Regions Financial Corp (RF) — Q2 2016 Earnings Call Transcript

Thank you, Paula. Good morning and welcome to Regions’ second quarter 2016 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 we will reference 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 may make forward-looking statements during today's call that are subject to risk and uncertainties. Factors that may cause actual results to differ materially from expectations are detailed in our SEC filings, including the form 8-K filed today containing our earnings release. I will now turn the call over to Grayson.

Good morning and thank you for joining our call. Second quarter results reflect continued momentum in 2016 and demonstrate that we are successfully executing on our strategic priorities. We are pleased by our continued progress despite a challenging and somewhat volatile economic backdrop. For the second quarter, we reported earnings available to common shareholders of $259 million and earnings per share of $0.20. We continue to deliver results in areas we believe are fundamental to future income growth. We expanded our customer base as we grew checking accounts, households, credit cards, and wealth relationships. Our approach to relationship banking and customer service excellence is instrumental to our success and we are always pleased to receive external recognition in these efforts. The Reputation Institute and The American Banker magazine recently ranked Regions as the most reputable U.S. bank overall and for the second consecutive year, the most reputable among customers. We are honored to again receive this top ranking as it recognized the efforts from all Regions associates in identifying and meeting the needs of our customers and communities we serve. Another outstanding recognition came from Temkin Group which ranked Regions among the top 10% of companies they rated in 2016 as we ranked second in the nation for online experience. Looking further at our results, we achieved total average loan growth of 4% compared to the prior year, despite market uncertainty; the overall health of the consumer remains a bright spot. Consumer loans increased 5% year-over-year with loan balances up in every asset category and our consumer credit metrics continue to improve. Consumer net charge-offs decreased 5% from the second quarter last year, non-accrual consumer loans decreased 16%, delinquencies decreased 5%, and troubled debt restructured loans decreased 4%. Active credit cards increased 12% year-over-year, and all active debit cards increased 4%. Total transactions on cards increased 6%, and total spend is up 5%. Further, average consumer deposits were up 3% year-over-year, including savings deposits which were up 9%. Turning to business lending, average loans increased 3% over the prior year. As we indicated last quarter, we are experiencing some softness in our commercial lending pipelines; still strong but soft. In some areas, customer sentiment continues to reflect less optimism and more uncertainty in the economy, and we have yet to see small business owners really return to market with confidence to invest and expand. We are also exercising caution and discipline as we approach internal concentration risk lending limits with certain segments and certain geographies. We continue to strengthen our loan portfolio with our focus on migrating credit-only relationships, recycling that capital into more profitable and deeper relationships that improve the overall portfolio. As a result, we expect to attract towards the lower end of a 3% to 5% average loan growth for 2016. Despite softer business loan demand, total adjusted revenue increased 4% over the second quarter of 2015, reflecting the effective execution of our strategic plan to grow and diversify our revenue. Our investments are clearly paying off as capital markets increased 41% and wealth management increased 6% on a year-over-year basis. With respect to market conditions, the global and macroeconomic environment remains challenging; as such, it's critical that we focus on what we can control. To that end, we remain committed to disciplined expense management and are on pace to achieve our 2016 efficiency and operating goals. For the first six months of 2016, our adjusted efficiency ratio was 62.3%, and we have generated 4% positive operating leverage on an adjusted basis. With respect to energy lending, while oil prices have improved, lower prices continue to create challenges for certain industry sectors while benefitting others. Our directly energy loans have declined by $324 million or 12% from the first quarter, currently standing at $2.4 billion or 2.9% of total loans. We continue to maintain appropriate energy reserves, which now stand at 9.4% of our direct energy exposure, up from 8% last quarter. We are substantially complete with our spring redetermination, which has resulted in a 22% decline in customer borrowing bases. Turning to capital deployment, we successfully completed the annual comprehensive capital analysis interview process and received no objections to our planned capital actions. Our Board of Directors approved a $0.065 dividend on common shares and a $640 million share repurchase plan. We remain committed to deploying our capital effectively through organic growth and strategic initiatives that increase revenue or reduce ongoing expenses while returning an appropriate amount of capital generated to our shareholders. In closing, our second quarter results reflect the successful execution of our strategic priorities and our continued commitment to our three primary initiatives: growing and diversifying our revenue streams, practicing disciplined expense management, and effectively deploying our capital. These are all integral to our success and we remain on track to deliver our performance targets. With that, I will turn it over to David who will cover the details for the second quarter.

Thank you and good morning everyone. Let's get started with the balance sheet and a recap of loan growth. Average loan balances totaled $82 billion in the second quarter, up 1% from the previous quarter. Consumer lending had another strong quarter as almost every category experienced growth and total production increased 20%. Average consumer loan balances were $31 billion, an increase of $303 million or 1% over the prior quarter. This growth was led by mortgage lending, with balances increasing by $162 million linked quarter, reflecting a 49% seasonal increase in production. Indirect auto lending increased $93 million and production increased 4% during the quarter as we continue to focus on growing our preferred dealer network. Other indirect lending, which includes point-of-sale initiatives, increased $87 million linked quarter or 15%. Turning to the credit card portfolio, average balances increased $16 million from the previous quarter, and our penetration into our existing deposit customer base increased to 17.7%, an improvement of 20 basis points. Total home equity balances decreased $87 million from the previous quarter as the pace of runoff exceeded production. As Grayson mentioned, we continue to experience softer pipelines in the commercial space. As a result, total business lending average balances were relatively stable compared to the previous quarter. Average commercial loans grew $178 million linked quarter inclusive of a $64 million decline in average direct energy loans. The net increase in average commercial loans was driven by corporate banking as our specialized industry segments added new relationships within technology, defense, and financial services. Let's take a look at deposits. Total average deposit balances decreased $253 million from the previous quarter. Deposit costs remained near historically low levels at 12 basis points, reflecting the strength of our deposit base, and total funding costs continued to remain low, totaling 29 basis points in the second quarter. With respect to deposits and loan growth expectations, we provided the opportunity to accelerate our planned reduction of certain deposits within our wealth management and corporate segments, which contributed to the overall decline in deposit balances. Within wealth management, certain trust customer deposits, which require collateralization by securities, were moved into other fee income producing customer investments. Average deposits in the consumer segment increased $1.2 billion or 2% from the previous quarter, reflecting the strength of our retail franchise, the overall health of the consumer, and our ability to grow low-cost deposits. Our liquidity position remains solid with a historically low loan to deposit ratio of 84%. Let's see how this all impacted our results. Net interest income and other financing income on our fully taxable basis was $869 million, decreasing 2% from the first quarter but up 4% compared to the prior year. The resulting net interest margin for the quarter was 3.15%. As you recall, the first quarter benefited from items that were not expected to repeat, which partially contributed to the linked quarter declines in net interest income and other financing income, as well as the net interest margin. Recent long-term debt issuances, lower loan fees, less favorable credit-related interest recoveries, along with reduced dividends from trading assets that benefited the first quarter, were the primary drivers behind the linked quarter decrease, though these were partially offset by higher loan balances. Non-interest income growth was strong in the second quarter reflecting our deliberate efforts to grow and diversify non-interest revenue. Total non-interest income increased 2% on an adjusted basis from the first quarter, driven by growth in service charges, mortgage income, and card and ATM fees. Service charges increased 4% in the second quarter reflecting the benefit of 2% growth year-to-date in checking accounts, again highlighting the strength of our retail franchise. Mortgage income increased 21%, driven by a seasonal increase in production. Of note, within total mortgage production, 75% related to purchase activity and 25% related to refinancing. Additionally, during the quarter, we entered into an agreement to purchase mortgage servicing rights on a flow basis, which is expected to service approximately $40 million to $50 million of mortgage loans per month going forward. Card and ATM income increased 4% during the quarter, driven by a 1% increase in active debit cards and an 8% increase in transaction volume. We had another good quarter in capital markets with increased fees from merger and acquisition advisory services. Linked quarter results declined 7% relative to the prior quarter's strong results; the decline was primarily due to reductions in fees generated from the placement, the permanent financing for real estate customers and syndicated loan transactions that were especially strong in the first quarter. Wealth management income decreased 3%, primarily due to seasonal decreases in insurance income, though this decrease was partially offset by increased investment management fees. Importantly, despite our reduction in wealth management deposits, total assets under administration increased 2% quarter-over-quarter. Non-interest income was also impacted by market value adjustments related to assets held for certain employee benefits, which increased $20 million compared to the first quarter; however, this has offset salaries and benefits with no impact on pretax income. Bank-owned life insurance decreased this quarter, primarily due to $14 million in claims benefits and a gain from an exchange of policies recognized in the first quarter. Let's move on to expenses. On an adjusted basis, expenses totaled $889 million, representing a 5.5% increase quarter-over-quarter. During the second quarter of 2016, we incurred $22 million of property-related expenses in connection with the consolidation of approximately 60 branches, as well as other occupancy optimization initiatives. Including these 60 branches, Regions has announced the consolidation of approximately 90 branches as part of the company's previously disclosed plans to consolidate 100 to 150 branches through 2018, and we continue to expect to be at the higher end of the range. Total salaries and benefits increased by $5 million from the first quarter, as previously noted, including $20 million in additional expenses related to market value adjustments associated with assets held for certain employee benefits, which are offset in other non-interest income. Additionally, severance-related expenses declined by $11 million quarter-over-quarter. Excluding the impact of market value adjustments and severance charges, total salaries and benefits would have declined compared to the first quarter. Year-to-date staffing levels have declined by 4%, serving to lower base salaries and fully offset the impact of the annual merit increase. Professional and legal expenses increased by $8 million, primarily due to $3 million in legal and regulatory charges incurred during the second quarter related to the pending settlement of previously disclosed matters, as well as the impact of a $7 million favorable legal settlement recognized in the first quarter. FDIC insurance assessments decreased by $8 million from the previous quarter, primarily due to a $6 million refund related to overpayments in prior periods. As previously disclosed, we expect FDIC insurance assessments to increase by approximately $5 million on a quarterly basis associated with the FDIC surcharge. We anticipate this will be implemented in the third quarter, resulting in a quarterly FDIC run rate in the $27 million to $30 million range. Other expenses increased by $25 million, including an $11 million increase to the company's reserve for unfunded commitments as well as $9 million of credit-related charges associated with other real estate and held-for-sale loans. Our adjusted efficiency ratio was 64% in the second quarter and 62.3% year-to-date. Annualized net charge-offs increased $4 million to $72 million and represented 35 basis points of average loans. The provision for loan loss essentially matched charge-offs in the quarter, and our allowance for loan loss as a percent of total loans remains unchanged at 1.41%. Total non-accrual loans, excluding loans held for sale, increased 3% from the first quarter and troubled debt restructured loans increased 4%. Total business services criticized loans increased by 1%. These increases reflect global market uncertainty and strength of the U.S. dollar, along with continued volatility in commodity prices. At quarter end, the loan loss allowance to non-accrual loans or coverage ratio was 112%. Credit improvement within the consumer portfolio saw net charge-offs decrease 24% from the prior quarter. Additionally, consumer total expense reserves improved compared to the previous quarter, while total delinquencies remained relatively stable. Within business services, we experienced $17 million worth of net charge-offs within the energy portfolio during the quarter. Approximately half were attributable to oil and gas, and half were attributable to coal. While oil prices have recently traded around $50 per barrel and are showing signs of stabilization, uncertainty remains. Should prices fall and consistently trade in the $35 to $45 range, we expect additional losses of between $50 million and $75 million. However, the timeframe for these losses now extends through 2017, as we expect resolution will take longer for certain customers in the portfolio. If oil prices average below $25 per barrel through the end of 2017, we would expect incremental losses of $100 million. Weakness in energy, mining, metals and agriculture continues to put pressure on certain commercial durable goods companies. We also continue to monitor investor real estate in energy-related markets. We believe our total allowance for loan losses is adequate to cover inherent losses in these portfolios. Given where we are in the credit cycle and fluctuating commodity prices, volatility in certain credit metrics can be expected, especially if related to larger dollar commercial credits. Let's move on to Capital and Liquidity. During the second quarter, we returned $258 million to shareholders, including the repurchase of $179 million of common stock and $79 million in dividends, completing our 2015 CCAR capital plan. We successfully completed our 2016 CCAR process and received no objection to our planned capital actions. Last week, our Board of Directors approved a $0.065 quarterly dividend on common shares and a $620 million share repurchase plan. Under Basel III, the Tier 1 ratio was estimated at 11.6%, and the common equity Tier 1 ratio was estimated at 10.9%. On a fully phased-in basis, common equity Tier 1 was estimated at 10.7%, well above current regulatory minimums. Let me provide an overview of our current expectations for the remainder of 2016. We continue to expect total loan growth in the 3% to 5% range on an average basis relative to the fourth quarter of 2015. Given current softer pipelines in the commercial space, we expect to track towards the lower end of that range. Regarding deposits, softer loan growth expectations coupled with a strategic reduction of certain deposits within our wealth management and corporate banking segments will result in total average deposits remaining relatively stable with fourth quarter 2015 average balances. Our expectation for net interest income and other financing income remains unchanged; assuming no rate increases for the remainder of 2016, we expect to be at the midpoint of our 2% to 4% range. As a result of our investments, we continue to expect to grow adjusted non-interest income in the 4% to 6% range on a full-year basis; given our year-to-date performance, we would expect to be at the higher end of that range. Our plan to eliminate $300 million of core expenses is on track, and we continue to expect to achieve 35% to 45% in 2016. Therefore, total adjusted non-interest expenses in 2016 are expected to be flat to up modestly from 2015. We also expect to achieve a full-year adjusted efficiency ratio of less than 63% and adjusted positive operating leverage in the 2% to 4% range in 2016. Full-year net charge-offs should be in the 25 to 35 basis point range; given the volatility and uncertainty in the energy sector, we expect to be at the top end of that range. In closing, we are pleased with our second quarter performance and we believe our results demonstrate that we're effectively executing our strategic plan in the context of a difficult operating environment. We look forward to updating you on our progress throughout the remainder of the year as we continue to build sustainable franchise value. With that, we thank you for your time and attention this morning, and I will turn the call back over to Dana for instructions on the Q&A portion of the call.

Thank you, David. Before we begin the Q&A session of the call, we ask that you please limit your questions to one primary and one follow-up in order to accommodate as many participants as possible. We will now open the lines for questions.

I want to ask a question about the other expenses. There was some credit related to the unfunded commitment as well as some other credit-related expenses that looked about $20 million higher than a run rate. I just wondered if that was something that elevated this particular quarter.

Yes, Marty, this is David. From time to time, we'll have some credits that go sideways on us. This particular quarter, we had really one large credit in the unfunded commitment that caused an $11 million increase, and the charge for that is run through noninterest expense. You'll see over quarters the volatility that can have – pluses and minuses. We expected that credit would fund in the third quarter but believed it was important for us to continue to have an unfunded reserve for that today. From an OREO and held-for-sale standpoint again, just a couple of credits that were large; we had some write-downs that we believed needed to take place, so to keep valuation adjustments in total of that, it was $9 million. So you're spot on, between the two there was about $20 million of charges that we had to take during the quarter.

But thinking about that and then your tangible book value growth has been created by the consistent 2% or better growth. You know as you're looking at premium shareholder value, one of the things that's probably the best way you've been able to de-risk because of just getting credit for the tangible book value growth would be an upward momentum for the overall valuation. So I just wanted to see if as you think about where you're at today versus where you were at as it went in the last downturn, what makes Regions different from just a risk profile, so significant changes it’s been able to address that should at least make investors comfortable with tangible book value.

Sure, over the past six years we've made a lot of changes in people and processes, which has dramatically altered the content of our whole balance sheet. The most obvious one is the decline in investor real estate which represented almost 30% of our loan portfolio at one time. Today it's about right at 9%. The credit discipline we have regarding how we approach business is also very different. We feel confident as we have our hands around our loan portfolio. Energy has been a challenge for our industry but our concentration risk management program has reduced the negative impact we might otherwise have had. Being the largest bank headquartered in the Gulf State, we have now about 3% of our loan portfolio in energy. We've talked about the reserves, and the 9.4% reserves so we believe we have that covered. There's some volatility and uncertainty there, but we feel like we're on top of that. As we think about our commitment to continue to grow our cash flow, our PP&R; look at the investments we've made over time, those investments are paying off as we continue to grow and diversify our revenue stream. We've had consistent margin if you look at that. To wrap up, I think Regions is a very different approach to business and the stability of growth in tangible book value. We've been leveraging our earnings well and returning mid-90% of our capital back to our shareholders in the form of a dividend around 30% of our earnings and over 60% in share buyback.

Thanks, David.

Question on your capital markets revenue. What do you think the potential is for this feed line over the next two to three years? It's been growing at a rapid pace for a few quarters now?

Yes, I mean as David mentioned earlier, we continue to see some softness in our wholesale sales pipeline. What we try to do strategically is to build out a lot of the product offerings we have, primarily in capital markets and also in treasury management. We can generate a reasonable return on invested capital in that business and the capital markets group is a place that we've made significant investments. We continue to believe that those have been thoughtful and smart investments. We have demonstrated strong growth this year and continue to challenge the team regarding the growth capabilities of that activity. We're coming from a relatively low base, so the percentage is remarkably high, but we have not publicly stated a percentage increase goal. We do believe strongly and confidently that that’s a business that we can continue to grow over time at an above-rate level to other parts of our business.

When I look at the criticized loan balances you're giving overall on Page 8, I see an increase, and then when I look at Page 12, just specifically the energy balances, I see a decrease. So I wondered if you could elaborate on what's driving the increase outside of energy?

Yes, this is Barbara Godin. Energy, as you said, did go down. We saw some other movements as we look at some of the other areas that we have considered to be a little soft: that would be agriculture, some transportation, and primary metals. We’re keeping an eye on that; we're being very cautious. In those categories, we're watching them and as we see signs of any deterioration, we’re immediately moving them into a special mention category. So that's accounting for the increase there.

And just a quick follow-up, I didn't catch earlier, but I think you said the non-interest income growth you thought should be at the higher end of the 4% to 6% range? I just wanted to check, I heard that right.

That's right. Just taking where we are today and looking at the investments we've made and what’s in the pipeline, we feel that we will most likely be at the higher end of that; we'll give you better guidance one more quarter out, but we feel confident to be able to lean towards the higher end of the range.

David, maybe a question to you. Just following up on your comments about the $300 million cost reduction and the 35% to 40% specifically you're targeting for this year. Is it reasonable to assume that the pace of that 35% to 40% reduction will be largely back-end loaded, or could it be perhaps a bit more evenly spaced over the course of this year?

Well, we haven’t paced it in any given quarter. We really are trying to guide more to the full year than any given quarter. You can have times spikes in expense from one quarter to the next, but we'd rather just stick with the guidance for the full year than be more flexible quarter by quarter.

Okay. And then just on what sounds like a little bit of softness in the commercial pipelines, particularly in CNI, are there specific industries where you are seeing particular softness, or is it more of a broadly greater level of caution on your borrowers' part given economic uncertainty?

I think where we try to compete is in the lower end of the commercial market, and you are seeing a lot of our competitors demonstrate growth. A lot of that growth has been in the higher end of commercial into the corporate space. But when you look at that middle market CNI customer, we are seeing a lower level of demand for lending to support capital spending. I would tell you that in energies is an obvious place where that has occurred, but you do see it spread across several different commercial industries, as there's been a strengthening of the U.S. dollar and some uncertainty created by a lot of events both globally and domestically. I wouldn't say it's limited to one particular industry; it seems to be more broad-based than that. But yes, if you look at credit quality, commercial is still very good. We've had a great experience now for several quarters in a row. We still expect it to be good, but it's modestly slow, modestly weaker than what we saw a quarter ago, and at the same time we’re just not seeing the new and renewed production that we were seeing this time last year.

Okay. That's helpful. And David, may just another quick one for you. In terms of the bank-owned life insurance numbers, you mentioned one of the reasons why that had moved around over the last couple of quarters. Guess I’m just trying to get level set on what a reasonable run rate would be for the second half of the year?

Yes, so the first quarter did benefit from a couple of things. We exchanged the policy into a different product, and we always had a plan there. Where we are right now is about where you ought to expect that for the rest of the year.

On net interest income, I wanted to just understand, you got the purpose full decline in the whole sale balances. So the balance sheet looks to have shrunk, and with the offset being a little bit better NIM. Can you just walk us through how you expect that trade-off to go going forward? Do we see not as much growth in earning assets but a lesser decline in the NIM in terms of growing NII?

Certainly. From an NIM standpoint, we are really trying to grow NII, but NIM will be under continued pressure if this rate environment stays where it is. I would expect you can have four to six more points of compression for the remainder of the year. But as we think about growing NII, we do it from a couple of different spots: one, growing earnings assets, which is really on the funding side, deposit side; and then putting that growth into good solid loan growth where we can get compensated for the risk that we are taking, where we can get compensated for having a full customer relationship versus just renting out the balance sheet from a credibility standpoint. It’s very hard to make money if you're just making loans only. We’re challenging our teams where we have relationship that’s a credit-only relationship to figure out how we recycle that capital into a more comprehensive relationship with a customer. Just because we don't have the loan growth doesn't mean we can't continue to grow NII if we execute that program appropriately. That’s kind of how we think about NII going forward.

Yeah, and Dave. Go ahead, Grayson. I am sorry.

I would just reiterate, we continue to see solid loan growth opportunities on the consumer side of our balance sheet and we expect that to continue. We don’t see a reason at this point in time to not believe that continues, and the health of that consumer customer continues to be remarkably strong. Now on the wholesale side, our focus continues to be on the lower end of that commercial middle market space. We're trying to be much more aggressive and certainly more disciplined at this point in the credit cycle to make sure that what we're putting on our balance sheet makes sense and has a reasonable return and a full relationship as David said.

And just my one follow-up on that, David. So you're getting to 3% year-over-year NII growth, and it's almost baked in the cake even if you don't grow it sequentially from here. But are you confident, though, that you can still envision an X-rates growth in NII from the second quarter point?

Again, we've landed on 3% for the full year, and we're working hard to take where we're right now to continue to grow. It's obviously very challenging given the rate environment, what’s rolling off versus what's going on in the flattening of the yield curve. So we have some reinvestment risks with regards to the securities portfolio. However, we think if we execute, we can continue to have some modest growth in NII, and again we believe strongly in the 3% growth for the year.

Following up on the previous point about the reinvestment risks in the AFS portfolio given the current tenure, is there any change in your approach to rolling over maturities and pay downs at current prices, or is there anything you would consider changing from that perspective?

We don't anticipate any major change. We haven't extended integration in a little over three years right now; it's been that way for a while. We don't look to make that change. We have a risk profile in the securities book like we want it to be, so we don't seek a lot of wholesale changes, particularly with the mortgage backs that we have there today. The points you raise are valid. The risks versus that reinvestment yield going forward will put pressure on our returns from the securities book, but we don't believe that the risk of trying to change that dramatically is worth it right now. You've kind of answered your own question.

Right, that makes perfect sense. And maybe on a related point, it's a good quarter from mortgage revenues, and you guys have made a point that it was mostly purchase related. Do you have expectations for how that business is going to shape out over the next couple of quarters and whether it gets a little bit more refi heavy and whether revenues can kind of stay high, nearly seasonally high levels for a couple of quarters?

We were pleased with the performance of our mortgage claims this quarter; again, the mix of business that we placed on the books this quarter was about 75% purchase and about 25% refinance. We expect to have a good third quarter based on what we're seeing today. We have seen a shift in application volume. Instead of being about 75-25, it appears to be shifting more to 60-40 in terms of purchase versus refinance. We should see that shift this quarter, but think we'll have a good quarter. Traditionally if you look at our numbers, the second and third quarters are always our strongest mortgage origination quarters. So, absent any change that we don’t see today, we believe we should have good progress going forward.

I had a question for you on the previously announced relationship with Avant and where that's at and if there have been any changes given kind of their volume cuts and their business or what that's going to look like for you guys moving forward.

Yes, so you know Avant is still in the early stages; we'll launch that in August. So it's premature for us to comment. We think it can be accretive to us over time, but the way we're treating some of these investments that we're making is that we're not taking a lot of risk. We're trying some things, we're seeing what we can learn, and we're seeing how we can better serve our existing customer base with these opportunities. We think it'll work for us, but again, too early to tell; we'll update you as we go through the third quarter and into the fourth.

We've been getting good feedback from our customers on our online experience and we've mentioned earlier in the call that we've received some recent recognition in that regard. Ironically, we're in the process, as we speak, of refreshing our online and mobile experiences for our customers. We're launching that as we speak, and then Avant will be in August, as David said. We think it's just one more way of trying to provide a better experience for our customers in both the online and mobile channels, but it will be incremental to what we're doing. We had great consumer numbers, and I think we were extremely pleased overall with consumer numbers this quarter across all channels; one of the better quarters we've seen.

Sounds good. And I guess maybe as a follow-up, do you have any trepidation from the standpoint of giving away customer data or losing customer contact in a relationship such as this? And also, you mentioned the growth in consumer as a whole. Any trepidation there in terms of increasing that exposure and what ultimate losses could be on the consumer side, even as I know credit metrics on the consumer side have been good here as of late?

First of all, the foundation of our business is built off customer trust. Without customer trust, our business model doesn't work, and so we are very sensitive to anything we do that involves customer data and the privacy of that data, the confidentiality protection of that data. We have very extensive risk management reviews, and our due diligence process is very rigorous and will continue to be. Cybersecurity is an area that we're all challenged with today, but we are spending an awful lot of resources and time on it. There's nothing more important to us than the trust of our customers with their information and their assets.

David, just one for you. Just going back to the energy scenario if oil was at $35 to $45, but what if we’re tracking above that into the back half of the year? What would that imply for total losses and maybe any updated commentary into '17?

We have, as you've seen, reserves of about 9.4%. Those reserves are established based in large part due to the risk ratings we assign; they come from our work and our credit team’s work and also evaluated by our regulatory supervisors. In terms of what ultimate losses are, we need to see if we continue to get stabilization in higher oil prices as that reduces our pressure and the risk of ultimate charge-offs. However, I would say that given the volatility we see in the prices, it’d be premature to predict how those reserves would come back into income in the short term. I think we need to let that play out over a longer period of time.

This is Barbara. I will say, Michael, that with oil even at $50 or higher a barrel, that certainly helps the E&P companies first, but the oil field services company they can't delay. So, again, that's the reason for us putting out the $50 million to $75 million range between now and next year.

And maybe just a quick follow-up: the reason for those charge-offs this quarter, obviously I understand the volatility with oil and the lack of service companies, but is the way to think about that that the provision should match pretty closely to charge-offs moving forward?

We have a process that we go through, and if anything unusual is a pretty good yes. However, as credit continues to improve across the board and risk ratings change, then you don't have to provide for those losses, and that would be the indicator of where the provision could be less than charge-offs. We need to let our model run, and trying to forecast that out is probably not the best thing for us to do.

You had two of your peers give guidance on dollar expenses beyond '16, going out to 2018, in a bid to tell investors that they can support efficiency gains without rates. I'm wondering if we think about 2017, you're guiding that we should enter the year with a base – a natural expense base of, let's say, 3.45 billion. I'm wondering how you're thinking about some of the cost savings that you've already identified to go into that 2017 number and whether they can overwhelm some of the investments. In other words, is there room to cut that 3.45 billion number to support efficiency if we don't get help from the rate environment?

It's a good question. I tried to address a little bit of that in the prepared comments. So we have the $300 million expense elimination program; we're on track with that. We're really challenging ourselves: How do we push some of those savings to start in 2018? The question is what can we do that is prudent, and make sense to move into 2017? That will take some work; we'll come back as we get later in the year and start giving you better guidance on 2017 and an update on that. The second would be, we have a lot of rationale that went around the $300 million that was roughly 9% of our expense base. We’re going to go back and challenge ourselves to think through how we might change that over time. Again we need to be very thoughtful, we need to make sure we don't benefit the short term at the expense of the long term. It's about building sustainable franchise value; we don't want just the short term. It gets trickier as we start thinking in these terms, but we believe rates are going to be lower for longer, and this is something we can't control. So we have more work to do here, and we look forward to the challenge.

We’ve been in this environment for a long while and have learned how to manage through it. We’ve had to defend our margin, defend the credit culture we’re trying to build in terms of how we grow our loan portfolio and managing expenses in this lower-for-longer environment has to be a skill set we exercise. We're aggressive on branch consolidations; we know how to do that and do it well. But as David said, in a lower-than-longer forecast we have to challenge ourselves and redefine how we manage through this for a longer period of time.

Thank you. I just have a follow-up question to Barb. You mentioned how energy prices impact different parts of your energy portfolio from a timing perspective. Investors are starting to wonder: What type of oil price level do we need to see to see that 9.4% reserve ratio start getting released or going down? Appreciating that this reserve is built on a loan-by-loan basis, is there any external factor that we can look to say, 'Okay, that's now done, and we can now expect to release some of those reserves into the rest of the book'?

Yes Erika, I think you hit the nail on the head relative to the reserve. It’s made up of different groupings. E&P will benefit from higher oil prices, where we see them in the $60 to $70 a barrel range; that's great for the E&P Company, but again, even at that level, oil field services companies will continue to be challenged. It takes them longer to restructure and get back on their feet. So, again, the extended tail on the oil field services and as we think of our provisions, roughly two-thirds of our provision right now is established against the oil field services sub-sector in our book.

Regarding the loan growth on the commercial side, I know you indicated some of the weakening of the pipeline but also a pullback in the single relationship credit. How would you split that up in terms of the impact on second quarter and the period loan growth from the commercial side? How much of that weakness came from the intentional pullback versus the softening demand?

That’s a great question. It’s one we've spent some time discussing and debating internally. Clearly part of the weakness we're seeing is just general market demand for credit. If you look at the top companies and U.S. domestic numbers, the level of fixed capital spending by wholesale customers continues to be below historical proportions, and we're seeing a net end demand for credit. At the same time, you also hear us talking about making sure we have full relationships and that we are getting paid a reasonable return for providing banking services to our clients. We need a full relationship to do that. The return on the credit-only relationship is simply not sufficient. We've also been very disciplined in ensuring that we have diversification in our balance sheet; we are committed to staying diversified. I think if you look at it today, we'd say it's about half and half: about half of it’s market and half of it is discipline that we're invoking. I’d also remind you that when you look at our loan growth for this quarter, keep in mind the reduction in energy loans that we've achieved over the past quarter. Without that reduction in energy growth, our wholesale book would have been much stronger.

That's helpful and then real quick, Barb on credit. Did you say that both the criticized balance increases as well as the NPA increase were attributable to the other areas that you cited: agriculture, metals, and transportation?

No, NPA was primarily an energy story. The other groups I talked about don’t contribute to the NPA increases.

Okay, got it. And then lastly, regarding the margin impact of putting on less thinly-priced relationships that you’re deemphasizing as a single relationship, just trying to put a number around it or in terms of yield. What yields are some of those loans running off that you're deemphasizing as a single relationship, and then how does that compare to new production yields on what you are putting on your book?

It really just depends, John, in terms of different products. On the C&I space, we haven't seen spreads change dramatically, but if you are at 225 over, you're working against yourself. That portfolio yields today about 3.5%. As we think about how to combat some of this, we want to get deeper relationships, and we're not always looking just at the spread. The spread is only a component part of the income we get from the customer. The other is NII sources that help round that out. So it's a factor that we had lower spread assets; we look for relationships; we can work with that. We're very focused on growth in the consumer; we've grown consumer loans about $300 million, and we’ve had nice production there, getting paid for the risk, helping to combat the downward pressure on loan yields. Our loan yields from the first quarter were only down 2 basis points. That’s the mixed shift and remixing of business that we're trying to make in our total balance sheet to be more profitable and get a better return for our shareholders.

Thank you very much. Most of my questions are answered, but I do have one on non-interest income. You gave a range of 5% growth there, and over the last year most of your growth has come from either card and ATM fees or capital markets. Is that what we should be modeling in? Is that what most of the growth is going to come from, or are there some categories that you've been investing in that you should start seeing some growth?

If you look at that, we've made lots of investments in capital markets; you see growth there, but also in terms of service charges and credit card and ATM growth, all that's really coming from the consumer household growth we're seeing. We're seeing better consumer growth across the communities we serve, and we really are pleased with the progress we've made in the customer experience in our consumer business. The results really are starting to come through, and we think that continues to be a good story. Additionally, we've made several investments in our wealth management offerings; you know wealth management had a good quarter this quarter, and we think that continues and has the prospect of improving.

And you're saying, where do you see most of the growth? I know you've invested in Florida pretty heavily over the years. Is it coming across your geographic footprint or is it coming in certain states?

It's more broad than it’s been in the past. You're correct; historically we've had very strong growth in the state of Florida, and Florida continues to be a critical market for our franchise. However, growth is much more broad than it's ever been historically in the company, which has been purposeful on our part. We've tried to ensure that not only do we diversify our business by product but by geography. We've made conscious investments to improve the production of our consumer and wealth management business as well as wholesale across all the communities that we serve.

Any update on the CRA downgrade from earlier this year in terms of what you're doing to remediate that and if there's any impact on your day-to-day operations?

Yes, Matt, it's David. So, we have to go back to the exam that we had. The results of our core CRA program continue to be robust. We have a lot of assessment areas, especially relative to anybody else in the country. We do a good job; our team is really committed to the customers and communities that we serve, and we feel like we're doing a pretty good job there. We did have an issue outstanding from another regulatory fee considered, and so we're going through, we had to go through another exam cycle for that to get cleared up, the timing of which is completely dependent on our regulatory supervisors. We believe we've done everything we need to do to continue working through this, and we hope the conclusion will be favorable once that is concluded by our regulatory supervisors.

And then just separately, if you look at the indirect consumer bucket which includes the POS loans of $600 million to $700 million of loans. You've had good growth there. It seems like there's kind of the typical beginning of the seasoning of that portfolio from a credit quality perspective. Obviously very small numbers, but do you have a sense of what losses in that book may get to? It's a good yielding book and you've been growing it a lot.

I mean with the indirect portfolio we've been growing steadily starting from a relatively small base. We've been very selective on where we participate in that market. We've been very selective in the auto space and a number of point-of-sales spaces that we participate in as we continue to test the production in that book. We believe that expected losses in this portfolio we're targeting them to be less than 2.5%.

A couple of questions please. MBS premium amortization can you just give us some nitpicky ones? What was the amount in the second quarter? When do you expect it to go in the third quarter?

So, Vivek, we’ve had in kind of the mid-30s in terms of premium amortization; we do expect that to increase modestly over the second half of the year, maybe up $5 million to $7 million each of the quarters, third and fourth quarter, just dependent on prepayments and the refinance activities that are occurring through pipelines. We can project that out a little bit in terms of prepayment fees, and expect it will tick up just a bit. Now that being said, that is embedded in our forecast of our NII growth which we say would be somewhere in the right at the 3% range for the year.

So, it didn't go up, David, in the second quarter; you're waiting for prepayments to show the path before you increase in the third quarter?

Yes, correct.

How do you manage to reduce your high payout level, which is nearly 100%? It's clear that in the long term, it won't grow much faster considering all the other factors you're evaluating.

We’ve mentioned that we would address a couple of things there. One, the stresses in each of the portfolios; we have learning that we can take from that as we reshape certain of our businesses to take out risk. This reduces the amount of capital you must have in a stressed environment. We did not exceed 100% of earnings; we had a couple of regional players that did for the first time. For us, we must optimize our capital structure regarding the nature of the components, so that includes preferred stock and common stock alike. We’re always working to optimize that over time to reduce our cost of equity. Working on the stresses in the balance sheet has produced results, and you’ve seen the commercial real estate losses come down quite dramatically. However, they are still high. How do we change our business model over time to reduce the amount of capital we need so that we can put it to work if there are opportunities to grow loans? When there is not, we must return that capital to our shareholders, especially when we trade at tangible book value.

Can I question your loan-to-deposit ratio? It upticked a little bit this quarter to 84%. What's the optimal level for the loan-to-deposit ratio for you folks, and how do you plan to reach that level?

We've been one of the lower loan-deposit ratios. Getting up a few more points, perhaps in the upper 80s, lower 90s, is the right place for us to be. In the good old days, it would be over 100% when you could rely on wholesale funding and withdraw money every night; that market doesn't operate that way. I would say upper 80s and lower 90s seems like an ideal target. The construct and deposits we have, given the LCR framework in terms of deposits, certain deposits are less useful. We’ll see that drift up over time, though the pace of it is hard to tell.

Looking at our deposits this quarter, core deposits is a very good story. We've created a much more favorable mix and we've reduced some deposits to David's point, and they are less attractive under LCR. But also less attractive at the end of the day from a liquidity perspective. The core value of this franchise is as a deposit gatherer, and we continue to believe that. To David's point, there was a time when we could fund loans in a very different way, but today the best way to fund loans is with core deposits. High 80s, low 90s would optimize the earnings power of this company. We are going to need good solid organic loan growth to make that occur.

Thank you. Regarding the consolidation of branches, have you done any work to measure when you consolidate or shut down a branch? What percentage of the customers stay with you? And go ahead.

From our perspective, we've continued to see that how the process for consolidating those offices has to do a lot with customer communication and how you equip, train, and staff the receiving offices. If the receiving offices are within close proximity, we’d say within 10 miles, you will see very good success with virtually no loss in customers. We believe that alternative channels, ATM, call center, mobile, and online all provide strong connectivity to customers. While we're seeing branches lose traffic in the sort of 3% to 5% a year range, we've seen tremendous growth in the online and mobile channels. So we need to provide strong connectivity to customers, and all these things have to be done well in order to have a successful consolidation. That’s a great question, and we continue to adjust and fine-tune on a regular basis.

I wanted to ask about Slide 14 which has loan splits in Texas and Louisiana. I guess I am curious, with energy prices trying to stabilize, does that imply that you'd want to see those markets to be stabilized in terms of loan balances, or could we actually see growth in those areas?

Texas and Louisiana are critical markets for us and quite diversified compared to a few years ago. We're seeing stress from customers directly or indirectly tied to the energy business; however, there's still a lot of strength and opportunities that provide banking services in those markets. Therefore, we remain confident about our ability to grow there.

Thank you very much for your attendance and participation today. I really appreciate your questions and your interest and thank you. We stand adjourned.