Regions Financial Corporation (RF) Q2 2013 Earnings Report, Transcript and Summary

Good morning, and welcome to the Regions Financial Corporation's Quarterly Earnings Call. My name is Paula, and I'll be your operator for today's call. [Operator Instructions] I will now turn the call over to Mr. List Underwood to begin.

Good morning, everyone, and welcome to Regions Financial's Second Quarter 2013 Earnings Conference Call. Our presenters today are Chief Executive Officer, Grayson Hall; and our Chief Financial Officer, David 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 section 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 that is 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 disciplined focus on expense management, and we completed several actions that improved our debt and capital structure, as well as reduced our future funding costs. We raised our common stock cash dividend. And finally, we began executing 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 U.S. where the majority of our franchises are located. According to a recent research report for 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. As housing starts had 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…

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 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 health care, 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 1 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…

Thank you, David. We are ready to begin the Q&A session of our call. [Operator Instructions] Operator, now let's open up the lines for your questions.

[Operator Instructions] Your first question comes from Ken Usdin of 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 shrinking the portfolio a little bit on the security side. So with period end earning 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 do 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 of 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 kind of look at it over 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 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 affecting revenue in that regard?

No. I mean we continue to -- we continue 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.

Your next question comes from Betsy Graseck of Morgan Stanley.

I just wanted to ask about your NIM guidance. You indicated that you could see some positive forward movement. Can you just give us a sense as to how much you're expecting from the funding cost and the asset repricing versus the mix shift? And part of the reason for asking is you do give the chart on the 100 basis points rise in rates at the long end of the curve, which 132 bps is 12 basis points to NIM. We did get that in the last quarter. I know it comes over the last 12 months, but I'm 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 kind of in a stable discussion with, relative to our NIM. And that'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. 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. Stable has been within 1 or 2 points, so modest could be slightly more than that. But I think your number's a little high.

I do think, Betsy, when you look at it, we've had a fairly disciplined approach to deposit pricing. We're down 3 basis points again this quarter. But we 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 cost. Loan yields continued to be under pressure. But -- and you saw a slight compression this quarter on 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.

I would add to that, you 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 10-year 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 bps, long end of the curve, $132 million NII impact, could 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 would take? Is that how I triangulate the 2 statements?

I think you 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 productions -- loan production's going to be, prepayments assumptions on the investment portfolio. So all that's really baked in, deposit cost, funding -- long-term debt cost. So it's really, everything's in that guidance.

Your next question comes from Paul Miller of FBR. Paul J. Miller - FBR Capital Markets & Co., Research Division: 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 your 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, broad-base in products. Health care 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. 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 come from a larger end of C&I middle market. We're seeing demand further down into that customer segment today. And as David said, still too early to call, but the small business owner, the small middle-market customer, it's coming back some. But too early to call it a trend. Paul J. Miller - FBR Capital Markets & Co., Research Division: And how is the multifamily markets -- are you participating in any of that -- 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're 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're putting on today.

When you look at it, the commercial real estate production has been historically, compared to historical volumes, had been very low. We saw production pickup in 2011. We saw it pick up even further in '12. And the pace we're at in '13, it will be a little bit above that. But as David mentioned in his earlier remarks, that portfolio continues to reduce an outstandings. We're down to about $7 billion. While we're encouraged by the new production, we still have not reached inflection point on that portfolio.

Your next question comes from Erika Penala of Bank of America.

May 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 2-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 NII guidance that you gave on Slide 6?

Yes, 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 supervisors. 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, the 40 basis points. We'd like to get that lower. And our long-term debt cost is somewhere in the 4.5 range, so it's a good point.

And is that, is redeeming that included in the NII upside guidance on Slide 6 or not?

It is not.

Got it. And my second question is on losses. I hear you 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, 2 years from now?

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

We talked a lot about 75 basis points through the cycle is what our risk appetite is. What that actually means as we come out of a 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 points depending on the mix of our portfolio between consumer and commercial books.

Your next question comes from Craig Siegenthaler at Credit Suisse. Craig Siegenthaler - Crédit Suisse AG, Research Division: So first just on compensation here, it's up modestly year-over-year. And I understand that you're adding bodies in income-producing roles, and of course, variable comp's going to move with 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 kind of modest growth in comp here, or could we see it kind of revert back to the downward thrust we saw the last 2 years?

Well, I think that, clearly, we're 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 opportunity to do that, we're going to take advantage of them, to grow and diversify our revenue streams. If we're 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, noncustomer-facing parts of the company, we continue to try to become more efficient each and every quarter.

Craig, I'll add to that. Our guidance that we had over the past several quarters for our efficiency ratio to be in that low- to high-50 range, which is dependent on an increase in rate, it's really the efficiency ratio, which came down, is more dependent on the revenue growth. And we see opportunities to hire talented bankers to help us grow that revenue line. And there are -- 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're wanting to make sure we look at our expenses. We still believe '13 will be lower than '12, as we've 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. Craig Siegenthaler - Crédit Suisse AG, Research Division: I understand. One follow-up on deposit growth versus earning asset growth. Your deposit growth actually has been quite negative, we understand why. CD runoff, you've been shrinking the bank in certain areas. But also you think earning asset growth now actually will trend up, given kind of your response to a prior question. So do you think earning asset growth will materially exceed deposit growth the next year or 2? And if so, how do you expect to fund that?

Well, first off, I would say our loan deposit ratio is 81%, which is about 9, 10 points below our peers. So we have some room there. We're always looking at growing earning assets, loans in particular, as well as households and deposits. So we would -- we've mentioned before that a loan deposit ratio in the low 90s would be fine with us as steady state. We want to make sure we don't have too much reliance on deposits from a funding standpoint and get 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.

Your next question comes from Josh Levin of Citi.

I want 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 that'll 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 an earnings impact to that. But that continues to be an internal conversation that is being nailed. And as we get further guidance, we will share that with you.

Okay. Secondly, I guess this is one of the more upbeat and optimistic regional bank earnings call that I've heard this earning 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?

Well, 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 forth a very determined effort to grow our business in a prudent manner. We think the Southeast is recovering a little faster than some other parts of the country. But the most encouraging part of this is how it's broadened. Out of the markets we're 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've come from over the last few quarters and showing net decline, this has been sort of a very important quarter for us in demonstrating that turn.

Your next question comes from Michael Rose of Raymond James. Michael Rose - Raymond James & Associates, Inc., Research Division: I just wanted to get a sense on the loan pipeline. You talked a lot about it by product, but can you talk about it on a geographic basis? I mean, are you seeing more of the pipeline come from some of the more distressed areas that are now rebounding?

Yes. I mean, the -- clearly, the more distressed areas in our franchise footprint have been Georgia and Florida. We're seeing good response out of both of those markets at this juncture. As I just mentioned, the demand is more broad than it was a quarter ago, certainly 2 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 our 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'll 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. It's 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 the decline, but it would look like it's somewhere in the 15% to 20% range for the second half of the year. I would tell you the mix has really shifted. We saw that mix shift start in the first quarter in our application pipelines. Today, purchase 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'll be a fairly sizable shift in mix in mortgage originations. All our lending applications continue to be up. We're seeing strength in those. We're seeing 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. Michael Rose - Raymond James & Associates, Inc., Research Division: I appreciate the color. Just as my follow-up, I just noticed that the branch count was 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 then 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're 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.

Your next question comes from Ryan Nash of Goldman Sachs.

David, just a follow-up to what you're referring to, the premium amortization falling from $77 million down to $73 million. So you saw rates of 100 basis points, I think the amortization is down $4 million. First, is the $73 million a good run rate, assuming rates stay at the current levels, or should we see a step-down into the next quarter? And also should we think about a 100-basis-point decline would lead to roughly $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 -- that $73 million would be down. 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 it.

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?

Well, we believe that we have evaluated all our refunds relative to -- to the policy change we made last year, $12 million was the additional number. So we -- based on what we know, that's our -- that's the final number, so we don't see that recurring. 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 can just squeeze in one last question, I mean, 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 a 200-basis-point parallel shift, you'd see $312 million of rise in NII. Given the changes you've had, where moving securities, adding derivatives, so first, how 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's our -- we wanted to really maintain our asset 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 receive-fixed swaps, if you will, with a portion of about $2.5 billion worth of receive-fixed swaps. To maintain that, I think we're 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. So we like that position and want to keep it.

Your next question comes from John Pancari of Evercore Partners.

If you could just -- if you can give us some additional color on new money yields that you're seeing in your loan book, particularly on the commercial real estate and the C&I side given the steeper curve here.

On the -- frustratingly, that the short end of the curve really has remained anchored, for us, 1 month LIBOR in that 19- to 21-basis-point range. Spreads have come under some pressure, but we still are off the lows that we have seen before. We're kind of -- we feel okay with those spreads. They've been in that 225, 250 range for a while, and we feel good about that. We are seeing some pressure on structure that we're 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. Grayson touched on it earlier. We really are a middle-market company, a small business lender. And if we can get the small business segment really demanding credit, then our overall yield and spreads will improve. When you're at the larger end in corporate, larger end of 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're in, spreads have hung in there.

Yes, I mean, I think if you look at it early on in the crisis, spreads really widened. Obviously, they came under competitive pressure and have compressed. But I would say, appear stable at the moment. An awful lot of competition in the market, got some very strong competitors, and so you're 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're keeping our new, ongoing business set from a pricing standpoint, we believe we're 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 want 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 x the debt extinguishment, could actually go up from here?

Well, again, I'll start with the end in mind, that is we believe 2013 expenses will 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 -- the right number of people and the right people doing what we need them to do. We'll look at occupancy and furniture and fixtures are the next 2 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.

Well, I mean, the conversation is really around creating positive operating leverage. We're trying to take a balanced approach running the business. We're very disciplined, a rigorous focus 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 realized 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.

Your next question comes from Matt O'Connor of 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, kind of growing plus or minus. And then the NIM's up on a modest amount, with some additional kicker from the premium 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 versus here, call it assuming stable rates in your loan growth assumption?

That was where we're kind of guiding in the prepared comments, that 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, Matt, how much that is with 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 security, its earning assets, is there a longer-term target as loan growth, hopefully, eventually picks up for everyone, including you? Is there a longer-term target versus the 24% currently?

Yes. We're sitting here at 81% loan-to-deposit ratio. So our ability to attract, maintain low cost deposits is really a strategic advantage for us. We haven'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've talked about that before. And within that portfolio, we, at one time, had them virtually all in mortgage-backs, and we've diversified a way 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, then you go back to a more standard relationship of the securities book, which would be in the high teens. So the 18 -- call it 18%, so it's 6 points away from there right now.

Your next question comes from Eric Wasserstrom of 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.

Yes, I mean, if you look at migration and you ask what's changed, it's really the mix. You're seeing much more commercial industrial loans in that migration mix and less commercial real estate loans. That's just sort of 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 if we have a credit come into a nonperforming status in a given quarter, we count it as gross migration into NPL. And 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's already been resolved and now out of our numbers for the next quarter. So with commercial lending credits, you're just going to see a little more unevenness. It's still in our 250 to 350 band, that we sort of 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 with comments that based on all that, if you look at criticized and classifieds and you see that continuing downward trend, early-, late-stage delinquencies getting better, everything tells us that credit quality is 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'd be in the 29% range, which we think is a reasonable proxy for going forward.

Your next question comes from Gaston Ceron of 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, at the mortgage business. I'm just curious if you have any more detail on how exactly you're going to go about the cross-sell opportunity and how high you think you can reasonably drive that 13% that you referenced kind of in the near and longer term.

Well, 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 Regions' banking relationship to our customers. We sort of internally branded that as Regions 360. We've been having meetings in every single market across our franchise, pulling together different lines of businesses, mortgages being a very, 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. They're predominantly 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're driving that across our company. There's nothing special about that effort. It's the effort you -- we'd 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're 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% kind of penetration rate to or no?

I don't know that we set a defined a limit on that. The way we're really measuring it today is sort of quality referrals from our branches. They've more than doubled in the last 9 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.

Your next question comes from Matt Burnell of 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 -- with -- under the Basel III final rule, and I appreciate that you're still thinking about some other steps that you can take in terms of the reduction in your debt cost, 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.

Well, I mean, clearly, we were encouraged by where the regional banks landed on Basel III and in 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're 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, a question for you related to the securities portfolio. I guess I'm just curious if you can 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 3-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, so longer-duration mortgage-backed securities, that we've pushed in there. And our duration in our investment portfolio as a result of the rate change did increase. Now we're probably in the 4-year range today, and that's acceptable to us given the interest rate environment that we have.

Your next question comes from Gerard Cassidy of 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 the 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 you think you're going to see your Tier 1 common ratio, which, obviously, is currently over 10%, settle in that? 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's hard to tell exactly where it will settle out. I will tell you, without OCI in there and having the volatility that would have been there under the original proposal, it was going to probably cost us 25, 50 basis points just for that. We have talked about being in that 8%, 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 the severely adverse stressed Tier 1 common ratio versus the spot capital. And so you really have to kind of reverse engineer that. We don't know what the severely adverse level will be under Basel III. Today it's 5% under Basel I. You would expect there to be some reduction in that given that the risk weighted asset number, in general, changed for everybody. And -- but we'll see what our regulatory supervisors do. But I think it's -- broad-based, we would put it, best guess, at 8%, 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 you think that the folks that do the CCAR, the Federal Reserve, the regulators, are they going to move -- 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 of -- assuming, of course, you pass 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're 200 basis points above where we should be, we should be able to give most of that back in some sort of time frame? Or they -- do you think they'll stick with this percentage of earnings thing?

Well, clearly, our regulatory supervisors, as do we, want a safe banking system. And I think there's been a lot of change that's been pushed through the marketplace. I think there's been an awful lot of thought that had 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 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 precrisis. 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 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 have been in that high teens, call it 18% just if you want a spot number. So that's about 6 points away, and that's a percentage of earning assets. So it's 6 points away from where we are today, which is $6 billion, $7 billion.

Your next question comes from Brian Foran of Autonomous.

I guess most of my questions have 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 this cycle from about 20% back in the mid-2000s 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, and I think I'll make a few comments. Obviously, this is a very different rate environment for our depositors than 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're 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 move, the pace of increase in those rates. And when you look at our portfolio today, we have dramatically reduced our dependence on higher-priced deposits. In particular, time deposits, 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'll 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.

Yes, I think we need to be really careful that we don't allow history to unduly influence what can happen this go-round. Because we all -- our industry has a lot of non-interest-bearing on the balance sheets that could move. Historically, that's -- 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're like 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 with an 81% loan-deposit ratio, 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 assumed today, than we had before. And we shock it a number of ways just to make sure that if we're wrong, what does that mean to us, again, in particular as it relates to liquidity.

Your final question comes from Marty Mosby of Guggenheim.

David, before I let you off the hook, I want to go back to your interest rate sensitivity analysis. And if I'm looking at this kind of steepening of the curve that you're doing on the long end. And I'm kind of drilling down into that premium amortization, right now we're running in the 70s. If you were to extend the duration by 50%, it seems like it would probably bring that down into the 50s, which would generate about $80 million to $90 million worth of benefit. Was just curious, if that's relative to the $132 million, is 65%, 70% of that coming from the premium amortization? Or is that out of line with what you're building into that number?

Yes, we have a piece of that, pretty large piece of the change in the premium amortization coming into the margin guidance, that $132 million. So yes, about 2/3 is built into that.

Okay. So about 2/3 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 the 100-basis-point increase, are you assuming that money market accounts and your CDs are going up 1:1? Are you giving yourselves some credit for lagging those deposit rates?

Yes. 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 experienced before. But we have a pretty immediate increase in rates to the extent that, 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've typically seen, especially with money market, mutual fund accounts maybe not being as competitive, that there'll be room for some kind of lagging as you first go through that first moving [ph] rate.

We're certainly seeing this at a really low deposit cost standpoint. So all these are best guesses, but we really need to -- we're going to be competitive with regards to our rates that we offer our customers. So it's really also dependent on the funding that our competitors and peers have, too.

Okay. Well, thank you very much for your attendance, and we appreciate your participation in today's conference call. We'll stand adjourned.

Thank you. This concludes today's conference call. You may now disconnect.