Regions Financial Corp (RF) — Q4 2017 Earnings Call Transcript

Thank you, Paula. Good morning, and welcome to Regions' Fourth Quarter 2017 Earnings Conference Call. Grayson Hall, our Chief Executive Officer, will review highlights of our full year financial performance; and David Turner, our Chief Financial Officer, will take you through the details of the fourth quarter. Other members of 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. Our forward-looking statements disclosure and non-GAAP reconciliations are included in the appendix of today's presentation and within our SEC filings. These cover our presentation materials, prepared comments as well as the question-and-answer segment of today's call. 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 we're pleased with our fourth quarter and full year 2017 results. We successfully met our profitability targets for the year as we continued to diligently execute our strategic plan. For the full year, we reported solid earnings of $1.2 billion, up 9%, with earnings per share of $1, an increase of 15%, while producing growth in pretax pre-provision income and generating positive operating leverage of approximately 2%. Keep in mind, these results include charges associated with tax reform, which speaks to our core performance in 2017. David will cover these details in a moment. Looking back over the year, I'm particularly pleased with our unwavering focus on customer service and the recognition we received in that regard. This is what relationship banking is all about, and it is at the core of our needs-based, go-to-market strategy. As a result of our efforts, the American Customer Satisfaction Index recently awarded Regions with a #1 ranking. Our focus on outstanding customer service has led to year-over-year growth in checking accounts, households, credit cards, wealth management relationships, total assets under management, and consumer loans, all of which are fundamental to growth and future income generation. As announced a few weeks ago, we have embarked on a new initiative called Simplify and Grow, which enables us to continue enhancing our ability to serve our customers as we make it easier for them to bank with Regions. The evaluation and discovery phase is well underway, and we expect to begin the execution phase in the first quarter. With respect to our financial performance, full year results continue to benefit from our asset-sensitive balance sheet and strong deposit franchise, which drove a 4% increase in adjusted net interest income and a 19 basis point increase in adjusted net interest margin. Prudent expense management remained a top priority in 2017. On an adjusted basis, total noninterest expenses increased less than 1% over the prior year, in line with expectations, reflecting disciplined expense management along with prudent investments in technology and other revenue-generating opportunities. In addition, we expect that our Simplify and Grow strategy will further enhance our efficiency efforts, which we will share with you later in the year. In terms of the economic backdrop, we are encouraged by improving conditions as well as customer sentiment, providing momentum as we head into 2018. As an example, loan production began to pick up in the second half of the year. For the full year, new and renewed loan production increased 8%, and total loans and leases grew approximately $600 million on a point-to-point basis in the fourth quarter. In 2017, deliberate risk management decisions regarding certain industries and asset classes within the Corporate Banking segment negatively impacted loan balances. For the most part, these efforts are now complete, and our improved credit metrics illustrate that these strategies are paying off. To that end, we experienced broad-based improvements during the quarter, including a reduction in nonperforming loans, the lowest level in over 10 years. Regarding tax reform, we are encouraged by the legislation passed in December and believe domestic businesses will be better positioned and more competitive in the global marketplace. For Regions, tax reform provided the opportunity to make additional investments that will benefit our associates, our customers, our communities and our shareholders. We announced an increase to our minimum hourly wage, benefiting approximately 25% of our workforce. We made a $40 million contribution to our charitable foundation to support financial education, job training, economic development and affordable housing. We also disclosed our plans to invest more in our company with a significant increase in our capital expenditures budget. As we enter 2018, there are four key areas providing considerable momentum for Regions. First, is our asset sensitivity and funding advantage driven by our low-cost deposit base, which we believe provides significant franchise value and a competitive advantage in a rising rate environment. Second is asset quality. As reflected this quarter, we continue to report broad-based improvements in credit. Next, robust capital returns as we continue to move towards our target Common Equity Tier 1 ratio. In 2017, we returned $1.6 billion to shareholders through share repurchases and dividends, representing a $488 million or 42% increase over the prior year. Finally, we expect additional improvements in efficiency and core performance through our Simplify and Grow initiative. We will provide additional details of the expected financial impacts later this year. Before I turn it over to David to cover the details of the fourth quarter, I would like to express my sincere appreciation and gratitude to our team of associates for their hard work and dedication this past year. And I'm proud of our accomplishments and results. We ended the year with good momentum and look forward to leveraging additional opportunities in 2018.

Thank you, and good morning. Before we get started, let me summarize the impact tax reform had on our fourth quarter results. The company revalued its net deferred tax assets and revised its amortization associated with low-income housing investments, resulting in a combined $52 million charge for income tax expense. The company also reduced income associated with leveraged leases, resulting in a $6 million reduction to net interest income and a 2 basis point decline to net interest margin. As a result of anticipated future savings, the company also contributed $40 million to its charitable foundation. As it relates to regulatory capital, tax reform also had a negative impact. The revaluation of deferred tax items includes approximately $130 million included in equity as a component of other comprehensive income. Despite our prior election to exclude accumulated other comprehensive income from regulatory capital, the full revaluation charge was reflected in net income, as noted above, reducing regulatory capital by approximately 10 basis points. Accounting rule-makers subsequently issued a proposed rule change to correct this issue via a reclassification between accumulated other comprehensive income and retained earnings. At this juncture, we expect to reclassify these components and recapture those 10 basis points in the first quarter of 2018. Further impacting 2018, the fully taxable equivalent benefit, provided primarily from tax-advantaged loans, will reset in the first quarter. We estimate the impact to be a reduction to net interest margin of approximately 4 basis points. Now turning back to the quarter. As Grayson mentioned, we are pleased with our fourth quarter results, which reflect improvements in several areas. Let's start with the balance sheet and look at average loans. In the fourth quarter, average loan balances totaled $79.5 billion, relatively stable with the prior quarter. Loans ended the year at $79.9 billion, reflecting approximately $600 million in point-to-point growth over the prior quarter. Within consumer, we continued to grow despite the negative impacts associated with our exit of a third-party relationship within the indirect vehicle portfolio. Average balances in the consumer lending portfolio increased $40 million in the fourth quarter. However, excluding the runoff in the indirect vehicle portfolio, average consumer loans increased $223 million. For 2017, runoff in the third-party portfolio totaled $508 million, and we expect the full year average decline in 2018 to be approximately $700 million. In the quarter, we experienced solid growth in residential mortgage, indirect other consumer and consumer credit card, partially offset by continued declines in home equity lending. Turning to the business lending portfolio. Average balances totaled $48.2 billion, reflecting a modest decline from the third quarter. However, ending balances increased by approximately $500 million. Commercial and industrial loans grew $672 million on an ending basis, led by growth in specialized lending. Owner-occupied commercial real estate loans declined $94 million, reflecting a slowing pace of decline. Additionally, investor real estate loans declined $101 million as growth in term mortgage loans was offset by declines in construction loans. As we look to 2018, we expect full year average loans to grow in the low single digits, excluding the third-party indirect vehicle portfolio runoff. Let's move to deposits. We continue to execute a deliberate strategy to optimize our deposit base by focusing on valuable low-cost deposits while reducing higher-cost, brokered and collateralized deposits. Total average deposits increased modestly during the quarter as growth in low-cost deposits exceeded strategic reductions within the wealth and other segments. Certain institutional and corporate trust customer deposits within the wealth segment, 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 due to our strategy to reduce retail brokered sweep deposits. We reported solid consumer deposit and strong seasonal growth in corporate deposits during the quarter, consistent with our relationship banking focus. Looking forward, we expect 2018 full year average deposits to grow in the low single digits, excluding brokered and wealth institutional service deposits. Let's take a look at the composition of our deposit base. Fourth quarter deposit costs remain unchanged at 17 basis points, and total funding costs remained low at 38 basis points, illustrating the strength of our deposit franchise. As a reminder, our deposit base is more heavily weighted towards retail customers of approximately 67%, and those customers have been very loyal to Regions as more than 43% of our consumer low-cost deposits have been deposit customers for more than 10 years. Our top market share in core states positions us well for future growth, and we expect continued benefit from lower deposit betas relative to peers. For these reasons, we believe our deposit base is a key component of our franchise value and a competitive advantage in a rising rate environment. Now let's take a look at how this impacted our results. Adjusted net interest income on a fully taxable equivalent basis, which excludes the tax-related reduction associated with leveraged leases, was $930 million, representing an increase of $9 million or 1% from the prior quarter. The resulting adjusted net interest margin was 3.39%, an increase of 3 basis points. The increases to adjusted net interest income and net interest margin were driven by higher market interest rates, offset by the full impact of debt issued during the third quarter and lower credit-related interest recoveries experienced in the fourth quarter. With respect to the first quarter of 2018 and excluding the tax-related fully taxable equivalent adjustment of approximately 4 basis points, we expect adjusted net interest income and net interest margin to increase, reflecting the full benefit of the December rate increase and the expectation for higher short-term rates consistent with current market expectations. Notably, modest growth in net interest income is expected despite two fewer days in the quarter, which reduces net interest income by approximately $10 million but benefits margin by approximately four basis points. For the full year of 2018, we expect adjusted net interest income growth in the 3% to 5% range. Let's move on to fee revenue. We experienced strong growth in adjusted noninterest income, which increased $36 million or 7%, driven primarily by increases in capital markets, mortgage and card and ATM fees. Capital markets had a record quarter, coming in at $56 million, an increase of $21 million or 60%. The increase was driven by higher merger and acquisition advisory services, loan syndication income and fees generated from the placement of permanent financing for real estate customers. Excluding M&A revenue, which decreased in 2017, other areas within capital markets experienced growth, increasing 28% compared to the prior year. Although timing can be difficult to project, we do expect capital markets income to be a significant contributor to adjusted noninterest income growth in 2018. As it relates to mortgage, production decreased seasonally 3%, while income increased $4 million or 13%. The increase was primarily due to MSR and related hedge valuation adjustments recorded in the third quarter, which did not repeat at the same level in the fourth quarter. Card and ATM fees increased $3 million or 3%, attributable to seasonally higher interchange income. Total consumer fee income is an important and stable component of fee revenue and is expected to continue to contribute to overall growth in 2018. Total Wealth Management income is up 2% quarter-over-quarter and 7% year-over-year, primarily driven by improvement in equity markets, growth in customers and assets under management. In addition, the company incurred $10 million of operating lease impairments during the third quarter that did not repeat in the fourth quarter. With respect to 2018, we expect total adjusted noninterest income growth in the 3% to 6% range. So let's move on to expenses. On an adjusted basis, expenses increased $21 million or 2%, attributable primarily to increases in salaries and benefits, outside services and Visa Class B shares expense. Total salaries and benefits increased $13 million or 3%, primarily due to higher production-based incentives and health insurance costs. Outside services increased $7 million or 17%, reflecting additional costs associated with the recent launch of our new Regions Wealth Platform in partnership with SEI Global Services. These cost increases will be offset by reductions in other expense categories, primarily salaries and benefits, in the future. The adjusted efficiency ratio improved 60 basis points to 61.1%, and the company produced solid growth in adjusted pretax pre-provision income, increasing 5% and reflecting its highest level since the third quarter of 2008. For 2018, we expect adjusted operating leverage of 3% to 5%, relatively stable adjusted expenses and an adjusted efficiency ratio of less than 60%. With respect to taxes, clearly, there were a number of moving pieces in the fourth quarter. The reported effective tax rate was 39%. Excluding the $52 million of additional income tax expense related to tax reform, the effective tax rate would have been approximately 30%. Following corporate income tax reform, our 2018 guidance for the effective tax rate is now in the 20% to 22% range. So let's shift to asset quality. The company reported broad-based asset quality improvement during the quarter. Nonperforming, criticized and troubled debt restructured loans all declined. Nonperforming loans, excluding loans held for sale, decreased $110 million or 14% and represented 0.81% of loans outstanding, marking the lowest level in over 10 years. We also reported a 17% and 13% decline in business services criticized and total troubled debt restructured loans, respectively. As expected, early and late-stage delinquencies for residential mortgage loans increased within hurricane-impacted markets, and the company's $40 million hurricane-related reserve remains unchanged. Despite increase within residential mortgage, total delinquencies, excluding government-guaranteed loans, declined approximately 1%. Net charge-offs totaled $63 million or 31 basis points of average loans, a 17% decrease compared to the third quarter. For the full year, net charge-offs represented 38 basis points of average loans, in line with expectations. Improving economic conditions drove broad-based improvements in credit metrics, particularly in risk ratings, along with payoffs and paydowns of criticized loans, resulting in a negative provision expense of $44 million for the quarter. The allowance for loan and lease losses decreased 14 basis points to 1.17%. However, the allowance, as a percent of total nonaccrual loans, increased 7 basis points to 144%. For 2018, we expect net charge-offs to be in the range of 35 to 50 basis points. And based on recent performance and current market conditions, we would expect to be at the lower end of that range. However, volatility in certain credit metrics can be expected, especially related to large-dollar commercial credits, fluctuating commodity prices and the impact of hurricane exposures. Let's move on to capital and liquidity. Similar to last quarter, we repurchased another $500 million or 31.1 million shares of common stock and declared $103 million in dividends to common shareholders. Our resulting capital ratios remained robust. Under Basel III, the Tier 1 capital ratio was estimated at 11.7%, and the fully phased-in Common Equity Tier 1 ratio was estimated at 10.8%. Finally, our liquidity position remains solid with a low loan-to-deposit ratio of 83%. And we were fully compliant with the liquidity coverage ratio rule as of quarter-end. So regarding 2018 expectations, tax reform changes made it necessary to recalibrate our long-term target for adjusted return on average tangible common equity. Our 2018 adjusted return on average tangible common equity ratio is now expected to be in the 14% to 16% range. Other targets have been discussed and are summarized again on this slide for your reference. So in conclusion, our strong fourth quarter results provide a solid foundation as we head into 2018. We believe our Simplify and Grow initiative, along with other opportunities and competitive advantages, position us well for 2018 and beyond. With that, we thank you for your time and attention this morning, and I will now turn it back over to Dana.

Thank you, David. We will now open the line for your questions.

You mentioned later this year that you would quantify some of the initiatives that you have underway. I guess, first, is there going to be both a revenue and expense component as we think about some of these efforts?

Yes. I mean, Matt, we've been working for a number of months now on this initiative, and it does have both expense and revenue components. But John Owen, he's with us today, and John is leading that initiative. So I'll ask John to make a few comments.

Just a little bit of background. Simplify and Grow, as you think about it, is a multiyear strategy for the bank. We kicked off the planning process in the fourth quarter working with McKinsey. We wrapped that planning process up in early January. But let me tell you, we've now moved on to what I call execution phase of the project. There are three areas of focus. First is how we make banking easier for our customers. Second would be how we accelerate revenue growth. And third would be about improving efficiency and effectiveness. From a timing standpoint, I will tell you many of the initiatives will go in the second, third quarter. Some will span into 2019 as well. But it's very early. We've got about 10 work streams kicked off very early in the process still.

David, could you discuss how we will respond to this publicly?

Sure, Matt. Regarding Simplify and Grow, as mentioned by John Owen, there are several initiatives that will influence our financial statements in terms of both revenue and expenses. We have provided guidance for the year up to this point and will be attending a number of conferences. As we gain more clarity on how these initiatives will impact our numbers and ratios, we will keep you updated. I expect that we will provide more specific details by the end of the first quarter or possibly the second quarter.

Regarding the investment program, I know you're going to give us a little bit more details later on. But in general, how are you thinking about the ultimate tax reform benefit? And how much of that gets deployed into the program? And accordingly, how much eventually falls to the bottom line?

Yes, John. So this is David. We wanted to give you some flavor for that. If you look at our expectation for return on tangible common equity, we've moved that up 200 basis points from 12 to 14 to 14 to 16. We anticipated some tax reform coming. We believed it was appropriate at the time to increase our capital expenditures to accelerate some opportunities we think we have to better serve our customer. Those capital expenditures, they don't find their way into the income statement. They'll find themselves in the income statement over time. So we have that baked into our guidance already. And we had other initiatives where we've made contributions to our foundation and our $15 minimum wage because we think it was important for us to continue to execute on our mission of shared value, which is taking care of customers and associates and communities as well as our shareholders.

Okay. So no percentage, reinvestment amount that you're willing to give?

No, we increased our capital expenditures roughly $100 million. Right now, you can see that we're keeping our targets for common equity Tier 1 where they are. Therefore, the benefit that we see coming through from taxes will help increase our return on tangible common net 200 basis points.

I wanted to ask if there's anything else besides the CapEx amount. Additionally, I would like to discuss capital deployment. Can you share your current views on M&A opportunities? What are your deployment priorities at the moment, and how does M&A fit into your strategy, both for non-bank and bank sectors?

Yes. So our priorities really haven't changed, John. We focus first and foremost on organic growth. It's important for us to take the capital we generate and put it back into the growth in the business appropriately. When we have opportunities to get an appropriate risk-adjusted return from that organic growth, we've been very disciplined with regards to not just making any loan, but making loans that give our shareholders their appropriate risk-adjusted return. We will continue doing that. Second, we wanted to make sure we have a fair dividend to our shareholders. We had talked about being in the range of earnings of 30% to 40% and that we would be increasing that to 35% to 45% over time. We believe that's important. So as income increases, whether it be through tax savings or otherwise, you should expect that to find its way into that dividend calculation. Then we said we would look at opportunities to expand through non-bank acquisitions. We've had a number of opportunities within that space, such as with BlackArch Partners in the advisory business; First Sterling, our low-income housing tax credit syndicator business, which was basically on ice this year, but we're looking forward to that expansion this year with tax reform. So that's been important. Bank M&A, given the fact that we have excess capital, we really have to look at banks versus share buybacks. And we believe that the share buyback program that we've had going on will continue and that we will continue to work our capital ratios down to that common equity Tier 1 level of roughly 9.5%. As credit quality and derisking continues, perhaps, that number changes. Perhaps, it could even go lower. If we tag on more risk, the number will go higher. But right now, our goal is to get that to 9.5%.

That's a great question, John. We are examining how our income statement is generating more capital and how we can deploy that capital in the most effective way. As David mentioned, our priority is to reinvest this capital back into our business when possible. If that's not feasible, we will consider mergers and acquisitions, primarily focusing on bolt-on, non-bank M&A. While we are also looking at bank M&A, the current economics make that particularly challenging. After we address organic growth and bolt-on acquisitions, our next step is to return capital through dividends and share repurchases. We aim for a competitive dividend and view share repurchases as a strategic option when other deployment opportunities are not viable. Given our current understanding, we believe this will be a productive use of the capital we are generating.

I have a question regarding the balance sheet. Considering the organic growth in loans and deposits alongside the ongoing runoff you've mentioned, how should we view the direction of the balance sheet? It seems to be becoming more efficient, but do you anticipate any expansion of average earning assets this year? Or will it just be adjusting to a final mix that leads to an improved situation?

Yes. So we've given you some guidance on low single digits on the balance sheet for loans and deposits. We see that continuing. We have not changed that guidance post tax reform. We'll see what demand for credit might look like. But right now, we feel pretty confident we can grow in the low single digits on both of those. We do have the headwind of our indirect auto book that will affect us about $700 million, as I previously mentioned. But we can overcome that. We continue to grow and grow the balance sheet both in dollars, but also as you mentioned, it's far more effective and efficient in generating better returns for us.

We are very pleased with the progress we've made in reshaping our balance sheet and the investments we've made. In 2016 and 2017, we made some risk-based decisions concerning our balance sheet and lowered our risk appetite for certain asset classes, which affected our loan growth. However, we experienced strong loan production growth in 2017, particularly in the second half. Currently, our guidance does not include any optimism for loan growth beyond what we are seeing. If businesses become more certain and confident in 2018, that could present an upside opportunity. For now, we have incorporated what we know and observe. We would be encouraged if the situation improves. John Turner is here with us, so John, could you share your thoughts on the potential for loan growth?

Sure, Grayson. I'm happy to. As has been currently suggested, we're currently projecting sort of low single-digit loan growth. That is based upon our assessment of economic conditions, market conditions prior to, as has been said, any tax reform. I would say that we are largely complete with the derisking activities. We'll continue to focus on improving the quality of our portfolio and client selectivity on risk-adjusted returns in the business. And so I anticipate that we will see, just as a result of better execution, continued improvement in execution for that low single-digit growth. And if the economy does, in fact, tick up as a result of tax reform, then we should benefit from that. But in the meantime, we do believe we can deliver low single-digit growth just based upon our day-to-day activities and expectations for the business.

Great. Understood. Can you clarify how much of the efficiency contributes to the net interest margin on its own compared to the impact of interest rates, assuming the anticipated rate hikes and curve?

I'm not exactly sure of your question, but let me see if I can give it a stab. So our efficiency ratio, we have a number of things we're going to have to deal with. The tax equivalent adjustment that we have does negatively impact the efficiency ratio as it does the margins. So I told you the 4 basis points in the margin. But it also negatively impacts the efficiency ratio about 50 basis points.

50 bps, right?

50 bps. But we're still committed to having an efficiency ratio under that 60% that we mentioned. So that will come from continuing to become more efficient on expenses. We did a good job of having it less than 1% growth in expenses this year. We see renewed growth in revenue coming. We gave you the guidance of 3% to 5% on NII. We feel good about that based on balance sheet growth and even more encouraged based on what we've seen of late with the market expectations for rates. And we also are getting back on the growth side of noninterest revenue, where we were down this year, but expect 3% to 6% growth in noninterest revenue. So if you put all that together, and we'll get some incremental benefits from the Simplify and Grow strategy that we talked about, we feel pretty confident we can be under 60%.

I guess, if I look back at the 3Q presentation, you talked about additional expense reductions beyond the $400 million. Details to be provided later in the year. And we're on the 4Q call in January, and it sounds like you've announced Simplify and Grow as a main project. But in terms of getting real financial details behind that, we're going to have to wait later into 2018. Has something changed that means you're taking a deeper look or you're thinking about things in a different way than you were back in October when you put out that 3Q presentation?

No, Geoffrey. There has really been no change in our perspective as we discussed in the third quarter. We have been on a multiyear journey to manage expenses very rigorously and with discipline. We are confident that we have done well in that regard. That said, in the third quarter, we announced that we would bring in McKinsey to help us take a deeper look at our expenses. We have started these efforts, as John Owen mentioned earlier. It's been a thorough evaluation with involvement from people across the company. These evaluations are best conducted thoughtfully and carefully, and we have taken our time to do so. We are currently in the execution phase, and there will be more details to come. However, nothing has changed from our perspective. Everything is proceeding as scheduled, just as we had forecasted.

And I guess, the long-term ROTCE target, it sounds like that's 14% to 16% long term, but also 2018 target, if I'm reading Slide 13 right. So is this going to take another look at that based on Simplify and Grow?

The 14% to 16% target was set for 2018 and is not necessarily a long-term target. We previously anticipated moving up from the 12% to 14% range towards the mid-teens for return on tangible common equity. Since then, there have been changes due to tax reform and the Simplify and Grow initiative. We will provide more detailed guidance within the 14% to 16% range as it becomes clearer. Another Investor Day is planned for around this time next year, where we will present a new set of three-year targets and compare them to the original targets we provided. We do expect growth beyond the results of 2018.

Could you just talk about what you think the main drivers of your forecasted fee income growth will be this year?

Sure. As we examine our noninterest revenue, we initially experienced a slower start in our capital markets business, but it recovered well in the fourth quarter. As mentioned in our prepared remarks, we anticipate that capital markets will significantly contribute to our projected growth of 3% to 6% in 2018. Our service charges have remained a stable part of our noninterest revenue, showing growth of just over 2%, nearly 3% for the year. We expect this to continue as we expand our core checking account households. We will also see growth in card and ATM fees, supported by an increase in transaction numbers. Our Wealth Management Group, especially in the investment management trust sector, has seen growth in both customer numbers and assets under management, which will be a contributing factor. We believe the mortgage sector will also recover, likely showing a nice increase compared to this year's production, which we view as a reset for the industry. These are the main aspects we expect to support our 3% to 6% growth.

Circling back to loan growth, just wondering how we should think about it. Strength throughout the year or perhaps back-end-weighted? And then what do you think will be the primary drivers of growth? C&I and commercial real estate or consumer?

Well, I think when you look at 2018 and you think through when loan demand occurs, I would tell you there's still an awful lot of liquidity in the markets. And if you look at '17 as an example, we've started off with the year in pretty good shape from a production pipeline standpoint. In the second half of the year, we wound up having an awful lot of payoffs and paydowns as people went into the public debt markets. We saw the strength of that stronger in the third than in the fourth, but still elevated. And so I do think that there's still a lot of liquidity that's out there, and so there's competition for that. Internally, we've had debates about the implications of tax reform and what that has on loan demand. We don't see that changing really what's occurring on the consumer side of the house. Consumer is a good story, and it's a steady story. Other than the headwinds that we have from the indirect auto runoff portfolio we've got, it's a good story. Even in mortgage, '17 turned out to be a very transformational year for mortgage as that market went from a refinance market to a home purchase market. But we've always been a strong home purchase mortgage originator, and so most of the impact of that will be past us in '17 on the consumer side. The only lingering effect we got on consumer is just the indirect auto piece. On the commercial side, we put together our forecast based on what we know today. If the economy strengthens, as John Turner said earlier, if the economy strengthens, we got an upside opportunity. But knowing what we know today, we think the forecast that we've given you, the guidance we've given you, we got a fairly high degree of confidence in it. John Turner, would you like to add to that?

Yes, I would just add. Typically, the second and fourth quarters are going to be better quarters. We begin the year with a lot of momentum coming off of a high degree of production in the fourth quarter. So pipelines are a little softer going into the year, but funding should be a little better in the first quarter given that activity in the fourth. We have confidence in our ability to deliver commercial banking and commercial lending activity this year. I think the difference is going to be that we have been shrinking, derisking our investor real estate book. And we have an opportunity to grow that business kind of with the economy, particularly as we see our term lending program begin to mature a bit as we shift our focus on a different kind of real estate customer. We're beginning to see some of that positive activity. So that will have an impact on loan growth as well in 2018.

Okay. And then on asset quality this quarter, nice improvement in the numbers. Wondering how much of that paydowns versus risk-weighted improvements. And how should we think about the loan loss reserve going forward?

Yes. This is Barb. And to answer your question directly, roughly 50% of what we saw in terms of the improvement of our business services classified loan book was payoffs or paydowns. The balance was risk weighted improvements. And it is broad-based. It wasn't just specific to just the energy sector. We certainly saw some improvement in energy, but we saw it right across the board in all the various asset classes. As it relates to the allowance, going to 1.17, again we follow a very formulaic way of doing our allowance. And you've heard me say in the past, we're not going to let it fall substantially. But at the same time, we do have to ensure that we have the right amount of allowance against the right amount of risk. So I don't have a specific number for you that we either target or aim for. We just make sure that the allowance we do have is appropriate and prudent at all times.

I would add that we gave you some guidance on the charge-offs being in the range of 35 to 50 basis points. And based on what we know today, we think we have charge-offs closer to the lower end of that. And you should think about provisioning equal to charge-offs in that case. To the extent it's higher than that, you probably have something that happened in a hurricane or an energy-type reserve, where the reserve is already there. It doesn't have to be replaced.

This is actually Steven Duong in for Gerard. Just circling back on your comments about capital expenditures. You said you're looking to increase CapEx, which should help you boost your ROTCE target. What are these investments exactly? And is it safe to assume that they're capitalized so they won't show in the P&L?

Yes. A couple of points to mention. The capital expenditures, approximately $100 million, exceed what we had in 2017. These investments are focused on making it easier for our customers to engage with us and driving revenue. We don’t directly link them to immediate returns. We see numerous opportunities arising from these capital expenditures, which will impact the balance sheet and be depreciated over time. Depending on the specific project, they may have long durations and could be associated with branch upgrades, digital initiatives, or cyber-risk management. So, consider this increase as impacting the balance sheet and not the income statement, but gradually over time. The expenses will be realized this year, but you will see very little of that reflected in the income for this year.

And Steven, you're seeing a lot of our customers really start to have a high utilization rate in our digital channels. And so obviously, those customers' expectations are being influenced not only by other banks they use but other providers for other services. And so we're having to compare ourselves to a larger community when you talk about digital, and so we make investments there. We also have a number of technologies that we use to help us manage risk and compliance. And so we have to continue to invest in those, continue to strengthen. And we make them better each and every year, and cyber being one of the lead candidates there. But lastly, I would tell you is, coming out of this Simplify and Grow initiative, we've identified a lot of places where technology can help us be not only more effective but much more efficient. And so you're going to see us continue to invest in technology as we go through that initiative. And last but certainly not least is see if you go into some of our branches, the technology we're deploying in our new branch format is entirely different than what we've had in the past. We've done a number of branches in the past in '16 and '17, but you'll see us accelerate that into '18. A huge benefit from us from a customer service perspective and a customer experience perspective when they come into one of our offices.

Great. And just a follow-up question. You guys are trading at about 1.3x book, 2x tangible book. Is there a price level where the buybacks don't make as much sense relative to the other opportunities that you have?

We continue to challenge ourselves on that very point, but we're sitting here with a pretty high Common Equity Tier 1 ratio relative to the risk that we have in the balance sheet. And so when you have excess capital, it's hard to see how the market gives you full credit for being optimized on your capital stack. And so we have to have a pretty high return hurdle for us to deviate from buying back our shares versus making some other type of investments. So when you get to the efficient frontier, having your capital amount and your capital stack optimized, then you've got a different calculus. But for us, getting to that 9.5% is very important to us, and that's where we're marching.

You may have mentioned this earlier. I just missed it. Does any relief in the LCR rule get baked into your outlook for this year? Or could you describe sort of how that would benefit if it plays out in your favor?

Yes, Chris. It's David. We do not have any relief in our numbers from LCR, given that the SIFI designation was changed, and as a result, we weren't subject to LCR. There are some deposits that were low-cost for us, but the runoff assumptions caused us to price those less favorably, and we let those run off. So yes, LCR would be somewhat beneficial to us. It would help us from a liquidity standpoint, allowing us to generate more liquidity. However, we haven't quantified an explicit cost at this point.

Okay. Great. Could it also help fuel further buybacks as well?

Not really. You're discussing different types of liquidity, specifically liquidity in the bank compared to liquidity at the holding company. These are distinct concepts, and any liquidity we require at the holding company to facilitate our buybacks and achieve our target capital ratios will be sourced through debt issuances, as we have done in the past.

Okay. Well, thank you. I certainly appreciate everybody's time and attendance. We think we just ended a very solid 2017 and are positioned well for a strong 2018. And I do appreciate you listening to our message this morning and our answers to your questions. So thank you. Let's have a great year. Thank you.