Regions Financial Corporation (RF) Q2 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’ second quarter 2017 earnings conference call. Grayson Hall, our Chief Executive Officer will review highlights of our second quarter year-over-year financial performance; and David Turner, our Chief Financial Officer, will take you through the details compared to the prior quarter. Other members of the 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’ll 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. Good morning and thank you for joining our call today. Let me begin by saying that, we’re pleased with our second quarter results, which demonstrate that we are continuing to execute our strategic plan with a long-term sustainable growth, while delivering value to our customers, communities and shareholders. For the quarter, earnings available to common shareholders from continuing operations increased 18% to $301 million, and earnings per share increased 25% to $0.25 compared to the second quarter of 2016. Importantly by expanding our customer base, we delivered results in areas we believe are fundamental to future income generation. This is evidenced by growth in checking accounts, households, credit cards, and wealth manager relationships, as well as total assets under management. We continue to benefit from our asset sensitive balance sheet, as interest rate increases drove a 4% increase and net interest income year-over-year, and the resulting net interest margin increased 17 basis points. Expenses remain well controlled with adjusted non-interest expenses increasing 1% year-over-year, as our efficiency efforts continue to mitigate core expense inflation and the impact of investments in new initiatives. As it relates to our loan portfolio, we remain focused on our deliberate and intentional diversification strategy, while we also seek to achieve appropriate risk adjusted returns. We are experiencing success with our remixing efforts. For example, we were early movers to reduce exposure in certain asset classes, including auto and multifamily lending. While our customers remain optimistic, many still do not have the confidence necessary to make meaningful investments and take on additional debt. That said, we are seeing some positive signs. For example, we experienced solid loan production increases across most loan portfolios during the second quarter, and we fully expect this momentum to continue through the second-half of the year. In the near-term, our interest rate sensitivity profile continues to position us well to grow net interest income even in the absence of meaningful loan growth aided in part by the strength of our deposit franchise. With respect to asset quality, our discipline approach to credit continues to deliver positive results, as we reported improvements in almost every credit metric. We continue to characterize overall credit quality stable. However, volatility from quarter-to-quarter and certain credit metrics can be expected, especially as it relates to large dollar commercial credits. Turning to capital deployment, we remain committed to achieving our long-term targets. We are focused on effectively deploying our capital through organic growth, strategic investments to increase revenue or reduce ongoing expenses, while also returning an appropriate amount of capital to our shareholders. We continue to benefit from the robust capital planning process that we’ve developed over a number of years, as evidenced by our recent CCAR results, where our planned capital actions once again received no objection. As part of the capital plan, our Board has authorized the share repurchase program of up to $1.47 million of common stock beginning in the third quarter. Subject to Board approval, plan includes 29% increase in Regions quarterly common stock dividend and $0.09 per share beginning in the third quarter. During the quarter, Regions was recognized by Javelin Strategy & Research as a Trust in Banking Leader award winner, reflecting our reliability in meeting customers’ needs and the confidence our customers have in Regions to look out for their best interests. In addition, Regions also received the Gallup Great Workplace Award for the third consecutive year. These examples illustrate how Regions’ comprehensive approach to providing financial services creates greater value for all of our stakeholders. In summary, our second quarter results reflect a continued execution of our strategic plan and our commitment to our three primary initiatives: growing and diversifying; practicing disciplined expense management; and effectively deploying our capital. With that, I’ll turn it over to David to cover details of the second quarter.

Thank you, Grayson, and good morning, everyone. Let’s get started with the balance sheet and take a look at average loans. In the second quarter, average loan balances remained relatively stable at $80.1 billion. Average balances in the consumer lending portfolio totaled $31.1 billion, a decline of $87 million. Consumer production increased 22%, but this growth was offset by the company’s decision to exit the third-party arrangement within the indirect vehicle portfolio. Excluding this runoff, average consumer loans increased approximately $140 million over the first quarter. Average indirect vehicle balances declined $201 million, or 5% during the quarter. Run-off in the third-party portfolio up $224 million, was partially offset by an increase of $23 million in our dealer financial services portfolio. The third-party portfolio is expected to decline between $500 million and $600 million on a full-year average basis during 2017. Average mortgage balances increased $168 million, or 1% consistent with seasonal increases typically experienced in the second quarter. We expect mortgage production in the second-half of the year to be comparable with the first-half of the year, despite additional declines in refinancing activity. Historically, our mortgage production mix has been weighted more heavily to home purchase versus refinancing activity, and enhancements to our online home loan direct mortgage channel will continue to provide a modest increase in production. Average home equity balances decreased $131 million, or 1%. Growth in average home equity loans of $52 million was offset by a decline of $183 million in average home equity lines of credit. Further, average line utilization decreased 66 basis points compared to the first quarter. Although, home equity balances are declining, the risk profile of the portfolio has improved significantly. We eliminated the interest-only option last year and today approximately 64% of total balances are in a first lien position. We also continue to have success with our other indirect lending portfolio, which includes point-of-sale lending initiatives. This portfolio increased $64 million, or 7% linked-quarter on an average basis. In addition, at the end of the second quarter, we purchased approximately $138 million of unsecured consumer loans, which are included in our other indirect lending portfolio. And we will continue to explore additional opportunities to further expand this portfolio. Average balances in our consumer credit card portfolio remained relatively stable with the prior quarter, as the number of active cards increased approximately 2%, helping to offset a seasonal decline in outstanding balances. Turning to the business lending portfolio, average balances totaled $49 billion in the second quarter, an increase of $19 million, as growth in commercial and industrial was partially offset by declines in owner occupied commercial real estate and investor real estate construction loans. As Grayson mentioned, we experienced solid production increases during the second quarter, with commercial and investor real estate loan production increasing 56% and 35%, respectively. In addition, commercial line utilization increased 20 basis points and commitments for new loans increased approximately $700 million from the previous quarter. Growth in average commercial and industrial loans was led by new or expanded relationships in government and institutional banking, asset-based lending, financial services, and the real estate investment trust portfolios. However, this growth continues to be offset as we produce exposure in certain instances. For example, average direct energy loans decreased $67 million, or 3% during the quarter and now represent less than 2.5% of total loans outstanding. Average medical office building loans decreased $40 million, or 12%. In addition, investor real estate construction loans decreased $41 million, due in part to our ongoing efforts to better diversify production between construction and term lending. While production is improving, the declines in average owner occupied commercial real estate loans reflect the continued softness in demand and competition for middle market and small business loans. We expect to maintain the momentum experienced this quarter through the second-half of the year, with future growth driven in part by the technology and defense, financial services, power and utilities and asset-based lending portfolios. Let’s take a look at deposits. Total average deposits decreased $478 million less than 1% from the previous quarter, while average low-cost deposits decreased $335 million. Total average deposits in the Consumer segment increased $890 million, or 2% in the quarter. And this growth reflects the unique strength of our retail franchise and the overall health of the consumer. Average Corporate segment deposits decreased $581 million, or 2% during the quarter impacted by seasonal declines in public funds deposits. Average deposits in the Wealth Management segment declined $496 million, or 5%, as a result of ongoing strategic reductions of collateralized deposits. Certain institutional and corporate trust customer deposits, which require collateralization by securities continued to shift out of deposits and into other fee income-producing customer investments. Average deposits in the other segment decreased $291 million, or 8%, driven primarily by declines in average retail brokered sweep deposits. We will continue to manage and optimize our overall deposit base in the context of our balance sheet growth. Let’s take a look at the composition of our deposit base. Second quarter deposit costs remained low at 15 basis points and total funding costs were 34 basis points, illustrating our deposit advantage. As a reminder, our deposit base is more heavily weighted toward retail customers. Approximately, 74% of average interest bearing deposits and 53% of average interest free deposits are considered retail. In addition, we have a loyal customer base, as more than 44% 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. It’s for these reasons, we believe that our deposit base is a key component of our franchise value and is a competitive advantage, in particular, in a rising rate environment. So let’s look at how this impacted our results. Net interest income on a fully taxable basis was $904 million in the second quarter, an increase of $23 million, or 3% from the first quarter. The resulting net interest margin was 3.32%, an increase of 7 basis points. Both net interest margin and net interest income benefited from several factors during the quarter, including higher interest rates and favorable credit-related interest recoveries. Further, one additional day in the quarter benefited net interest income by approximately $5 million, but negatively impacted net interest margin by approximately 2 basis points. Looking forward to the third quarter, we expect continued growth in net interest income, net interest margin will be stable to up modestly, and this includes the negative impact of one additional day in the quarter and the potential need to issue debt in the near-term. Non-interest income increased $15 million, or 3% in the quarter. This included the recognition of $5 million deferred gain associated with the sale of affordable housing mortgage loans that occurred in the fourth quarter of 2016 and an operating lease impairment charge of $7 million recorded during the second quarter, compared to $5 million impairment charge recorded in the first quarter. When indications of possible impairment arise, we evaluate the current value of operating lease assets and record impairment charges when necessary. These impairment charges are recorded as reductions to other non-interest income. Adjusted non-interest income increased $9 million, or 2% in the quarter, driven primarily by increases in capital markets income and bank-owned life insurance. Capital markets income increased $6 million, or 19%, as increases in fees generated from Fannie Mae DUS real estate placements and merger and acquisition advisory services were partially offset by declines in revenues associated with debt underwriting and loan syndications. Bank-owned life insurance increased $3 million, as a result of higher claim benefits. Mortgage production increased 25% during the quarter, while mortgage income remained relatively stable within total mortgage production, 80% was related to purchase activity and 20% was related to refinancing. An increase in mortgage servicing income was offset by modest spread compression and lower hedging gain. During the quarter, we completed the purchase of rights to service $2.7 billion of mortgage loans. And including this transaction, we have purchased the rights to service more than $15 billion of mortgage loans over the past four years. And looking ahead, increased servicing income is expected to help offset the impact of lower refinancing volumes. Looking forward, we expect a pickup in capital markets revenue along with modest growth in wealth management, mortgage and card and ATM fees to contribute to overall growth in adjusted non-interest income during the second-half of the year. Let’s take a look at expenses. Total non-interest expenses increased 4% during the quarter. On an adjusted basis, expenses totaled $899 million, an increase of $27 million, or 3% compared to the first quarter. Total salaries and benefits increased $19 million and included $10 million associated with a pension settlement charge. Excluding the pension settlement charge, salaries and benefits increased $9 million, or 2% and included a full quarter’s impact of merit increases, as well as increases in production-based incentives. These increases were partially offset by lower payroll taxes and a modest decline in staffing levels. Looking ahead to the third quarter, we expect higher production-based incentives commensurate with revenue growth. However, we expect total salaries and benefits to decline as pension and settlement charges are not expected to repeat at this level. Professional and legal expenses increased $6 million during the quarter, primarily due to an increase in legal settlement expense. Furniture and equipment expense increased $5 million, primarily associated with capital investment projects, including an enhanced online banking platform and other technology initiatives. As these are now included in our run rate, we expect furniture and equipment expense to remain approximately this level for the remainder of the year. The second quarter adjusted efficiency ratio increased 50 basis points to 63.2% and includes the impact of the pension settlement and operating lease impairment charges. These charges negatively impacted the adjusted efficiency ratio by 100 basis points during the quarter. And despite the negative impact of these charges, we continue to expect the full-year adjusted efficiency ratio to be approximately 62%. With respect to taxes, the effective tax rate improved 90 basis points in the quarter to 29.5%. Now shifting to asset quality, net charge-offs totaled $68 million in the second quarter, a 32% improvement over the first quarter and represented 34 basis points of average loans. The provision for loan losses was $20 million less than net charge-offs. A reduction in non-performing and criticized loans resulted in an allowance for loan and lease losses decline of 3 basis points to 1.3% of total loans outstanding. The allowance for loan and lease losses associated with the direct energy loan portfolio increased to 6.9% in the quarter, compared to 6.1% in the first quarter, reflecting a specific reserve increase related to one oilfield service credit. Total non-accrual loans, excluding loans held for sale decreased $181 million, or 18% to 1.03% of loans outstanding, driven by broad-based improvement in commercial loans. Total business services criticized loans decreased 7% and total delinquencies decreased 5%. The improvement in criticized loans was primarily due to declines in energy and transportation and warehousing loans. The allowance for loan losses as a percentage of total non-accrual loans, or coverage ratio was 127% at quarter-end. Excluding energy, the coverage ratio increased from 135% to 163% in the second quarter. Total direct energy charge-offs were $18 million during the quarter, bringing the year-to-date total to $31 million. Let’s move on to capital and liquidity. During the quarter, we repurchased $125 million, or 9.1 million shares of common stock and declared $84 million in dividends to common shareholders, resulting in 70% of earnings being returned to shareholders. At the same time, our capital ratios remained robust. Under Basel III, the Tier 1 capital ratio was estimated at 12.% and the fully phased in common equity Tier 1 ratio was estimated at a 11.3%. And finally, our liquidity position remains solid, with a low loan-to-deposit ratio of 82%, and we were fully compliant with the liquidity coverage ratio rule as of quarter-end. As Grayson mentioned, we are pleased with our CCAR results and remain committed to prudently investing in our businesses for future growth, as well as returning an appropriate level of capital to our shareholders. Turning to our outlook for the balance of 2017, our expectations remain essentially unchanged from last quarter. Excluding the impact of our third-party indirect vehicle portfolio, we expect full-year average loans to be flat to slightly down compared to the prior year. However, looking ahead, we expect to modestly grow average and ending loans on a sequential linked-quarter basis over the second-half of the year. We expect full-year average deposit balances to be relatively stable with the prior year. We expect net interest income another financing income growth of 3% to 5% and full-year adjusted non-interest income growth of 1% to 3%. Total adjusted non-interest expenses in 2017 are expected to increase between zero 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. We now expect the full-year effective tax rate in the 30% to 31% range, and we expect full-year net charge-offs to remain in the 35 to 50 basis points range. So in summary, we are very pleased with our second quarter results and remain focused on continuing to execute our strategic plan to drive growth and shareholder value. With that, we thank you for your time and attention this morning. And I’ll now turn it back over to Dana for instructions on the Q&A portion of the call.

Thank you, David. Before we begin the Q&A, as a courtesy to others, please limit your questions to one primary and one follow-up to accommodate as many participants as possible this morning. We will now open the line for your questions.

Thank you. The floor is now open for questions. [Operator Instructions] Your first question comes from the line of Betsy Graseck of Morgan Stanley.

Good morning.

Hi. Hi, good morning. A couple of questions. One, I appreciate all the detail on deposits composition that you gave us. And I’m just wondering in the context of your loan-to-deposit ratio, 82%, can you just give us a sense as to where you’re anticipating? What levers you can pull to drive the deposit growth to continue to fund the loan growth? And are you thinking about that loan-to-deposit ratio staying flat, or are you comfortable having it migrate higher?

Yes, I mean, I’ll start and I’ll ask David to add to it. One, we’ve had a very thoughtful and prescriptive deposit strategy. And if you look at our deposit composition over the last two or three years, you’ve seen us really drive to create greater diversity in that portfolio, more granularity and less cost And you’ve seen us execute a strategy, where we’ve reduced some of our highest cost deposits. We’ve reduced a substantial amount of deposits that require securities for collateralization. And so we’re very proud of the deposit base we put together. And as rates have started rising, you look at the deposit betas that we’ve been able to learn and we feel good about that. We think the big part of the value, this franchise is a strength of our deposit base. We would actually like to see our loan-to-deposit ratio improve, go up, if you will. We believe that we’ve got the capability and the capacity to fund a great deal of our growth with deposits throughout the communities we operate in.

Yes, Betsy, I want to add a couple of things. We don’t focus on trying to get to any particular loan deposit ratio. We believe the core of any bank franchise is the ability to attract and retain low-cost core deposit and we are very good at that. Regardless of if our loan-to-deposit ratio was even lower, we send a message to the field every day, all day about attracting low-cost core deposit. That’s just so fundamental to our profitability. That being said, we would love to have those deposits deployed in the loan book versus somewhere else, securities or otherwise. And we’re looking to grow loans as is prudent. And we did a little better this quarter, we’ll talk about loans in a minute. But we have good core funding. We’re ready to grow loans, but we’re not going to force it. We’re going to take what’s out there. Our teams are working hard to grow appropriately, and again, we’re not trying to solve for a given ratio.

Yes, I mean, we’ve made a very conscious effort to do – take a different risk appetite on certain of our lending segments, energy and multifamily, medical office building. You’ve seen us do that in auto lending as well. We’ve made some risk changes into our equity lending products that take risk off of that. So we’ve been very thoughtful about what part of our lending portfolio we want to grow. And we feel like, we’ve sort of remixed, both our deposit and our loan balance sheet. So we think, we’re in a very good position to grow. As we said earlier in our prepared remarks, we had over a 20% increase in consumer lending production this quarter and over 50% increase in our commercial lending production. So we think that second-half of the year, we can see much improved numbers.

Okay. That makes sense. I was just – I really like the detail on ID and how much of that is coming retail. And I just – when I heard your comment about the outlook for issuing some debt, I was a little confused there. Are you looking to hold the LDR flat and issue debt to fund growth? But maybe there’s a different reason why you’re issuing the debt, if you could just explain a little bit?

Yes, that’s a great question, because we’re really talking about holding the company debt versus bank debt. We – the liquidity profile of the bank is in great shape, as we just mentioned. We do have some corporate needs too at the holding company that that we need to take care of. The exact timing of that not sure, which quarter that will hit in. It likely be towards the end of the year. So I don’t know that there will be a whole lot of impact from that this year could be some. But the general corporate purposes include things like our share buyback too that we had to think through how we fund that. So that’s really what it’s about.

Okay. And so it’s more on optimization of capital structure as opposed to any kind of regulatory request?

Yes, that’s correct.

Okay. And do you have a sense of the size of the debt issuance?

We’ve talked about anywhere from $750 to $1 billion range that we would be looking at.

Okay, perfect. Thanks.

Your next question comes from John McDonald of Bernstein.

Good morning, John.

Hi, good morning. Just wondering if you could talk a little bit about the puts and takes to the outlook for the margin next quarter stable to up modestly. And what are some of the underlying assumptions for your NII and NIM guidance for the year?

Yes, sure. So before we get to NIM, which is at the result what we talked about NII. So we believe we can continue to grow NII. We’ve talked about the fact that we had good production from a loan standpoint. We expect loan growth to be more robust in the second-half of the year than it was in the first-half of the year. We’ve done a good job of controlling our deposit cost. Our deposit costs were up 1%, call that at 10% beta. Thus far, we’re not been able see, it’s been among the lowest of our peer group. And it really gets back to all the discussion we had on our deposit franchise and our beta and our core accrual smaller markets that we get deposits from. So we think that – the curves helped a little bit. I would tell you on the corporate side, LIBOR starts to move before increases happened. So we did get the June increase. The commercial side of that started to reflect it earlier, because LIBOR moved in advance. We do pickup a little bit more on the consumer side their prime base. Kudos in terms of the probability of the December rate increase, it’s not very high from a profitability standpoint right this minute. But as the market starts to anticipate that LIBOR to move too, I think our outlook really takes into account today’s boards. From a NIM standpoint, we did have 2 basis points that came through NIM this past quarter on recoveries – credit recoveries. We had guided a three to five. Last quarter, we ended up with seven and the two points really came from that. We don’t forecast those recoveries if they happen, they happen. And so that’s a little piece of the disconnect, where you’re trying to figure out why it’s stable to up modestly. You also have to look at where we are. I mean, we have a – on a relative basis to our peers, a pretty strong NIM. And when we have the curve, it’s pretty flat. So the profitability of what goes on relative to our existing NIM is even harder. So you don’t see quite the expansion that we’ve had. But if you take out the 2 points that I just mentioned, we should see growth similar to what we saw in the last quarter.

Okay, that’s helpful. And just as a follow-up, David, wanted to ask about your updated thoughts on normalizing the equity base and getting that CET 1 to the 9.5% you talked about. I think earlier in the year, you were talking maybe end of 2018, early 2019 getting there. I was wondering if the successful CCAR and the big ask to help you get there faster, or just reinforce your confidence about getting to that target?

Yes, we put in a plan to get down to that 9.5% by the end of 2018. We’ve mentioned numerous times, we can’t quite get there. We don’t think, at least, it depends on what loan growth looks like over that period of time. We’ll get close. We had anticipated, of course, we knew what our ask was at that time. We just are reluctant about sharing anything specific until our regulatory supervisors have an opportunity to object or not object. And so we’re confident at the submission even though we didn’t know. And we’re confident, we can get to that 9.5 in due time and we’re confident we’re going to get to our 12% to 14% return on tangible common by then as well. So everything is coming together, as we planned. As we stated in the Investor Day over a year-and-a-half ago, we feel very good about where we’re marching towards that goal at this point in time.

Okay. Fair enough. Thank you.

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

Good morning, Matt. Matt O’Connor: Good morning. Overall credit quality was quite good. I did notice an increase in the commercial TDRs. And apologies, if I missed, any opening comment on that, but what drove that rise?

No, I mean, I think, what you saw this quarter is that, we’ve characterized our credit quality as stable. We continue to believe that. There’s some volatility from quarter-to-quarter. And then the granularity of that portfolio isn’t quite as small as we’d like. So one or two credits can make a difference and TDRs, that’s the case. There’s one or two energy credits. But I’ll ask Barb Godin, our Chief Credit Officer to expand on that.

Thank you, Grayson. And that’s exactly what it was. It’s a small handful few energy credits and an ag credit on the energy side. Of course, we’ve just finished or in the midst of finishing our spring borrowing base redetermination. So there’s some of that and working with out oilfield services. So nothing systemic at all. And in fact, I think that number you will start to see it move down through the balance of the year as well based on what we know.

Thank you, Barb. Matt O’Connor: Okay. Thank you.

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

Good morning, Erika.

Hi, good morning. The investor community seems to be losing a little bit of faith in terms of the revenue outlook for the industry generally, as the year has progressed. And I’m wondering, as you think about your efficiency target first sub-60% for next year – for the full-year of next year. Is there enough sort of as you look out on the budget and the expense pipeline to continue to support that target even if sort of the rate outlook once again is maybe a little bit short of what we thought it was going to be to begin the year?

Well, Erika, we -- clearly, we can’t bet on rates. We’ve got to maintain a very disciplined, very rigorous expense management program. We’re absolutely committed to that, we don’t believe. We believe that’s fundamentally the right thing for us to be doing in a low-rate, low-growth economy. We continue to press hard on a number of fronts to make sure that we’re delivering on that. As David said earlier, our personnel expenses quarter-over-quarter, our staffing relatively flat, but we had to absorb merit increases. And also I guess year-over-year, we’re down a little over 300 positions. We have tried to structurally change our expense base and continue to do that. I’m going to ask John Owen, if you’ll speak for just a moment. We continue to rationalize our branch franchise and recently made some announcements that further complete some commitments we made at Investor Day year-and-a-half ago about what we’re going to on branch closures. So, John?

Good morning. This week we announced consolidation of 22 additional branches. At Investor Day, we made a commitment that we would consolidate between 100 and 150 branches and we’ve got to about 160 right now. Over the last 10 years from our peak between 127 branches is where we peaked. We’re down now about 1,500. So overall, we’re down about 30%.

And we’re delivering on that 150, which is now at 260, a year early.

Right.

And so, I mean, I just used that as an example of where not only we’re trying to reduce expenses, but we’re trying to accelerate the pace of that expense management activity.

Got it. And as we look forward – this is a follow-up to John’s line of questioning. Clearly, best-in-class in terms of total payout, as we look forward over the next couple of years, how are you balancing the preference between dividends and buybacks? And over the medium-term, what’s a more normalized dividend payout ratio for your bank and given how – what you observed of your CCAR results?

Yes. So it’s a great question. Clearly, we – it’s critical that we get our common equity Tier 1 and other ratios to follow along with that to an appropriate level of capital for our company and optimized best we can, both in common and preferred – common items like preferred And I think that we can do that over this fairly short period of time. As you optimize your capital based on the risk within your balance sheet, we do start leaning more towards a higher percentage of our income being paid out in a full dividend. So we had as files our ratio in the 30% to 40% range, that’s moving up in the 35% to 45% range. As time goes, we’ll refine that as well. But I would think that right now based on where we are in the 35% to 45%, would seem to be a reasonable dividend payout ratio for us.

Got it. Thank you.

Your next question comes from Ken Usdin of Jefferies.

Good morning.

Thanks. Good morning, guys. I want to ask a question on expenses. David, good control again if you take the $909 and then you add the two $10 million items. So if we’re starting it somewhere in the 90-ish type of range, which is, I think around the zone that you had kind of spoken to as possible in the past. Can you just give us an understanding of just seasonality and just and growth from here? How well can you kind of control, given the points you made earlier about the branch plan and other initiatives? Can you keep them pretty tight from here?

Yes, Ken, it’s a great question, and you did the math exactly right. So you’re – take that $899 and back out the settlement fees, you get closer to another items you mentioned, you get about where our run rate is. Clearly, we are intently focused on managing our expense base. Grayson mentioned revenue is challenged. Erika brought up revenue being challenged. We get that. We’re not counting on rates to bail us out. And as a result, we are focused on everything expense-related from people, process, technology. And right now, we think that that run right that you mentioned is fairly accurate for us for the remainder of this year.

Got it. And to your point about adjusting to revenues, last year you had talked about the 300 program, you up that to 400, but you kind of rolled out the timeline of that two. Are there things within the program that you could bring forward if you needed to? So I know you’re focused on it. But how much of that is – how much optionality is there around timing of those expected saves that you have for – over the time?

Yes, as you know, about 60% – a little over 60% of our – or right at 60% of o our total expenses is compensation-related. So if you’re going to move the meter on expenses, you’re going to move it based on that. And so being able to – we have natural attrition as every company does, takes care of a piece of that, trying to change processes up quicker than we otherwise would have done to the piece of that not having to backfill people that attrit is important. As John mentioned, the branch consolidation, so we’ve put 22 on the Board and maybe we don’t consolidate quite at the pace that we have done in the recent history. We continue to look at our retail footprint in terms of consolidations and additions. So for us managing expenses all about optimizing everything that we do and we have a pretty high sense of urgency to get that done. So we’re going to look to bring forward as much as we can. Again, our goal is focusing on getting our return by the end of 2018 in that range of 112% to 14% and expense management is a critical piece of that.

Es, understood Thanks, David.

Your next question comes from John Pancari of Evercore ISI.

Good morning, John.

Good morning. On the efficiency ratio and operating leverage, I know you gave the 2017 expectation of 62% and 2% to 4%. I’m wondering, where do you think that could go for 2018 just given the progress you’ve made on the expense front? I mean, do you think you can get to a 60% level or anything like that in 2018 without the help of rates? And we’re – or conversely how about with the help of rate? Just curious where you think you you could go?

Yes, I think that’s kind of where Erika was going with her question too, And clearly, rates matter to the extent that we don’t get increases that we had anticipated that puts a lot more pressure on it – on us being able to get there. But as we’re talking through all these questions, if the revenue is not there, then it’s going to cause us to have to put even more pressure on our expense base, because we have certain goals that we want to meet and makes it more challenging, makes it more difficult. I can’t say an absolute right now for 2018. We’re in the middle of our strategic planning process, and of course, roll out a new budget towards the end of the year, we’ll give you better guidance into 2018. But we’re committed to doing best we can to get – ultimately, we believe to be in the 60%, even over time, we think below that.

Okay. All right. Thanks, David. And then on the credit side, quick one there. The – I know you bled the reserve about 7 basis points or so this quarter to about 1.26, I believe, in terms of ratio to loan. Curious where you think that to go? Could it go a little lower, I believe, the industry is maybe a little bit below that, but just want to get your thought?

John, it’s Barb Godin. Yes, we moved it from 1.3% last quarter to 1.30% this quarter. We are looking at the reserve, as you know, every quarter. And so there is always opportunity for downward movement. A lot of that is dependent on continued improvement as we’ve seen so far in all of our credit metrics and in particular in our energy portfolio.

Well, and the composition of the portfolio. All that drives it as we derisk the composition of our portfolio and derisk individual credits within the – the allowance was done what it ought to do, it’s rationalized to that inherent risk of the portfolio, and we think we continue to see opportunities to improve that.

Okay, thanks. One more, I know you said the beta right now on the deposit side is 10% ballpark. What are your assumptions assumed about where that could go over the next one or two like?

Yes. So I’ll give you some parameters. So we don’t really factor in data for the next quarter. But kind of over the next 12 months, our beta assumptions really haven’t changed. They started 40%, end up at 60% at the terminal pass-through. I think a good guide that you might want to have everybody could use is for every 5 data points, it’s about $8 million for us. So as we get a hike, that could be anywhere from $50 million to $60 million of NII just depending on what happens from a beta standpoint. We do think that the pace of change or pace of rate increases is helpful to keep beta down. But we also are realistic in knowing at some point, we’re going to have to pass-through some of the increase at a faster pace than we have today, which is only 10%. So we think we’re probably a little conservative in terms of our longer-term beta assumption, especially for the next increase or two.

Well, I mean, the other side of it is, we’re coming from a relatively low position. And thus far, our industry, our competition has been pretty rational on deposit pricing. But with modest loan growth, there we’re seeing modest economic growth. Then you should anticipate modest betas until a point in time that competition for deposits increases.

Okay. Thank you.

Your next question comes from Steve Moss of FBR.

Good morning. In terms of the loan growth here, it sounds like it’s turning the corner a bit. I was wondering, is this result of pricing or has runoff is getting closer to the bottom here?

If you look at the economic recovery, fixed business investment has been really modest throughout the recovery. And we’re – that’s a combination of confidence and courage and uncertainty. And – but we saw really good production numbers, particularly in the commercial middle market space last – this past quarter. And while we still aren’t certain that we’re turning the corner there. We are seeing some encouraging signs and I’ll ask John Turner who runs that business for us to make a few comments, to give you a little bit more detail around it.

I think that we are in a better place to begin experiencing the loan growth. I think the derisking activities that we’ve undertaken certainly are beginning to slow a bit. We saw good growth in a couple of different industry sectors. Our pipelines remain stable. When I look at our loss business reporting, we had still about $2.5 billion in opportunities over the last six months that we lost these because of our dissatisfaction with pricing or some sort of structural element, some other structural element, as I said with credit, another $700 million or so related to internal limits that we impose on ourselves to ensure that we have good balance and diversity within our loan portfolio. So when you think about production being up over 50% quarter-over-quarter, and yet we still have some opportunity in our pipeline through continued – just good execution. I think, as portfolio mitigation strategies begin to play out and we don’t have the kind of run-off that we have been experiencing, and assuming that we can turn the tide and run off an owner-occupied real estate. I think we’ll – we will begin to see some growth particularly as business investment activity, as Grayson suggests, picks up. Our pipelines are pretty stable, economies are still growing slowly in the markets, where we operate. But there are some signs of businesses gaining some confidence, or at least just running out of patience so to speak in deciding they’re going to take some risk that they haven’t been willing to take so far.

Got you. And then on the derisking subjects here, wondering what’s the prospect of moving your 9.5% target down towards 9% or lower, given your balance sheet profile ahead of next year’s CCAR?

Yes, that’s a great question. And I’m glad you brought it up, because that’s not a static number. The 9.5%, we evaluate that all the time. We look at our risk profile. We think through the derisking that we’ve done. That 9.5% could go both ways. I mean, if we put more risk on the balance sheet, because we decide do something else, we’ll hold appropriate capital for it. But if we derisk continue to derisk the 9.5% goes lower than that, and I think it’s incumbent upon us. We’ve espoused 9.5% and we’ve kind of left it alone at that, because we’re at 11.3. Now let us get the 9%, as we start approaching 9.5%, we’ll give you a better indication as to what – tighten that up a little bit. But it’ll be over time for us get to that number.

Thank you very much.

Our final question comes from the line of Geoffrey Elliott of Autonomous Research.

Good morning, Geoffrey.

Good morning. Thank you for taking the question. It’s another one on capital. If I look at the DFAST release that was about a 70 basis point GAAP between your common equity Tier 1 and your Tier 1 under stress. But if we look at CCAR that increases to about a 140 basis points with the capital actions. So that seems to suggest that there’s about 70 basis points of preferred issuance baked into that. Just wanted to check that math was correct?

You did really good math, that’s about where we’ll be we need right at $700 million of preferred over time to bolster our Tier 1, which we’re solving through common equity. So, our capital regime is really about getting the capital down to the appropriate level, but optimizing this fact as well. So we want to solve the common equity Tier 1 with common equity obviously non-common needs to be a component of that, it’s cheaper than our cost of common today and you’ve nailed it.

And then, I get clearly that preferred is cheaper than common. But why issue any preferred at all when those capital actions post stress you’re still at 7.4% that’s still a long way ahead of the, I think, it’s a 6% minimum per preferred of the total Tier 1 under stress and CCAR why issue any preferred at all?

Well, we won’t. And we will – we’re going to wait as long as we can, because we don’t want to have the negative carry. And we’ll do that in conjunction with the whole optimization and rightsizing. So timing is critically important to us and we’ve got that timing down path.

And then just lastly, are you committed to assuring that now, now that’s gone into the CCAR ask? And barring any resubmission or anything like that, so you kind of balance to issue non-preferred?

To the extent that we have – so our commitment is to have an appropriate amount of capital common equity Tier 1, as well as Tier 1. And if we’re solving Tier 1 with common equity, I don’t think there’s regulatory supervisor that hears that you solve that with that type of capital instrument. So we don’t have to issue of non-common instrument, preferred instrument unless we’re taking our common out as well at the same time. So we’re not forced to have negative periods, where I think we’re going.

Great. Thank you very much.

Okay.

I’m sorry, go ahead with your concluding remarks.

Well, that’s being our last question, we really appreciate everyone’s time. We thank you for your attendance today. I appreciate your interest in Regions Financial, and look forward to speaking to you next quarter. Thank you.

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