Regions Financial Corporation (RF) Q1 2017 Earnings Report, Transcript and Summary

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 online have been placed on listen-only. At the end of the call there will be a question-and-answer session. [Operator Instructions] I will now turn the call over to Ms. Dana Nolan to begin.

Thank you, Paula. Good morning and welcome to Regions' first quarter 2017 earnings conference call. Participating on the call are Grayson Hall, Chief Executive Officer; and David Turner, Chief Financial Officer. Other members of senior management are also present and available to answer questions. A copy of the slide presentation referenced throughout this call, as well as our earnings release and earnings supplement are available under the Investor Relations section of regions.com. I’d also like to caution you that we will make forward-looking statements during today's call that are subject to risk and uncertainties and we will also refer to non-GAAP financial measures. Factors that may cause actual results to differ materially from expectations, as well as GAAP to non-GAAP reconciliations are detailed in our SEC filings. I will now turn the call over to Grayson.

Thank you, Dana and good morning. Thank you for joining our call today. I will review highlights of our first quarter year-over-year financial performance and then David will take you through the details compared to the prior quarter. Let me begin by saying we are pleased with our first quarter results, which highlight our continued focus on effectively managing expenses and strengthening of our asset sensitive balance sheet. For the quarter, we reported earnings available to common shareholders from continuing operations of $278 million, an 8% increase over the first quarter of the prior year. Earnings per share were $0.23, representing a 15% increase over the prior year. Importantly, by expanding our customer base, we continue to deliver results in areas we believe are fundamental to future income growth as evidenced by growth in checking accounts, households, credit cards, and wealth management relationships. Taxable equivalent net interest income and other financing income was stable year-over-year, as interest rate increases offset the impact of lower average loan balances, and the resulting net interest margin was 3.25%, an increase of 6 basis points. Non-interest expenses remained well controlled, up less than 1% year-over-year as our efficiency efforts helped mitigate core expense inflation and the impact of investments in new initiatives. As it relates to loan growth, we are encouraged by conversations with our customers. Moreover, consumer and small-business sentiment continues to improve. In addition, customers particularly in the middle market segment are beginning to plan for future capital expenditures. However, this optimism is yet to translate into the conference needed to take on additional debt today. For now, customers appear to be in more of a wait and see mode. In the near-term, our asset sensitive balance sheet positions us to grow net interest income even in the absence of loan growth aided in part by the strength of our deposit franchise. We will continue to work closely with our clients to meet their financial needs, while also maintaining a disciplined focus on expense management and appropriate risk-adjusted returns. Year-over-year, average loans decreased $1.3 billion as growth in consumer lending portfolio was more than offset by declines in the business lending portfolio. The overall health of the consumer remained strong as we experienced solid demand and steady loan growth in almost all consumer loan categories. Average consumer loans grew by $719 million or 2% from the first quarter of the prior year. Average business lending balances declined $2.1 billion or 4% driven by continued focus on achieving appropriate risk adjusted returns, the de-risking of certain portfolios and asset classes, and an ongoing softness in demand for middle market commercial and small business loan. We are optimistic that loan growth will improve as the year progresses, but remain committed to prudently growing loans without compromising our risk or return requirements. With respect to asset quality, we continue to characterize overall credit quality is stable. Our energy portfolio is performing as expected, and there are no emerging concerns. However, given the current phase of the credit cycle, volatility and certain credit metrics can be expected, especially as it relates to large dollar commercial credits. Turning to capital deployment, we remain committed to managing capital towards our long-term targets. That includes effectively deploying our capital through organic growth and strategic investments to increase revenue or reduce ongoing expenses, while also returning an appropriate amount of capital to our shareholders. Over the course of several years, we’ve developed a robust capital planning process to ensure we have sufficient capital levels to withstand a variety of stress scenarios. We continue to focus on effective capital deployment and have submitted our CCAR plan in line with this initiative. We look forward to discussing the details of that plan with you next quarter. Our commitment to superior customer service also remains a top priority. And we are pleased that Regions was recently recognized as the highest rated bank in the US in customer experience by the Temkin Group. Moreover, Regions was the fourth highest rated company across all industries. Our teams remain focused on providing outstanding service as well as solid financial advice, guidance, and education to help our customers reach their financial goals. In summary, our first-quarter performance reflects a solid start to 2017, and we look forward to building on this foundation for the remainder of the year. With that, I’ll turn it over to David to cover the details of the first quarter. David?

Thank you Grayson and good morning everyone. Let's get started with the balance sheet and a look at average loans. In the first quarter, average loan balances totaled $80.2 billion, down $411 million from the previous quarter. Average balances in the consumer lending portfolio decreased $215 million driven by the company's decision to exit a third-party arrangement within the indirect vehicle portfolio, as well as a sale of affordable housing residential mortgage loans at the end of 2016. Excluding these items, average consumer loans would have increased approximately $140 million in the first quarter. Average third-party indirect-vehicle balances declined $186 billion or 9% during the quarter, and we expect this portfolio to decline between $500 million and $600 million on average during 2017. Excluding the third-party indirect-vehicle portfolio, average indirect vehicle balances increased $33 million. Average mortgage balances decreased $16 million during the quarter. However, excluding the impact of the fourth quarter affordable housing residential mortgage loan sale of $171 million, average balances increased approximately 1%. We expect mortgage production to hold up relatively well despite the rising rate environment. This is due in part to Regions’ mortgage production mix being more heavily weighted to purchase at approximately 70%. In addition, we recently enhanced our capabilities within our online home loan direct mortgage channel, and although it is a relatively small portion of total mortgage production today, we are encouraged by the recent results, which were up 41% year-over-year. Average home equity balances decreased $105 million as customers continue to pay off equity line of credit balances faster than new production. Average home equity lines of credit decreased $184 million, while average home equity loans increased $79 million, and we continued to experience success with our other indirect lending portfolio, which includes point-of-sale initiatives. This portfolio increased $48 million or 5% linked quarter. Average balances in our consumer credit card portfolio increased $20 million or 2%. Penetration into our existing deposit customer base increased to 18.6%, an improvement of 20 basis points compared to the prior quarter and 110 basis points year-over-year. Now turning to business lending, average balances decreased $196 million as declines in owner occupied commercial real estate and investor real estate were partially offset by growth in commercial and industrial loans. As Grayson mentioned, customer optimism has yet to translate into balance sheet growth. The linked quarter decline in average balances was primarily due to our continued focus on achieving appropriate balance and diversity, while also improving risk-adjusted returns. The company experience modest growth in average commercial industrial loans led by growth in government and institutional banking and increased utilization within real estate investment trust. However, we continue to reduce exposure due to concerns about increased risk in certain industries and asset classes. Average direct energy loans decreased $93 million or 4% during the quarter and ended the quarter at 2.5% of total loans outstanding. In addition, average multi-family loans decreased $147 million or 8%, compared to the fourth quarter. Further, softness in demand and competition from middle market and small business loans continues to impact loan productions. While headwinds to growth remain, we are experiencing success through improved overall returns, and the company continues to expect business lending growth in 2017, driven in part by growth in technology and defense, healthcare, power and utilities, and asset-based lending portfolios. Let's take a look at deposits. Total average deposits decreased $530 million from the previous quarter and average low-cost deposits decreased $173 million. Total average deposits in the consumer segment increased $605 million or 1% in the quarter. This growth reflects the unique strength of our retail franchise and overall health of the consumer. Average corporate segment deposits decreased $565 million or 2% during the quarter, impacted by seasonal declines. Average deposits in the wealth management segment declined $204 million or 2% during the quarter, as a result of ongoing strategic reductions of collateralized deposits. Certain institutional and corporate trust customer deposits, which require collateralization by securities, continue to shift out on deposits and into other fee income producing customer investments. Average deposits in the other segment decreased $366 million or 9%, driven by the strategic decision to reduce approximately $500 million of higher cost retail brokered sweep deposits that were no longer a necessary component of our current funding strategy. Deposit costs remain at historically low levels at 14 basis points and total funding cost remained low totaling 32 basis points in the quarter. It is important to point out that our deposit base is more heavily weighted towards retail customers. Approximately 74% of average interest-bearing deposits and 52% of average interest-free deposits are considered retail. In addition, we have a loyal customer base as more than 40% of our consumer low-cost deposits have been deposit customers at regions for more than 10 years. And finally, approximately 50% of our deposits come from MSAs with less than 1 million people and approximately 35% from MSAs with less than 500,000 people, both are in the top quartile versus our peer group. For these reasons, we believe that our deposit base is a key component of our franchise value and will serve as a competitive advantage in a rising rate environment. So let’s see how this impacted our results. Net interest income and other financing income on a fully taxable basis was $881 million in the first quarter, an increase of $7 million or 1% from the fourth quarter. The resulting net interest margin was 3.25%, an increase of nine basis points. Both net interest margin, and net interest income and other financing income benefited from several factors during the quarter, including higher interest rates, and lower premium amortization on investment securities, partially offset by lower average loan balances, and modestly higher deposit cost. The modest increase in deposit cost is primarily attributable to index deposits, which make up approximately 6% of interest-bearing deposits. In addition, too fewer days in the quarter negatively impacted net interest income and other financing income by approximately $10 million, but benefited net interest margin by approximately 2 basis points. Premium amortization on mortgage related securities declined to $38 million from $43 million during the quarter. If interest rates remain at current levels or rise further, we would expect to benefit from additional declines ultimately achieving a quarterly amortization run rate in the low-to-mid $30 million range in 2017. Looking forward to second quarter, we expect net interest margin to expand by an additional 3 basis points to 5 basis points in spite of the negative impact from one additional day. Non-interest income decreased $12 million or 2% in the quarter, primarily due to $5 million gain associated with the sale of affordable housing mortgage loans and $5 million gain from the sale of securities recorded in the prior quarter that did not repeat. Adjusted non-interest income decreased $2 million in the quarter. Wealth management income increased $6 million or 6%, primarily due to seasonal increases in both insurance and investment services income. Card and ATM fees increased $1 million or 1% due to an increase in interchange income. Checking account growth helped to offset seasonally weaker service charges, which declined $5 million or 3%. Mortgage income decreased $2 million or 5%, driven by lower production related to seasonality and rising interest rates. Consistent with our strategy to further increase the mortgage servicing portfolio, during the quarter the company reached an agreement to purchase the rights to service approximately $2.9 billion of mortgage loans with an expected close date of April 30. Including this transaction, the company will have purchased the rights to service more than $15 billion of mortgage loans over the past four years. Increased revenue from mortgage servicing is expected to help offset the impact of lower mortgage production. Capital markets income increased $1 million or 3% during the quarter as increased revenues associated with debt underwriting and loan syndications were partially offset by lower merger and acquisition advisory services. Looking forward, we expect capital markets revenue to improved throughout the remainder of the year and expect first quarters adjusted non-interest income to represent the low point for the year. Let’s move on to expenses. Total non-interest expenses decreased 2% during the quarter. On an adjusted basis, expenses totaled $872 million, $5 million less than the prior quarter, reflecting our continued commitment to disciplined expense management. Total salaries and benefits increased $6 million. Seasonal increases and payroll taxes were partially offset by declines in production-based incentives, while staffing levels remained relatively unchanged. Professional and legal expenses decreased $4 million during the quarter, primarily due to lower litigation related cost. Net occupancy expense decreased $4 million as the fourth quarter included elevated charges related to flood damaged branches, while the first quarter included insurance recoveries related to branch damages in prior periods. Other real estate expenses included within our other non-interest expense category also decreased $4 million during the quarter. Looking at second quarter, salaries and benefits are expected to increase as a result of merit and the issuance of long term incentive awards. In addition, increases in certain non-interest income categories will drive related increases in production-based incentives. However, our outlook for adjusted non-interest expenses for 2017 is unchanged as we continue to expect a year-over-year increase between 0% and 1%. The first quarter adjusted efficiency ratio improved 50 basis points to 62.7%, and the effective tax rate improved 80 basis points to 30.4%. Let’s take look at asset quality. Net charge-offs totaled $100 million in the first quarter, an increase of $17 million and represented 51 basis points of average loans. The current quarter included the impact of three large dollar commercial credit charge-offs totaling approximately $39 million. However, much of these large dollar commercial credits were already included in our reserve estimates. This combined with improvement in other credits meant that the provision for loan losses was $30 million less than net charge-offs and our allowance for loan losses as a percentage of total loans decreased 3 basis points to 1.33%. The allowance for loan and lease losses associated with the direct energy portfolio decreased to 6.1% in the quarter, compared to 7% in the fourth quarter as our exposure to direct energy continued to decline, and the overall portfolio continues to stabilize. Total non-accrual loans, excluding loans held for sale increased $9 million or 2 basis points to 1.26% of loans outstanding, driven by increases in non-energy commercial loans. Total business services criticized loans decreased 2% and total delinquencies decreased 16%. The improvement in criticized loans was primarily due to the declines in energy and energy-related credits. The decline in total delinquencies was driven by improvement in consumer loan categories. Allowance for loan losses as a percentage of total non-accrual loans or [indiscernible] coverage ratio was 106% at quarter end. Excluding energy, the coverage ratio decreased from 138% to 135% in the first quarter. Total direct energy charge-offs, including the large commercial credit charge-off were $13 million this quarter. Given current market conditions, our expectation for additional energy related losses during the remainder of 2017 remains unchanged at $27 million or less. Regarding overall asset quality, we continue to view core credit metrics as stable. And although we experienced elevated charge offs during the quarter, associated with the larger dollar commercial credits, our expectations for full-year charge-offs of 35 basis points to 50 basis points remains unchanged. Let’s move on to capital liquidity. During the quarter, we repurchased $150 million or 10.2 million shares of common stock and declared $78 million of dividends to common shareholders resulting in 80% of earnings returned to shareholders. At the same time, our capital ratios remain robust. Under Basel III, the Tier 1 capital ratio was estimated at 12.1% and the Common Equity Tier 1 ratio was estimated at 11.3%. Now on a fully phased-in basis, the Common Equity Tier 1 was estimated at 11.2%. And we were also fully compliant with the liquidity coverage ratio as of quarter-end. Finally, our liquidity position remains solid with a historically low loan and deposit ratio of 80%. So in terms of our expectations for the remainder of 2017, with respect to loan growth, several risk management decisions impacted our first quarter average balances, including declines in energy, multi-family, and third-party indirect vehicle portfolios, as well as a strategic affordable housing mortgage loan sale in the fourth quarter of last year. Excluding these decisions, we would have reported average loan growth of approximately $200 million for the quarter. So looking ahead, we expect to modestly grow average loans on a sequential linked-quarter basis throughout the rest of 2017, and on an ending basis we expect to grow loans approximately 2% for the remainder of the year. Excluding the impact of our third-party indirect vehicle portfolio, we now expect full-year average loans to be approximately flat with the prior year. Regarding deposits, we now expect full-year average balances to be relatively stable with the prior year as continued consumer deposit growth is expected to offset the strategic reduction of certain collateralized and broker deposits. In spite of the revision to average loan growth, the improvement in market interest rates allows us to revise expectations for net interest income and other financing income growth upwards to 3% to 5%. Regarding non-interest income growth, due to a weaker start to 2017, we are revising downward our expectation for adjusted non-interest income growth to 1% to 3%. Total adjusted non-interest expenses in 2017 are still expected to increase between 0% and 1% and we remain committed to achieving a full-year adjusted efficiency ratio of approximately 62% with positive adjusted operating leverage in the 2% to 4% range. Additionally, we expect to continue to expect a full-year effective tax rate in the 30% to 32% range and expectations for full-year net charge-offs remain in the 35 basis point to 50 basis point range. So in summary, while there are several puts and takes this quarter, it is important to point out that our total revenue growth expenses efficiency and operating leverage expectations remain essentially unchanged despite lower balance sheet growth assumptions as we continue to focus on profitability and returns. With that, we thank you for your time and attention this morning, and I’ll turn it back over to Dana for instructions on the Q&A portion of the call.

Thank you, David. [Operator Instructions] We will now open the line for your questions.

Thank you. [Operator Instructions] Your first question comes from Ken Usdin of Jefferies.

Good morning.

Thanks, good morning. Hi David, I was just wondering when you talk about your NIM expectations for the second quarter, can you talk a little bit about the betas that you are expecting underneath that and the impact from premium am that you’d expect to kind of hope as that lags forward as well?

Sure. We believe that we are going to continue to have some benefit from premium amortization coming in a little lower. We were down about $5 million this quarter and expect that to continue to drift down until we get to that $30 million range where we think it stabilizes. As we think about NIM expectations and betas, we have baked in or beginning beta at about 40%, so there is a little upside opportunity. Our beta thus far has been less than 10% in both and vast majority of that was driven by the index deposits that we talked about, about 6% of interest-bearing deposit. So, if our beta comes in, a little better than we forecast, maybe we can outperform, we do have kind of baked in, so the remainder of the year about hike and half baked in for this year with that 40% beta in our guidance that we have just given you. So, if we get rate increases quicker, if we get a steepening in the yield curve, those would benefit us above the guidance that we have given you.

Okay, great. And then just as a follow-up to that, so given that you have been in part purposely reducing some of the auto loans and you still haven't seen this year re-loan run-off, how much of keeping a low beta is just the fact that loan growth is somewhat purposely quiet for you guys, and so just in terms of that push and pull between behavioral out there versus your need for excess deposits given that the balance sheets remain pretty stable?

We've had historically one of the lowest loan deposit ratios and it really speaks to our ability to attract low-cost deposit, our retail franchise, and the stickiness of our deposit base. What we have done is, we clearly want all the good low-cost deposits we can get. We would like to have a more robust demand for loan growth, but we're not going to force it, we’re going to take what the market is going to give us, and we have made some strategic choices in terms of where we want to grow loans and we have looked at different categories that I have mentioned and Grayson has mentioned to be very careful. So, we clearly have the funding to the extent that the economy fixes up in the second half of the year, which we hope and expect, but we have good core funding that can take advantage of those opportunities, and we think we will keep our deposit beta down partly because of loan deposit ratio, partly because of our [indiscernible] deposit make up in the less sensitivity of our deposit franchise to price increases, which is why we think we can have expanding margin continuing.

Well we’ve had very stable loan deposits even though behind the scenes we’ve really been changing the composition of our deposit base quite materially. Every quarter, the composition of our deposit base has gotten more favorable. And to David's point, we’ve made a lot of tactical and several strategic decisions about how we build that composition of deposits, and so I think it puts us in a very unique position as we go forward. To David's point, we don't have the loan demand we would love to have today that does take an awful lot of pressure off of deposit pricing, so we could be more thoughtful and disciplined in that regard, but really the composition of our deposit base is probably the most compelling argument for how we will perform.

Understood, thanks.

Your next question comes from Peter Winter of Wedbush Securities.

Hi, good morning.

Good morning.

I was just wondering on the fee income, if I look at fee income, last year it was very strong and I’m just wondering, can you talk about some of the puts and takes of the weaker guidance this year?

Yes, thanks Peter. So from an NIR standpoint, we have made a lot of investments over the years. Last year, a lot of those were coming to fruition from the investments we made the year before, so the growth rate was necessarily going to be higher last year and even our guidance in the beginning of the year was lower because of that phenomenon. Clearly, some of the businesses that we’ve gotten into have more volatility than other streams and we are okay with that because we are seeking the diversification, that’s important to us and we are also seeking to have those products and services that fulfill the need of a customer. In this particular quarter, our capital markets showed a little bit of volatility to the downside, in particular on our M&A advisory service, which we believe will grow from here, it just takes time, the pipeline to get emptied out. It takes time to rebuild those. So, we feel comfortable with that. I would say in the fixed income space, March was a much better month than January and February was. There was more activity there and so we expect that to continue to grow. We are really proud of our folks in mortgage, obviously the first quarter is seasonally low, but done a great job because of being a purchase shop there, and a strength of roughly $8 billion of mortgage servicing we bought last year coming through. They just do a great job in low-cost servicing and we're proud of that growth. So that checking account growth and customer growth have really helped us to bolster NIR. So, we did revise guidance down, but feel very good about where we are and we think it will pick up. We guided that this was the low watermark for the year.

Okay, and just a quick follow-up. On the 10-year treasury, in the expectation page, you are showing the 10-year treasury at 2.48, 10-year treasury right now is lower, if it continues to move lower, would that put pressure on the net interest income to come in more towards the lower end of your range?

Clearly, if you stayed here or kept going lower, you would ultimately have some pressure in terms of prepayments coming in and premium amortization not declining at the pace that I’ve mentioned. We think we are well-positioned, we have about 40% of our sensitivity on the backhand. We believe we are well positioned in particular as the Fed's balance sheet comes under scrutiny towards the end of the year, and we just think there is going to be ultimately upward pressure, but we still think our guidance is, we had enough confidence to give an increase in the guidance that we just shared with you.

Great. Thanks very much.

Your next question comes from Marty Mosby of Vining Sparks.

Good morning Marty.

Good morning. Got more of a long-term strategic kind of question, on Slide 10 you look about your capital liquidity kind of ratios, you are more than fully compliant with any regulatory requirement that you have, capital ratios continue to ebb up, and your loan to deposit ratio continues to go down, is there a chance in the future strategically to address these accesses that are on your balance sheet that need to be deployed to get your returns higher?

Marty, this is a great question. I will start with capital and come back to liquidity. From a capital standpoint, we clearly have given the Street, our guidance that we believe our common equity Tier 1 ratio target of 9.5% is right for us based on the risk in our balance sheet today. We know to get it to 9.5%, you have to get it deployed appropriately. We seek to do that through organic loan growth properly priced with the proper returns on it. We then deploy that capital into bolt-on acquisitions and you have seen a number of acquisitions over the years, including the mortgage servicing right deal that we did last year, a series of deals and the one we are going to close at the end of this month. And we also want to have an appropriate dividend to pay to our shareholders. And then outside of that to the extent we continue to [indiscernible] capital we are going to work our capital ratios down returning it to our shareholders. Last year we returned to 105% of our earnings to our shareholders. We can't tell you what our CCAR request is this year, but given what I just said, one would expect a fairly robust return to our shareholders this year and that over time is important to us to get towards to that 9.5% because we still are expecting to have a return on tangible common in 2018 between 12% and 14%. In order to do that, we have to get the denominator down to that approaching 9.5%. So that’s capital. From a loan and deposit standpoint, we would like to have a loan deposit ratio perhaps in that low [indiscernible] range will be a sweet spot. And we're working hard to grow loans, but we are going to force it as I mentioned earlier. We are going to grow loans, when we have the opportunity to do that and calling efforts are ongoing and also on the deposit side we’ve looked at certain deposits that either were punitive and LCR or they weren’t providing liquidity such as collateralized deposit where we might not have had a full relationship and we are letting those deposits go. So that’s why if you just look at the deposit growth you would see it declining in part. Those are strategic choices that we are making to [indiscernible] those deposits that really don't benefit provide much benefit to us.

My worry is that in what we are seeing is growing market mortgage servicing which is low return business, when you are just looking at allocating to it, capital, when you have capital there and you put it on it generates better returns because you are just utilizing excess capital, you are also, over the last two credit cycles, the large dollar corporate is what kind of jumped out and we're seeing that again this quarter and when you think about organically in your markets given the appropriate pricing and credit underwriting you have there is a real catch between being able to organically build or fill these buckets and really being able to eventually get a lot of this trapped capital and then utilize some of those liquidity and pushing that back to the shareholders. So, I know it is a struggle, but some of these decisions that are being forced upon you because of the situation you are in are causing some of these events or things or decisions to be made that may be affecting things differently down the road.

Well they are Marty, again, we know it is harder today in a competitive environment to grow the kind of loans that we want to grow, but this is when it requires discipline and we're going to say disciplined regards to capital allocation to organic growth. And as I mentioned, some of the choices we have made outside of those, we actually are growing. So we are seeing opportunities to put the capital to work and frankly, we don't have the qualitative aspects of CCAR and we don't have much capital we need to have to run our business, so we do have an avenue to deal with that access common equity more specifically in returning it to shareholders that we didn't have before. So, in time we can get the capital base to the right level.

Marty, this is Grayson. I mean to David's point, we have got to take the market for what it is and take advantage where opportunities present themselves, but the operating environment has got some challenges, this has also got tremendous upside if some things go the way we owe. That being said, we’ve been very rigorous and very disciplined about how we are managing our balance sheet. We think we have made tremendous progress on both loans and deposits in terms of how we have built our balance sheet over the last several quarters. We are trying to take advantage of what the market will give us, but not to force it, and we do think that in this sort of slow growth low rate environment that we have to be thoughtful about it. That being said, we are seeing a lot of optimism on the part of our business customers, it’s encouraging, but it has not yet resulted in the kind of demand for bank credit that we would like to see. That being said, tremendous amount of liquidity in the market and we have seen a lot of our customers access public debt markets, and so we do think over time that bank credit demand become stronger. I will ask John Turner to speak to that for just a moment to give you a better perspective of what we are seeing in customers and markets.

Thanks Grayson. As we talked about before, our customers are clearly more optimistic, I would say not confident, they are cautious. We are seeing a little improvement in our pipeline, I would say our pipelines are growing a bit. They are okay relative to where we would like them to be. When we look back on and we talk about choices we’ve made and the impact that that has had on us, our objective is to create a more predictable, more sustainable, more consistent revenue base and performance, and we’ve been very focused on de-risking on risk-adjusted returns. So if I look at our lost business or the opportunities that we had to grow, in 2016 we looked at over $44 billion in credit, we've won about $14 billion or roughly a third that means that of the $28 billion that we didn't win over half of that was because we were not satisfied with the pricing or some other structural element. That same momentum or same sort of paradigm has continued into 2017. We have looked at over $10 billion in credit through the first quarter, we have won a little over a third and as a business we didn't win again about 55% of that was a result of pricing or returns or some other structural element. Point being, we could change our risk appetite and grow loans, but we are very committed to creating a culture that is focused on risk adjustment returns and that we will create more predictability, more consistency, and I think that’s going to pay off in the long run.

Thank you, John.

Thanks. Those are tough decisions and I know you are working through them.

Your next question comes from Jennifer Demba of SunTrust.

Good morning.

Thank you. Just curious about, I know you guys have a small commercial real estate portfolio and retail and shopping centers, I just wonder if you could give us some details around that composition as it stands as of now?

I will ask Barbara Godin our Chief Credit Officer to respond to that question please.

Good morning, Jennifer. Thank you, Grayson. Yes, we currently have roughly $2.6 billion in our commercial real estate retail. Another comment though, just general comment on the retail sector is what we're seeing is in retail where they have very good shopping centers, very well placed, there is hardly any vacancy rate and then in others there is just a kind of vacancy rates where you are not appropriately placed, but we're working that sector very closely, we still feel okay about that sector, the bankruptcies that we have heard about and the issues we have heard about in that area. We have an applied market research group that actually spends a ton of their time looking at retail and retail shopping centers. Those bankruptcies were not unexpected. In general, we weren't involved in any of those. And again, a lot of those chains that closed were because they were poorly placed.

Grayson I just might add to that. Jennifer this is John Turner. Of the 2.6 billion exposure, roughly $1.5 billion in outstandings I should say, is in our REIT portfolio where we largely are doing business with a small number of investment grade names. The balance or just about $1 billion is in our income property finance group and that outstanding level has been fairly consistent now for four five quarters. That exposure is fairly widely distributed. The largest, I guess tenant would be grocery anchored and most of it is basic needs kind of anchors. And so while we have a little mall exposure in the REIT book and less in income property finance, let’s say generally it is a very diversified portfolio and one we feel pretty good about. On the commercial side, and we also have a nice size retail book that portfolio again is very diverse, our largest asset class is to automotive retailers. So think of companies like [indiscernible] something like that, and largely administered through our asset based lending or Regions business capital platform.

Thank you.

Or would you see this area has something you would want to reduce over time or just kind of watching it for a while here?

We are watching it again. We have concentration limits on everything. It is nowhere near its concentration limit on these two pieces, so we feel fine of that.

Thank you.

Your next question comes from Ryan Nash of Goldman Sachs.

Hi good afternoon guys. I wanted to follow-up on a question that Marty had asked just regarding delivering the 12% to 14% RTCE, David you talked about you need to get towards the 9.5% CET1, do you think you could, given what’s happening with the balance sheet, do you think you can get there organically with loan growth and capital return or do you think we would need to see some strategic activity over the next two years in order to manage their capital base down?

Ryan, it’s a great question. So, we can approach that 9.5%. We can't quite get to 9.5% by 2018, right after that, shortly after that we can, but we will approach it close enough to help us get to that 12% to 14% return and we will do that through primarily focusing on those two things. Organic growth and some bolt-on acquisitions that have been fairly small today. And capital returns to the shareholders.

Got it. Grayson if I can ask a bigger picture question, you know the bank has done a lot over the last few years to improve its credibility with the investor community, you guys did a great job delivering last year, when I look at today we are obviously making some changes to the outlook, while NII is better, that’s obviously rate driven, so it’s not necessarily client driven and I take the point that you guys are doing this with the mind on return, so if loans are shrinking fees are coming in lower, was there any thought towards taking another crack at expenses, I know you are cutting 400 million or at least saying given the slightly weaker top line outlook, we are going to hold expenses flat or maybe even flat to up modestly down?

I mean, great question. And I would tell you that as we look at the first quarter, first quarter loan demand was softer and we had anticipated it would be couple of quarters ago and so we’ve had to adjust our thinking to a little bit slower loan growth environment. We’ve never really tempered our focus on expense management. We’ve stayed dedicated to that throughout this process and continue to do so. We took a very aggressive stands on expenses and have delivered on that. You should expect to continue to see our results on that issue. From a sustainability standpoint, we do have to find where we used to grow long term, but until those opportunities come about then we have to continue to stay focused on being as efficient as possible from an expense standpoint and so you should not see us back down from that at all.

Thanks for taking my questions.

Your next question comes from Steve Marsh of FBR.

Good morning.

Good morning. Following up on expenses, I was just wondering here, you had another good quarter with regard to total expenses, does your guidance here not go into the low-end reflect continued investment or other factors in terms of expectations around improved business activity later on the year?

I mean we will focus on interest expenses. We do at this point in time anticipate stronger growth opportunities in the second half of the year then we had seen in the first quarter and so, that’s just a prudent position we have taken and I think that if that group growth doesn't, occur then obviously we have other decisions to make. David you want to add to that?

Yes, I think that we have built into our kind of inflation run rate on expenses in the 2.5% range and so if you take that, if you take the investments we will want to make, need to make and have made relative to diversifying our revenue stream we have to overcome that by having other expense eliminations elsewhere. And so we put our $400 million program together and I think we have done a really good job in there. Our efficiency ratio target is intact of 62% this year, and 18 we will be in that 60% range, and so I don't think that when you deliver to 2% GDP type environment that you can take your eye off the expense ball whatsoever. And we didn't change, kind of went through all the changes and guidance, you also know the things that didn't change, which was our commitment to generating parts of operating leverage in that 2% to 4%. So, everything is in check, but we can always continue to work even harder on expense management and we will, each and every day we work hard on.

Okay. And then my second question with regard to the three large credit stake, you experienced charge-offs and what industries where they in?

Yes, this is Barbara again. One of them was in healthcare, one was in oilfield services in the energy sector and the third was an educational services, but you will see it show up in our commercial real estate owner occupied because it was secured by the real estate and those three made up to $39 million.

Okay, thank you very much.

Your next question comes from John Pancari of Evercore ISI.

Good morning John.

Good morning. Also on the credit front regarding the trends, I know you indicated the inflows into MPLs in the quarter they were also commercial related, are they similar sectors or are they related to those charge-offs you just flagged, the healthcare and educational services and OFS?

They are.

Okay.

And again having said that, I would just stay on credit in general though I would want to reemphasize we are very comfortable where we are in our credit numbers, our credit metrics, where credit is going, even those three large credit charge-offs that we had, generally not unexpected, generally they were provided for, it was simply a matter of timing as the resolve themselves in the first quarter and we want to hit and charge them on.

Okay, so despite the fact that MPLs were flat, I mean I hear you that you feel good about it, but I guess what I’m worried about is that, I know you didn't change your charge of guidance of 30 bips to 50 bips despite coming into that 50 because of those items this quarter, is the risk to that 30 bips to 50 bips is going higher?

No, I don't feel that there is a risk there. Again, I feel fine about it. I think about our non-performing loan portfolio. In total, including our small credits all the way up to our large ones in the business services book. We have 73% of them are paying current and as agreed and 98% of those that are in our CNI and CRE owner occupied area are also paying current and as agreed. So, again I hate to position it as a good quality non-performing book, but we do see a lot of upside opportunities that those can and will return to accruing basis at some point.

Okay, thanks Barb and then separately, on the expense side, I heard what you said about the not re-uping your expense program or anything, but in light of everything going on, what would you call your normalized efficiency ratio once we get a little bit more about way of higher rates and maybe a bit of improvement in loan growth?

Yes, it is a great question John. So, what we have said is that we would get to that 60% range in 2018. I do think over time if you can get normalized rates whatever that might mean to everybody that were you having a margin in that 350 range that perhaps you can be in that mid upper 50s over time, I think our industry is going to have to become more efficient, I think we will, I think we will leverage technology better in the future than we do today, but it is going to take some time to get there and so you should see us continue to march down. Let’s get to 60 and then we will give you better guidance as to where that might end up post that.

And David one more thing, sorry, with that 60%, how much by the way of hikes does that require?

We have baked in 1.5 this year and the 2 the year after that through 2018. That’s what our number is.

And therefore getting to that 60% by the end of 2018?

Say that again John.

And therefore getting to that 60% level by the end of 2018?

That's right.

All right. Got it. Thanks David.

Really for the year of 2018, John.

Okay. Thanks.

Your next question comes from Saul Martinez of UBS.

Hi thanks for taking my questions. Couple more on capital, just to follow-up, first is more of a clarification and sorry if I missed this in response to an earlier question, but David I think you mentioned that you can get to 9.5% CET1 by 2018 or close to it organically, is that correct, is that by year-end 2018, is that for 2018 CCAR cycle, just want to make sure I understood the specific guidance you gave there?

So, we said we could approach 9.5% by the end of 2018 through organic growth and capital return to shareholders and some bolt-on acquisitions, not large ones, but some bolt-on non-bank type acquisitions during that same period of time.

Okay got it. And then just following up on your acquisition strategy, your thought process I should say on acquisitions and M&A, can you just give us a little bit more color, I think obviously up until now it has been bolt-on acquisitions, it’s been focused on fee-based businesses, but could that or under what conditions would that change and would you start to think about perhaps more sizable deals and doing bank M&A?

Right now we have been for the last several quarters, primarily focused on organic growth and augmenting that with a limited number of, what we would call bolt-on acquisitions. Those acquisitions have largely been in the capital markets group, also and well planned, in particular insurance, and also in our mortgage business. You should expect us to continue to look for those opportunities to make investments, these are not large investments, but they are investments that are accretive to our earnings, and we think they have been good in terms of expanding our product line, leveraging our strengths to serve our customers. And so you just continue to see that occurred. And when it comes to bank acquisitions, we still actively look at opportunities and review those. Quite frankly the economics around those today are particularly challenging given where regional bank stocks trade in relationship to the smaller institutions and sellers if you would. The economics that the market is giving us, they are not particularly compelling, so we have not spent an awful lot of time looking it there. I think at any acquisition we do, it has to be both strategic and economic, and at this point in time we have not seen that as a particularly productive thing for us to be heavily focused on. That being said, we make sure that we are mindful on what’s going on in the market. Right now, our focus is on organic growth and on limited bolt-on acquisitions.

Okay, is it fair to say that if relative valuations between smaller banks or potential acquires and larger banks were to narrow that on the margin that would make you a bit more have to consider bank M&A?

If the relative multiples were to come closer together than the attractiveness of that as an acquisition strategy improves. [Indiscernible].

Alright, great. Thanks a lot.

Your next question comes from John McDonald of Bernstein.

Hi John.

Hi good morning. Just following up on two other questions, on credit Barb with the reserves ex energy at around 135, do you think there is more room for reserve release this year or do you - you probably going to more match the charge-offs going forward?

Well we're back to our [indiscernible] of, we don't predict what the results are going to be, what we do is we have a very disciplined process, 135 is on the higher end, so there could be some room for improvement, but I wouldn’t want to enter a guess as to what that might be.

Okay. David regarding the branch reductions what are your thoughts on longer term potential for more branch consolidations post the 150 expected by the end of this year?

So, we have got more - limited more branches post crisis than any other bank. We continue to do that like any retail franchise you should expect to have some consolidations and some new investments as we have new branch designs that are going in. We haven't had a lot of new branches go in off late, but we need to bolster our retail network presence in some places and so you should expect us to do both, consolidate, as well as to add, you know, after we get finished with this series we will come back with better guidance, but we don't see any large branch consolidations at this particular time, but continue to challenge ourselves in terms of what the retail network franchise needs to look like.

Okay that's helpful. And then and one just quick follow-up on the net interest margin, near-term David, how relying is the near-term expectation of that 3 basis point to 5 basis point increase for the second quarter, on the 10-year being at a certain level whether it is the 248 or whatever you are assuming?

It’s not all that meaningful in the near term, I think we can, we have given you, we feel pretty confident in that range, clear for the next quarter.

Okay, thank you.

Your next question comes from Michael Rose of Raymond James.

Good morning.

My questions were actually just asked. So thanks guys, appreciate it.

Thank you.

Your next question comes from Matt Burnell of Wells Fargo Securities.

Hi, Matt.

Good morning, Grayson. Thanks for taking my question. David, good afternoon to you. Just couple of days quickies, one, on the mortgage side of things that held up pretty well year-over-year and I think that has a lot to do with the purchase focus. as well as some of your MSR acquisitions, but a couple of your competitors have suggested that they are reducing the acceptable level of the spreads of new production to hopefully drive some better purchase volume, and I’m curious if that is anything that you all have considered, I presume giving your earlier comment, the answer is no, but I am just wondering if you are seeing any evidence of that and if you are doing it yourself?

No, we haven't done anything really to go out there and try to spur growth using rates, being historically a purchase shop using our own mortgage loan originators versus third parties had been one of the reasons why we have outperformed historically. If you look at our change in yields on raising mortgage, we were down 1 basis point over the quarter, so we think we can have an appropriate growth. This first quarter production was nice. Clearly gets challenged as rates go up, I think being a purchase shop is really beneficial to us.

First quarter is seasonally a soft quarter for us on mortgage originations, but the team did a very good job and rarely outperformed same quarter last year and so we’ve got fairly strong confidence going into the second quarter on production. About a third of our mortgage originations come from referrals out of our own branches and so to David's point the mortgage originators were all on our team and they are working closely with our branch offices, the strong referral process across the two. We had about 70% purchased 30% refinance in the first quarter. We see those numbers shifting even stronger and the early days of the second quarter, so we think repurchase is going to be very strong in the second quarter.

And then David if I could follow-up with a question in the realm of no good deed goes unpunished, we’ve now had three rate hikes and I guess I’m just curious, when do you think you start thinking about potentially reducing your rate sensitivity, just in terms of trying, just to reduce the concern about rates going back down?

Yes, that is a constant challenge for us. We think that when the market gives as our kind of returns that we want to have in our business that we would take that sensitivity down. We are not there today. We need to be and continue to be asset sensitive is important to us. So we went up 100s and still in that $150 million range. So we have done some things to protect us on a down rate perspective. We had taken some of the sensitivity off a few quarters ago, by booking some - receive fixed swaps. I think we are in pretty good shape today to let our sensitivity run. In part, it is really the benefit we get from our deposit base. That is so critical to us to keep that in mind as we think about our ability to continue to grow NII and resulting margin is that core sticky customer deposit base is not as price sensitive as others. And I think right now given what we think rate increases were going, there will come a point in time we have to start paying up for deposits. We get delivered, the kind of spread and margin we want and gets our return to where we need to be, and we can take our sensitivity to more of a neutral state at that time.

Thanks for taking my question.

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

Good afternoon Matt.

Hi guys. I just want to follow-up on the fee revenue side, the last couple of years you have been investing in a number of the businesses, couple acquisitions, modest, but a couple of deals, you know it feels like the outlook for the fees is somewhat tempered, somewhat modest and I know there are still some drag in the service charges, but I guess it was kind of like all in, how are you measuring the investments and the performance of those investments and I guess the real question is, do you want to keep trying to build out the fee businesses when maybe you haven't gotten as much momentum from what you have done so for.

Matt it is a great question. I do think that’s a challenge for us. Any time we make an acquisition and purchase something to understand what that alternative return is, I will tell you we are ahead of the game on most of our acquisitions that we have had over time. And I think that we do realize there is some volatility. So in the given quarter you can’t look at one of these transactions and give up on it. We continue to challenge ourselves, we know some of these aren’t as efficient and some of the businesses that we have, but they are synergistic. They offer a service or product to our customers and our customers need and will pay for. So you have to look at the whole relationship profitability and not just cherry pick one product at a time. That being said, we have expectations on capital returns for our businesses and if those businesses can't get the returns that we need to have, the product or the business is not synergistic to our customer base, then we will make different decisions, but right now we feel very good about what we’ve added over time and frankly we are looking for other opportunities to continue to grow.

And you did mention the mortgage servicing acquisition, but cross the other fees categories, investments, capital markets, insurance any preference there or does depend on what’s available and how might it fit with you guys?

Well the reason we are doing, the mortgage servicing rights acquisition are for couple of reasons. The primary one is, we're very good at it. We have a group folks that work in South Mississippi that are very talented. They have been doing this for a long time. We didn't get into trouble like others did during the crisis because of their expertise. We also have capacity. We could add about right at $10 billion of servicing in round numbers without changing our fixed cost infrastructure. And so we want to take advantage of that and continue to grow that portfolio. So being a low cost servicer I think is beneficial to us, and one area that we do have the opportunity to grow and get deals presented to us, periodically, some we turn down and some we take. So, I wouldn't put any particular category that we would want to grow in NII, if I had to point one card in ATM fees, card fees in particular through interchange, our credit card growth has been very nice, up about 10% last year. And that is a good product, one of our best products in terms of return because it gives us interchange, it gives us carry, it gives us a hook into our customers, very synergistic with our business model. And so we would like to have more cards and so getting our penetration rate up from 18.6%, that’s the penetration into our deposit base. Hitting that up in the mid-20% range is really important to us and teams got that focus and I expect to get there in time.

Well I just remind everyone we have been very aggressive on branch rationalization, branch consolidation and at the same time we have been able to accomplish that and still grow accounts, grow households, deliver and get recognized for very good customers, and all of that fosters some real good fundamental execution, own our plans and at the end of the day most of the growth on our balance sheet and on our income statement is going to come from really increasing in number of customers that we have banking with us and making sure we are meeting as many of their needs that they value is possible. And so we’ve really done a good job even in the face of brand consolidation we have done a good job of growing our business across all of our consumer account segments.

Okay thank you.

Your next question comes from Kevin Barker of Piper Jaffray.

Good morning.

Good afternoon rather.

Good afternoon. You mentioned that you anticipate stronger growth in the back half of this year, is that primarily due to the small business optimism that you are hearing right now, given the outlook for lower regulation and changes from the administration or is it primarily just because of other factors that are developing or a stronger pipeline?

I mean, I think one, when we looked at the second half of the year, we are encouraged by the optimism, but we are not trying to factor that and too much into our forecast and our plans, but when we look at how the first quarter has performed economically across communities we operate in, we think first quarter was somewhat soft and so we do think and believe that the economic metrics we are following and the sentiment of our customers all sort of point to a stronger second half of the year. Now we are not fully counting all of that. We are trying to make sure that we are taking a very disciplined and thoughtful approach to it, but all of our metrics indications would tend to favor more upside in the second half.

Okay and then just to follow up on some of the comments around capital return, obviously CCAR and stress test are changing significantly this time around, do you expect that you peer group to be a lot more aggressive this year in returning capital or do you think it could be relative muted given last year?

Your guess is as good as mine. I can’t really comment on what others are going to do. I see what others have written about our peers, but I can tell you from our standpoint what is incumbent upon all of us to ensure we have an appropriate amount of cap for the risk that we have and I think most people have more common equity than they need at this point. The question is how do each of us plan to deploy, we have our plan as we just discuss. So, I think for us it is a robust, should be a robust return and we will discuss that at our next call.

Surely not appropriate for us to comment on what others might or might not do.

Okay, thank you for taking my questions.

Your next question comes from Gerard Cassidy of RBC.

Thank you. Good afternoon Grayson. Maybe you guys can share with us, earlier you had talked about the underwriting and the loan opportunities that you guys see in the small business area and you are missing out on some of the opportunities due to pricing and then the structure of the loans, so can you guys share with us what are some of the structures that you are seeing that really you are not comfortable with whether it is on a real estate loan to value or possible debt service and how do those underwritings tend to compare to maybe a year or ago?

Gerard this is John Turner. I would just maybe Barb can help me too, but I would say we are seeing more competitive pricing, we are seeing longer tender, we are seeing higher loan to values with respect to real estate, particularly the owner occupied real estate sector. We are seeing appetite for more leverage than we might be willing to accept. Less guarantee, sometimes no guarantee, where we think a guarantee is appropriate, all those would be factors that are impacting a loan growth in our view. I don’t know that it has changed a lot, although I would say since 2015. So over the last five quarters we think there has been less activity and so more competition for the opportunities we see and I would guess that it has - competition has impacted the marketplace for sure.

Gerard the only other one I would throw in, a lot of pressure around coming in late structures throughout in the market right now.

Okay, is it coming from smaller community banks or other regional banks or of some of the big for bank, the universal banks?

Yes.

The competition that is? Everyone.

I mean I think it depends on the opportunity and the market, the customer, and how that customer proceeds in a marketplace, it varies, but I would say a competition is competition and we see it from time to time from everybody and somebody would probably say the same thing about us at some level. We certainly want to protect relationships that we have, finding it more difficult to win new business in our existing markets.

Great and then just to pivot a bit, obviously you guys have done a very good job in reducing the branch count, can you give us some color, I don't know if you have any statistics at your fingertips about the mobile usage, how many of your customers use the mobile channel, what percentage of your deposits might be coming through the mobile channel and things like that?

I will ask John Owen, Head of General Banking to respond to that question.

When we look at the digital space we could see pretty rapid growth on our mobile usage, we have got about 2.3 million digital users today. That number has been growing double digits over the last couple of years. We'll see that continue. From a deposit standpoint, about 30% of our deposits go through digital channels.

Great, thank you.

Your final question comes from Christopher Marinac of FIG Partners.

Thanks for taking my question. Barb can you delve into the CNI trends in terms of credit quality, just saw small changes on the non-accruals as well as the performing TDRs and just wanted to compare that on the non-energy side, I thought that the criticize on energy were up slightly, just curious if there is a trend there or anything you can delve into?

Really is in a trend again as I look at what has gone into our issues about non-accrual, this quarter we had credit in transportation warehousing, we had a couple in energy, we had a couple in healthcare, we had one in AG, so no real trends that we are seeing and when I look at each one and read the stories on each one, again there is nothing that’s underlying that connects any of them, they were individual circumstances, you know, when one takes, when somebody died we're waiting for the stage to settle as an example. Those kinds are same. So across the board in general for all of the other sectors doing pretty well, remember we thought energy, but what we don't give a lot of detail of it because it is spread everywhere else is those industries that also support energy. So, one of the transportation of warehousing credits I'm looking at that when in this quarter is to support the energy sector as an example. And I can point to a couple of others that have tangential relationships to the energy sector as well. But broad-based again feel good about where our credit numbers are, feel good that we will add up between that 35 to 50 basis points this year. And on the one credit charge of that we take there was one this quarter that was a larger one, but actually the charge of happened on a Saturday, it was April 1, the quarter that ended and we knew the right thing that the right thing to do was to take this quarter instead of moving it into the second quarter and that was a $22 million charge. Again causing us to show more elevated charge-offs and perhaps the other ways [indiscernible] to the quarter, but again it was the right thing to do.

Okay, got it. Thank you for the color and just a quick follow-up, if we take the remaining energy losses out of those sort of guidance range will it be closer to the 35 and if we just excluded energy on a calculation?

If you excluded the energy it would be again somewhere between, I'm still going to see 35 to 45 port probably recognizing that our business mix has changed, you know as we recall we talk about some businesses we are doing in our cost consumer book that we weren't doing previously. They were all great businesses they are doing well. If you look at what they are providing us from a revenue perspective they are hitting on their mark, but again they are going to provide some higher losses that are going to come into that 35 to 50 basis point range, but they otherwise didn't in prior periods.

Okay, great. Thank you so much.

Thank you. I will turn the call back over to Mr. Hall for closing remarks.

Well thank you for your participation. We appreciate the opportunity to tell the Regions story and we will stand adjourned. Thank you.

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