is, you do give the short on the 100 basis point rise in rates at the long end of the curve, which -- 132 bits is 12 basis points to NIM.

We did get that in the last quarter.

I know it comes over the next 12 months, but I am wondering if we're triangulating to 12 basis points, and that's what you mean by modest?

12 basis points is above what modest is.

We've been in the stable discussion with -- relative to our NIM.

And Betsy, it's really dependent on what happens with the interest rate environment.

We've seen some pretty incredible volatility over this past quarter, so it gets a little harder to pin it down exactly.

And we understand that's why you're asking the question.

And we tried to put a little guidance both in the short-term and long-term rates to give you our thoughts.

So modest, to us, there would be some increases, perhaps a tad higher than what stable has been, within 1 or 2 points.

So modest could be slightly more than that, but I think your numbers are a little high.

But I do think, Betsy, when you look at it, we have a fairly disciplined approach to positive pricing, down three basis points again this quarter.

But when you look at where deposit pricing is today, the opportunities to drive that number lower are diminishing.

But we did make, with the debt and capital restructuring we did this quarter, we did reduce our funding costs.

Loan yields continued to be under pressure, but -- and you saw a slight compression this quarter in loan yields.

But our portfolio yield should improve incrementally over time.

So we do believe we've got a modest opportunity for expansion.

But a lot of that's going to depend on how rates move and what the slope of the curve eventually turns out to be.

Betsy, I would add to that we need to really think through -- and I mentioned the impact of prepayments on our investment portfolio -- the premium that we have that we're amortizing was down.

It was $77 million in the first quarter, $73 million in the second.

So that change in the tenure really does impact that amortization quite a bit, so that's really one of the things to look at.

Okay.

The follow-up is just on that page 6 slide, where you do indicate the interest rate sensitivity summary.

That assessment of the 100 bits, longer than the curve, $132 million NII impact.

Can you just give us some color as to what the assumptions are in there?

Is that just static portfolio, static moves.

And your modest increase in NII takes into consideration competitive actions that you take?

Is that how I triangulate the two statements?

Yes, I think you've got to take all that into account.

It's not just the static portfolio that has baked in what we think our balance sheet changes are going to be.

Our production is -- loan production is going to be.

Prepayments assumptions on the investment portfolio.

So all that's really baked in, deposit costs, funding long-term debt costs, and so it's really -- everything is in that guidance.

Okay.

Paul Miller, FBR.

Going back to your C&I loan growth, was that new stuff that was coming in, or is it your people tapping the utilization rate?

And what is the utilization rate at this point on those portfolios?

The utilization rate was up to about 44.7%.

That was not the big driver -- the big driver really was new production from customers.

And as I mentioned in the prepared comments, it was really broad-based geographically.

Over 70% of our geographies grew loans.

We had not only that but products -- a broad base in products, healthcare and transportation were a couple, REIT lending was embedded in that too.

So we're seeing a little broader push towards production.

We also have seen that drift a little bit into small business at -- that's too early to call.

We're starting to see that, which is very encouraging for us.

I would just add to that as -- this quarter versus last quarter, the diversification of our loan production was much better.

Obviously, we'd love to see even more diversification and granularity in that production, but it was more broad-based across markets, more broad-based across products, and in particular more broad-based across the size of the corporate borrower.

Most of our business in the last several quarters in C&I has gone from the larger end of C&I middle market.

We are seeing demand further down into that customer segment today.

And as David said, it's still too early to call.

But small business owner, the small middle-market customer coming back some, but too early to call it a trend.

And how is the multifamily markets?

Are you participating in any of that -- or this type of lending, or is that something you guys don't get involved with?

Yes, we do.

If you look at commercial real estate for us, one of our big drivers has been multifamily.

It represents about 27% of our production year to date.

And it's right behind our home builder product, which I touched on is starting to come back as well, so we are looking at multifamily.

In particular where that multifamily is, make sure we don't let that get out in front of us.

But we feel good with those projects that we are putting on today.

(multiple speakers) When you look at it, the commercial real estate production has been historically -- compared to historical volumes has been very low.

We saw production pick up in 2011, we saw it pick up even further in '12, and the pace we are at in '13, it will be a little above that.

But as David mentioned in his earlier remarks, that portfolio tends -- continues to reduce in outstandings.

We are down to about $7 billion.

While we are encouraged by the new production, we still have not reached the inflection point on that portfolio.

Okay.

Erika Penala, Bank of America

My first question is a follow-up to Betsy's.

Even with some of the redemptions that occurred this quarter, it seems like you still have a higher cost long-term debt footprint.

And I guess this is a two-part question.

One is, what is the propensity to redeem some of that long-term debt, especially given your capital ratios are quite high under Basel III?

And if so, is that included in the NOI guidance that you gave on slide 6?

We do continue to look at our long-term debt cost and ways to get that down.

So we haven't stopped looking at it.

Any of those instruments, though, that have any type of capital attached to it requires approval from our regulatory supervisor, so it goes through a little longer process to get approval to do that.

But we are continuing to look at opportunities to get our total funding cost down of 40 basis points.

We would like to get that lower, and our long-term debt cost is somewhere in the $4.5 million range, so it's a good point.

Is that -- is redeeming that included in the NOI upside guidance on slide 6, or not?

It is not.

Got it.

And my second question is on losses.

Very loud and clear in terms of the trajectory of asset quality improvement from here.

But as you think about how the improvement in the Southeast is going, where do you think normalized losses will be for regions as we think about earnings power a year from now, two years from now?

I'm going to ask Barb Godin, our Chief Credit Officer, to answer that.

Barb?

We have talked a lot a lot about 75 basis points through the cycle of what our risk appetite is.

What that actually means as we come out of the cycle that we should see something better than 75 basis points.

Somewhere down in that 50 basis point area would be appropriate.

And then as we move through the coming years, that that will move somewhere around that 75 basis point, depending upon the mix of our portfolio between consumer and commercial book.

Got it.

Craig Siegenthaler, Credit Suisse

First, just on compensation here, is up modestly year-over-year.

And I understand that you're adding bodies in income-producing roles and of course, variable comps going to move with the loan production, here.

But what is really the outlook here, now that loan growth is positive and your guidance is positive.

Should we expect to see continued modest growth in comp here?

Or could we see you revert back to the downward pressure we saw the last two years?

I think that clearly, we are still focused on rigorous expense management, and we are looking for opportunities to make our organization more efficient.

That being said, we also are continuing to add resources that are customer-facing revenue-producing.

And where we see opportunities to do that, we are going to take advantage of them to grow and diversify our revenue streams.

If we are successful in growing our revenue streams, then I think you should anticipate that our salaries and compensation would follow that success.

That being said, in our non-revenue-producing non-customer-facing parts of the Company, we continue to try to become more efficient each and every quarter.

And Craig, I'll add to that that our guidance that we had that was past several quarters for our efficiency ratio to be in that low to high 50 range, which is dependent on an increase in rate, is really the efficiency ratio which came down.

It is more dependent on the revenue growth.

And we see opportunities to hire talented bankers to help us grow that revenue line.

And there is some time where you make investments that get the new folks up and running to generate the revenue.

But to Grayson's point, we are very -- we are wanting to make sure we look at our expenses.

We still believe '13 will be lower than '12, as we mentioned.

But we are rigorously reviewing the expense management.

But we don't want to stop making investments in people and technology as we've done, because that's really what the future of the franchise is all about.

All right, understand.

One follow-up on deposit growth versus earning asset growth.

Your deposit growth actually has been quite negative, and we understand why CD runoff even shrinking the banks in certain areas.

But also you think earning asset growth now actually will trend up, given your response to a prior question.

So do you think earning asset growth will materially exceed deposit growth the next year or two?

And if so, how do you expect to fund that?

First off, I would say our loan-deposit ratio is 81%, which is about 9 points, 10 points below our peers.

So we have some room there.

We are always looking at growing earning assets, loans in particular, as well as households and deposits.

So we would -- we have mentioned before that a loan-deposit ratio in the low 90%s would be fine with us as steady-state.

We want to make sure we don't have too much reliance on deposits for up from a funding standpoint and getting the overnight market like most banks did in '08.

But 81%, we would argue, is a little lower than we want.

And that's why we've been stressing really wanting to have appropriate loan growth to match off with the great funding that we have.

And when you own deposit market share and have the density we do in the Southeast, that's our competitive advantage coming through, but we still want to grow deposits and grow households.

Great.

Josh Levin, Citi.

I wanted to follow-up on the check posting question from before.

Are you still doing high to low?

And if so, if you switch to low to high, how should we think about that impacting earnings?

I think, Josh, that we continue to look -- we are still high to low from a posting standpoint on most of our transactions, but you have to look at your availability policy as well as your other policies surrounding insufficient funds, all in aggregate, to decide where were that will turn out from an earnings standpoint.

We've not finalized on -- exactly on all of those decisions, and have not put forth what we believe would be in an earnings impact to that.

But that continues to be an internal conversation that is being held and, as we get further guidance, we will share that with you.

Okay.

Secondly, I guess this is one of the more upbeat and domestic regional bank earnings calls I have heard this earnings season.

You seem to be more optimistic on loan growth than a lot of your peers.

Why do you think that is?

Is it your footprint?

Is it something else?

I think it's a number of reasons.

I think one is that we've been showing good loan production numbers for several quarters now.

But the runoff in the commercial real estate portfolio and the runoff in our residential mortgage portfolio has, if you will, has muted the benefits of that loan production.

As both of those asset segments, as the attrition slows in those segments, we've been able to show positive growth.

We do believe that we've got a lot of bankers that are calling on customers and trying to put the forth a very determined effort to grow our business at a prudent manner.

We think the Southeast is recovering a little faster than some other parts of the country, but most encouraging part of this is how it's broadened.

Out of the markets we are serving, we had over 70% of our markets show net growth this quarter for the first time.

And it's a real improvement over where we were.

I think that, if you read the other reports, we probably are a little more optimistic than many of the peers in this report.

But from a place we have come from over the last few quarters and showing that decline, this has been a very important quarter for us in demonstrating that turn.

Michael Rose, Raymond James

Just wanted to get a sense on the loan pipeline.

You talked a lot about by product, but can you talk about it on a geographic basis?

Are you seeing more of the pipeline come from some of the more distressed areas that are now rebounding?

Yes.

The -- clearly, the more distressed areas in our franchise footprint have been Georgia and Florida.

We are seeing good response out of both of those markets at this juncture.

As I just mentioned, the demand's more broad than it was a quarter ago, certainly two quarters ago.

We are seeing, if you will, on the business side of our lending, we demonstrated pretty strong production quarter in the fourth quarter.

Things slowed down a little bit in the first quarter, and then strong production here in the second quarter.

Third quarter is typically a slow quarter for business lending production.

Our pipelines are good.

But we aren't forecasting third-quarter to be as strong as second, but that is really more of a seasonal bias on our part.

We are seeing -- but we are seeing strong pipelines.

So third quarter could surprise us to the upside.

We will wait and see.

On the consumer side, we are seeing with -- I guess over 100 basis points increase in mortgage rates.

We are seeing some mix shifts in our application volumes.

We did $1.9 billion in mortgage production in the second quarter.

Was up about 6% from the first quarter, so good production there.

And our pipelines look good.

But we are forecasting that we think that mortgage applications will decline.

It's a little early to predict that decline, but it would look like it is somewhere in the 15% to 20% range for the second half of the year.

I would tell you the mix is really shifted.

We saw that mix shift start in the first quarter in our application pipelines.

Today, purchased mortgages is running better than 50% of total production, and in the applications, it's even higher than that.

So we do think that there will be a fairly sizable shift in mix and mortgage originations.

Auto lending applications continue to be up.

We're seeing strength in those.

We have seen good production of new accounts on credit card.

So on the consumer side of the house, I think we are seeing some improving signs of strength.

In particular, I think the rise in home valuations in some of the more distressed markets that we serve, we've seen that provide some opportunities for financing, particularly on the equity side of the house.

That was probably more than you asked for.

(laughter) No, that -- I'd appreciate the color.

Just as my follow-up, just noticed that the branch count was actually flat this quarter for the first time in a while.

I wanted to get your sense for the branch network from here.

Are you looking to continue to consolidate maybe some smaller branches?

And how should we think about that going forward?

We continue to rationalize our physical footprint.

We continue to believe that the physical branch office is very relevant in our business model.

But we also recognize that customers are moving to other channels, and we are investing in those channels.

We will continue to consolidate some of our offices.

We look at that.

We go through a very detailed analysis on where consolidations make sense, and we have -- you'll see us continue to do that.

We've been more aggressive - we were more aggressive earlier in that regard.

And -- but we continue that, and you'll see a very limited number of new offices being opened, but on a net basis I would say you should look for us to continue to be stable to slightly down.

Ryan Nash, Goldman Sachs.

David, just a follow up on what you were referring to in the premium amortization falling from $77 million down to $73 million.

So you made 100 basis points, I think, the amortization is $4 million.

First, is the $73 million a good run rate, assuming rate stay at the current levels?

Or should we see a step down into the next quarter?

And also, should we think about 100 basis point decline would lead to $4 million of decline on a go-forward basis?

I think if you looked at rates where we are today, that you should see a reduction in the $73 million.

This has been an awful volatile environment.

So it's hard to pinpoint it.

But I think directionally, you're correct to assume that the $73 million would be down on a -- and if you get an increase in rates from here, some go down, obviously, that much quicker.

But -- yes, so that's the direction you ought to think about to.

Okay.

And just as a follow-up to a question that had been asked earlier.

Just in terms of the $12 million of reserves for customer funds, is that a one-time item?

So should we expect that not to resume over the coming quarters?

We believe that we have evaluated all of our refunds relative to the policy change that we made last year.

And $12 million was a fictional number.

So we -- they told me, no, that's our -- that's the final number, so we don't see that recurring.

Yes, we constantly look at our service charges and how we treat customers and make adjustments, but we don't anticipate anything at this point.

Got it.

And if I could just squeeze in one last question.

You've obviously given us a lot of disclosure around the rate sensitivity, but if I were to look at your most recent 10-Q, I think it says for 200 basis point parallel shift, you'd see $312 million of REITs and Given the changes you've had where moving securities adding derivatives.

So first, has that overall sensitivity changed?

And do you guys have any customer-facilitating derivatives that will be rolling off over the next years, such that you -- we could see your asset sensitivity increasing over time?

That -- our -- we will want to really maintain our assets sensitivity, so you saw an awful lot of actions that we took during the quarter.

But we really have maintained that asset sensitivity.

In particular by entering into receipt-thick Swaps, if you will, with a portion of about $2.5 million for the receipt-thick swaps.

To maintain that, I think we were up 6% on 100 basis points, and that's about where we are right now.

Obviously, higher rates, that much more of an increase in income that we could expect.

But we like that position and want to keep it.

John Pancari, Evercore Partners

(multiple speakers) I wanted to see if we can get some -- if you can give us some additional color on new money yields that you are seeing in your loan book, particularly on the commercial real estate and C&I side, given the steeper curve here?

On the frustratingly that the short end of the curve really has remained anchored for us one month LIBOR and that19 to 21 basis point range.

Spreads have come under some pressure, but we still aren't off the lows that we have seen before.

We are -- we feel okay with those spreads.

They been in that to 225, 250 range for a while and we feel good about that.

We are seeing some pressure on structure that we are not chasing, but we've seen that anecdotally in the marketplace.

But from a spread standpoint, we feel good about that.

What's important on spread is to think about the customers that are in there, and Grayson touched on earlier, we really are a middle market company, small business lender.

And if we can get the small business segment really demanding credit, then our overall yields and spreads will improve.

But when you're at the larger end -- corporate, larger -- in the corporate, the spread tightens up quite a bit.

Not as profitable, but obviously not as risky either.

So you have to trade off risk and profitability there.

But in our core middle market business that we are in, spreads have hung in there.

Yes, I think if you look at, early on in the crisis, spreads really widened.

Obviously, they came under competitive pressure, and had compressed, but I would say appear stable at the moment.

Awful lot of competition in the market.

We've got some very strong competitors, and so you are seeing competition on every transaction.

We still are staying very committed to our relationship banking model, trying to make sure that we're banking customers that have full relationships with us.

And we believe that we are keeping our new ongoing business that, from a pricing standpoint, we believe we are keeping that stable at this juncture.

You do see the strength of our customer base improving.

I'd say the overall credit quality of our customer book continues to improve, which certainly helps those customers from a rate standpoint.

Okay.

And then on the expense side, I wanted to get a better feel of what is a good run rate in your eyes in terms of total expenses?

I know you indicated that your answer on the comp expense seems to imply that it may not pull back from the jump that the comp expenses saw this quarter.

So if that doesn't necessarily pull back, but you do see that negative unfunded provision go away, could that mean that your expense level on the core basis ex the debt extinguishment could actually go up from here?

Again, I'll start with the end in mind.

That is, we believe 2013 expenses would be down from 2012.

We do acknowledge the unfunded commitment credit that came in.

That line item has a tendency to be a little volatile.

That being said, we are looking very hard at every expense category.

Obviously, our largest one is related to salaries and benefits.

We do and have made investments in talent.

We believe that's important to us long-term, but we do continue to look at and make sure we have the right people and the right number of people, and the right people doing what we need them to do.

We look at occupancy and furniture and fixtures are the next two biggest ones, and continue to look at square footage, and trying to become as efficient as we can.

So I think it's hard to get on a specific run rate, but we are continuing to stay focused on improving expenses each and every day.

The conversation is really around creating positive operating leverage.

We try to take a balanced approach to running the business, very disciplined, rigorous, focused on expenses.

But also understanding that not all expenses are bad.

We need to figure out a way to grow our revenues, and that requires investing in people and technology.

And so our determination is to deliver positive operating leverage.

That's been challenging in this economic environment.

But I think just focusing on expenses alone is not in the best interest of the long-term sustainability of this franchise.

But at the same time, we realize in this environment, given the economy and given reduced demand for some of our products and services, we really have to be disciplined around expense management, and we will continue to do that.

Okay.

Matt O'Connor, Deutsche Bank

Just one more clarification on the moving pieces in the net interest income.

Clearly, the earning asset base is a little bit smaller at the end of the quarter, and I assume that's the level that you're talking about growing plus or minus.

And then the NIM is up a modest amount, with some additional kicker from the pre-amortization coming down.

So when you bring all those moving pieces together, do you think you can grow the net interest income dollars in 3Q of rest of year?

Call it assuming stable rates and your loan growth assumption?

That's where we are guiding in the prepared comments is, if rates will stay where we are right now, we think we could have some modest improvements in NII and the resulting margin there.

It's just hard to gauge exactly that -- how much that is for this kind of volatility, but I think that would be the appropriate guidance.

Okay.

And then just longer-term, as you think about the mix of the balance sheet, the securities to earning assets.

Is there a longer-term target as long growth hopefully, eventually picks up for everyone, including you?

Is there a longer-term target versus the 24% currently?

Yes, we are sitting here at 81% loan-deposit ratio, so our ability to attract, maintain a low-cost deposits is really a strategic advantage for us.

We hadn't had the loan growth we wanted, so we've had to put the Delta in the securities book.

So today, we probably have the second-highest concentration of earning assets in our investment portfolio.

We talked about that before.

And within that portfolio, we, at one time, had virtually all in mortgage backs.

And we have diversified away by introducing a little bit of credit risk in the investment portfolio, since we weren't growing credit in the form of loans.

But we do believe that, as loan growth comes about, the economy generally improves, that you go back to a more standard relationship of the securities book, which would be in the high teens, so call at 18%.

So it's 6 points away from there right now.

Okay.

All right.

Eric Wasserstrom, SunTrust Robinson Humphrey.

A couple of questions on credit quality.

I was noticing in your NPL migration schedule, in the commercial segment, there was a fairly significant uptick.

And I'm wondering if that was just one particular credit that moved, or a combination of a few?

If you look at migration and you ask, what's changed?

It is really the mix.

You're seeing much more commercial and industrial loans in that migration mix, and less commercial real estate loans.

That's just where we're at in the cycle.

Commercial and industrial loans by their nature are going to be a little more uneven.

There is obviously more substantial credits in that category.

The other thing we do is that we have a credit come into a nonperforming status in a given quarter, we count it as gross migration into NPL.

And in -- even if we resolve it within the same quarter.

This quarter we had that situation occur, and so you see a fairly large credit in our migration.

But that has already been resolved, and now out of our numbers for the next quarter.

So with commercial lending credits, you are just going to see a little more unevenness.

It's still in our $250 million to $350 million band that we think is normalized, but will be some unevenness from time to time in that migration.

And Eric, that's where we -- I was trying to leave you in comments, based on all that, if you look at criticized and classifieds and you see that continuing downward trend, early and late stage delinquencies getting better.

Everything tells us that credit quality's going to continue to improve from here, so we weren't overly concerned with that migration.

Great.

And then just one quick one.

The -- can you give us what you think your tax rate is going to be for the back half?

Yes, we had a couple of points in the effective rate this quarter because of the lack of ability to deduct certain of the charges that came through on the termination costs.

That was 2 points, and we were at 31.

So if you take that out, we would be in the 29 range, which we think is a reasonable proxy for going forward.

Gaston Ceron, Morningstar Equity Research.

I just had one quick question going back to the issue, I think that you brought up of -- regarding cross-selling, I think, in the mortgage business.

I'm just curious if you have any more detail on how exactly you want to go about the cross-selling opportunity?

And how high you think you can reasonably drive that 13% that you referenced, in the near and longer-term?

What we've been trying to do over the last several quarters is really push a relationship banking model that focuses on the customers and focuses on delivering the full benefits of our Regions banking relationship to our customers.

We have internally branded that as Regions 360.

We've been having meetings at every single market across our franchise, pulling together different lines of businesses, mortgage being a very important part of that, to try to stimulate more conversation between teams, more referrals between teams.

We've seen referrals from our branch offices, predominately focused on consumer banking.

We've seen a lot more referrals from those offices into our mortgage bankers.

Likewise, we've seen a lot of referrals coming out of mortgage banking into our branches.

We are driving that across our Company.

There's nothing special about that effort.

It's an effort you would probably hear of and be espoused by most banking institutions.

The key is in the execution, is how well can we execute that?

And part of what you are seeing in our numbers this quarter is that execution has materially improved over the last few quarters.

But do you have an area where you'd like to drive that 13% penetration rate to, or no?

Yes, I don't know that we set a defined limit on that.

The way we are really measuring it today is, quality referrals from our branches.

They have more than doubled in the last nine months.

We'd love to keep that number going higher.

The -- obviously, with the way the mortgage market is changing at this point in time, certainly changes the mix of those referrals, but we haven't internally set a penetration number that I know of.

Okay.

Great.

Matt Burnell, Wells Fargo Securities.

Grayson one for you, and then maybe one for David.

Grayson, given what appears to be a substantially greater level of capital flexibility with your -- under the Basel III final rule, and I appreciate that you are still thinking about some other steps that you can take in terms of the reduction in your debt costs.

But I'm curious if that -- if the Basel III -- your current Basel III position makes you any more confident about going for potentially bigger buybacks in the 2014 CCAR and capital planning process than you might have originally thought?

Clearly, we were encouraged by -- we're -- the regional banks landed on Basel III, and particular where we landed in that final set of rules.

We believe it does provide opportunities for us to think differently to some degree, as we go through our capital planning process.

More than anything else, it provides clarity.

And that clarity, I think, gives us all more confidence.

And so we are integrating that into all of our capital planning thoughts and processes.

And I do believe it gives us as a Company some flexibility that, at one point, we were concerned we might not have.

But today, I think we feel pretty good about our capital position and are building the appropriate plans to manage that.

Okay.

David, the -- question for you related for the securities portfolio.

I guess I'm just curious if you could provide a little more color as to what investments you moved into the held to maturity bucket this quarter?

It looks like it's about 10% of your total investments at this point.

And if the portfolio duration has changed meaningfully from the three-plus years that it was at the end of the first quarter?

Yes, we really took those assets that are more sensitive to interest-rate movements that are longer-duration mortgage-backed securities that we pushed in there.

And our duration and our investment portfolio, as a result of the rate change, did increase.

Now we are probably in the four-year range today.

And that's acceptable to us, given the interest-rate environment that we have.

Okay.

Gerard Cassidy, RBC

Coming back to capital, clearly, with the final NPR from the Federal Reserve, the Tier 1 common ratios for the regional banks comes in at 7%.

You may have a small SIFI buffer, possibly 25 or 50 basis points.

Recognizing that you're not probably going to want to run close to that 7% number, what level do think you're going to see your Tier 1 common ratio, which obviously is currently over 10%, settle in at?

What -- have you guys given much thought yet on where you want to put that number so that there could be greater amounts of return of capital down the road to shareholders?

Gerard, we think about that every day.

And it is hard to tell exactly where it will settle out.

I will tell you, without OCI in there, and then having that volatility that would've been there under the original proposal, it was going to probably cost us 25, 50 basis points just for that.

We had talked about being in the 8% to 8.5% range.

We'll see how it settles out.

I will tell you, really, the gating factor for us has been, and we believe will continue to be, a severely adverse stress Tier 1 common ratio versus the spot capital.

And so you really have to reverse engineer that -- don't know what the severely adverse level would be under Basel III.

Today it's 5% under Basel I. You would expect there to be some reduction in that, given that it's a risk-weighted asset number in general change for everybody, and -- but we will see what our regulatory supervisors do.

But I think it's -- broad-based, we would put it, best guess, 8.5% right now, but really reserve the right for that not to be the correct number, based on how we see what the regime looks like through this next CCAR filing

And speaking of that, do think that the folks that do the CCAR, the Federal Reserve, the regulators, are they going to -- now that the final NPR is in and statutorily, everyone knows what the capital ratios need to be for banks, will they move away from the percentage -- assuming, of course, your past with strong numbers on the CCAR.

But will they move away from percentage of earnings to just -- or can you guys argue that, look at our capital levels.

We are 200 basis points above where we should be.

We should be able to get most of that back in some sort of time frame.

Or are they -- do you think they will stick with this percentage of earnings thing?

Clearly, our regulatory supervisors asked, did we want a safe banking system?

And I think there's been a lot of change has been pushed through the marketplace.

I think there's been an awful lot of thought that has gone through trying to do the right thing by everybody, and we've had a recent change, obviously, in Basel III.

We need to see how that thinking evolves.

So it's a little premature to bet on exactly on what will happen.

Clearly, there's more capital in the industry than we've had.

We expect that the amount of capital in the industry will not go back to where it was pre-crisis.

And I know that's a pretty large gap.

But I think we need to be careful about getting ahead of ourselves, and let's see how this thing evolves in an appropriate manner.

But --

And then finally, on your securities portfolio as a percentage of assets.

You pointed out that your loan-to-deposit ratio is lower than you'd like.

Where should we see when things get back to normal, possibly in 2 to 3 years, where should we see the securities as a percentage of assets?

Where are you guys comfortable with that number?

That came up a minute ago.

We really think, if you look at history, we would've been in that high teen, call at 18%, just if you want a spot number.

So it's about 6 points away.

And that's a percentage of earning assets, so 6 points away from where we are today.

Great.

Which is $6 billion, $7 billion.

Sure.

Great.

Brian Foran, Autonomous

I guess most of my questions been asked, but maybe one on deposits.

If you could remind us, any embedded assumptions as you think about asset sensitivity?

And then just more broadly, the way we measure it, you guys have one of the bigger jumps in non-interest-bearing deposits as a percentage of total risk cycle, from about 20% back to the mid-2000's to 32% now.

And just thoughts around sustainability of that increase.

Clearly, there's been a lot of efforts internally that you've made to increase that number, but clearly, also in a low rate environment, non-interest-bearing deposits tend to be a little higher.

Yes, I and think -- and I'll make a few comment that obviously, this is a very different rate environment for our depositors that we've seen before.

And so a lot of the historical evidence we have, I'm not sure how valid that is coming out of this cycle.

We are having to stress test our deposit portfolio to make sure we understand what some of the possibilities are, depending on how rates move and how fast rates moved.

The pace of increase in those rates and, when you look at our portfolio today, we have dramatically reduced our dependence on higher price deposits.

In particular, timed deposit, as well as some high-priced depository accounts, that we just have been less competitive on in this kind of environment.

Obviously, as the market moves, we will all have to move, and we've run a number of scenarios to try to forecast what those movements might be, but clearly, in this environment, it's a little different than anything we've seen before.

David?

Yes, I think we ought to be -- we need to be real careful that we don't allow history to unduly influence what can happen this go-around.

We all -- our industry has a lot of non-interest-bearing on the balance sheets that it could move -- historically, that's a -- there's a core level of non-interest-bearing that's going to be with us.

We have some pretty drastic moves off the balance sheet.

I think we are 25% higher than we experienced last time in terms of our assumptions.

That's been baked into our guidance.

And I think it's important to think about these moves not only in the sense of thinking about what our net interest income and margin would be, but liquidity risk management, which is as important to us.

And although we are sitting here at an 81% loan-to-deposit ratio, we cannot -- we can never lose sight of that.

So we -- you've asked a great question.

It's something we look at all the time, but we have higher outflows, assume, today, than we had before.

And we shock it in a number of ways just to make sure if we are wrong, what does that mean to us, again, in particular, as it relates to liquidity?

That was it for me.

Marty Mosby, Guggenheim

David, before I let you off the hook, I want to go back to your interest rate sensitivity analysis.

And, if I am looking at this steepening of the curve that you're doing on the long end, drilling down into that premium amortization, right now we are running in the 70%s.

If you were to extend the duration by 50%, it seems like it would probably bring that down into the 50%s, which would generate about $80 million to $90 million worth of benefits.

We're just curious if that's relative to the $132 million?

Is 65%, 70% of that coming from a premium amortization, or is that out of line with what you are building into that number?

We have a piece of that -- pretty large piece of the change in premium amortization coming into the margin guidance, that $132 million.

So yes, that two-thirds are built into that.

Okay, so about two-thirds of the impact is from premium amortization coming down?

Right.

Okay.

That's about what I was thinking.

And then, when you go over to the short-term increase here, what are you assuming on deposit pricing?

Are you -- as a 100 basis point increase, are you assuming that money market accounts and your CDs are going up one for one?

Are you giving yourself some credit for lagging those deposit rates?

I think that we'd end up having about 60% of those that would be adjusted pretty quickly.

Again, maybe that's higher than what we've experience before, but we have a pretty immediate increase in rates to the extent that starts happening.

So you're not really building any deposit lag into the benefit of the $81 million?

Yes, less than before.

Okay.

All right.

Because it seems like, as we come off the floor, at least for the first 100 basis points, we have typically seen, especially with money market, mutual money accounts, maybe not been as competitive, that there will be room for some lagging as you first go through that first (multiple speakers).

Yes, and we are certainly seeing this at a really low deposit cost standpoint.

So all these are best guesses, but we really need to -- we are going to be competitive with regards to our rates that we offer customers, so it really also depends on the funding that our competitors have and peers have, too.

Very good.

Okay.

Thank you very much for your attendance, and we appreciate your participation in today's conference call, and we will stand adjourned.

Thank you.

This concludes today's conference call.

You may now disconnect.