Regions Financial Corp (RF) — Q2 2019 Earnings Call Transcript

Thank you, Shelby. Welcome to Regions’ second quarter 2019 earnings conference call. John Turner will provide highlights of our financial performance and David Turner will take you through an overview of the quarter. The slide presentation as well as our earnings release and earnings supplement are available under the investor relations section of our website. 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. With that, I will now turn the call over to John.

Thank you, Dana, and thank you all for joining our call today. Let me begin by saying that in the face of significant market volatility, we are pleased with our second quarter results. We reported earnings from continuing operations of $374 million, a 3% increase over the second quarter of the prior year and earnings per share of $0.37, an increase of 16%. We also delivered solid pretax, pre provision income growth compared with the prior year, and generated 4% adjusted positive operating leverage. This quarter's results demonstrate that our core business remains strong. Our focus on meeting client needs is producing sustainable growth. We grew revenue, average loans and deposits and new customer relationships across the market while reducing expenses. We are also experiencing success in our priority markets which included Atlanta, Houston, Orlando, and St. Louis. For example, in Atlanta, the pace of new account and deposit growth is approximately twice that of the total company. Further, we are outperforming the general market in terms of household account growth in each respective location. Shifting to the corporate bank, in just six months we have added a significant number of new clients across these same markets. Commercial banking growth has been particularly strong in Houston where pipelines for credit and deposits are at all time high. Although it’s early, we believe these facts provide evidence that our investments in growth are paying off. We remain focused on those things we can control, and we continue to feel very good about our future. We are largely complete with our hedging strategy that we began about 18 months ago. These instruments will provide stability to our net interest income and net interest margin. Dave will spend some time discussing the details of that strategy in just a moment. We also remain well positioned to prudently manage through the next credit cycle because of our ongoing risk mitigation activities, including client selectivity, sound underwriting, rigorous credit servicing, and appropriate concentration limits. We remain focused on appropriate capital allocation, balance sheet optimization, and risk-adjusted returns. This work led to our exit of indirect auto and insurance and the decision to exit a point-of-sale relationship earlier this year. It also informed our strategic decision to achieve better balance between construction and term commercial lending within our real estate business. Another meaningful example of our commitment to build a business that's sustainable over the long term. This quarter, we repositioned a portion of our investment securities portfolio, continued to focus on client selectivity and relationship profitability with our loan portfolios, and improved our funding mix. These actions will help support net interest income and the net interest margin going forward. Despite recent market uncertainty, the economy still feels pretty good. While our customers are more cautious than they were just a few months ago, they maintain a positive outlook, and most continue to expect better performance this year than last. Many of our customers have a backlog of orders, with the biggest challenge being an insufficient supply of skilled labor. Fundamentally, the domestic economy remains solid, and credit quality continues to reflect relatively stable performance with some continued normalization. While lower interest rates support continuing economic expansion, they will certainly pressure future revenue growth. To respond, we will continue to build on the momentum we've established through our simplifying growth initiative to make banking easier, accelerate revenue growth, and importantly, become more efficient and effective. Should the market's current path for lower interest rates persist, with short rates declining in the second half of 2019 and remaining at lower levels into 2020, and the economy softens faster than we expect, achieving some of our long-term financial targets will be challenging. That being said, we remain committed to doing all we can to appropriately adjust our plans and respond. To summarize, this was another solid quarter for Regions, and despite the market volatility and uncertainty, I feel good about where we are today and believe we're well positioned to generate consistent and sustainable long-term performance throughout all phases of the economic cycle. With that, I'll now turn it over to David.

Thank you, John. During last quarter's call we spent time talking about certain balance sheet optimization efforts that were either underway or actively being developed. Today, I want to spend a few minutes highlighting the results of those efforts. When we say balance sheet optimization, we're referring to the strategies we execute every day to challenge the efficiency of our balance sheet in order to maximize net interest income and margin, as well as overall profitability and returns. This quarter, adjusted average loans grew approximately 1%. As you may recall, late last quarter we experienced loan growth from certain large corporate customers that, while high in quality, generated thinner spreads. We anticipated some of these customers would use refinancing in the capital markets. Although we have experienced some movement, the moderation in loan growth this quarter was primarily due to our continued focus on client selectivity and overall relationship profitability. As John mentioned, loan demand in our markets remains reasonably healthy, but maintaining our disciplined approach impacted overall balance growth. We remain focused on risk-adjusted returns and are not interested in trying to outgrow the economy by pursuing nominal loan growth for short-term benefit. With that said, we continue to expect full-year growth in average adjusted loans to be in the low to mid-single digits. During the quarter, we also executed strategies to better optimize our securities portfolio. We reduced the overall size by approximately $1.5 billion through a combination of maturities and sales. We sold another $2.8 billion of lower yielding securities and reinvested those proceeds into higher yielding securities, improving our yield run rate by 8 basis points, while recognizing approximately $19 million of net losses. The new securities were selected to ensure appropriate prepayment protection with a focus on improving performance in a declining rate environment. Turning to the liability side of the balance sheet, average corporate segment deposits decreased 3% during the quarter and included seasonal declines within public fund accounts, as well as an intentional exit of approximately $700 million of higher cost deposits that were added during the first quarter to support loan growth. Despite this reduction, total average deposits still increased approximately 1% driven primarily by growth in consumer. Exhibiting the strength of our core deposit franchise, average consumer deposits increased $1.3 billion, and importantly average noninterest-bearing consumer deposits increased almost $600 million. These optimization strategies also triggered a reduction in wholesale funding needs during the quarter. Average FHLB advances are down approximately $1 billion compared to the prior quarter. So let's look at how this impacted net interest income and margin. Net interest income was down slightly compared to the first quarter, and net interest margin totaled 3.45%. As expected, continued deposit pricing pressure was the largest driver of this quarter's margin. What is important to know, however, is that we did see deposit costs peak within the quarter in May and subsequently trend down in June. Our total deposit costs remain one of the lowest in the industry, and our cumulative deposit beta for the recent tightening cycle is 29%. Assuming the Federal Reserve begins to ease in orderly increments of 25 basis points, we currently expect an initial deposit beta of approximately 35% at the beginning of a down rate cycle. In addition to deposit cost and after normalizing for days, another driver to this quarter's margin was declining market interest rates. This includes the decline we saw in LIBOR in anticipation of potential rate cuts by the Federal Reserve, as well as the decline in loan rates. Currently, the market is pricing in further interest rate declines over the second half of 2019. So let's spend a few minutes looking at how this could impact our results. While reducing deposits could provide some relief using the June 30 market forwards, which includes roughly 325 basis points of reductions, we would expect full-year net interest income to be modestly higher than the prior year. While fourth-quarter margin would approach 3.40%, the low end of our long-term range, we would expect the first quarter's margin to expand into the low-to-mid 340s as the benefit of our forward starting hedges begins. Now I want to take some time and walk you through our hedging strategy and its expected financial benefit. Slide 6 contains additional details regarding our use of forward starting swaps and floors along with their anticipated impact on our future asset sensitive profile. The chart provides a cumulative build of the notional value of our hedges broken out by the quarter in which they become effective. We are substantially complete with our hedging program. Importantly, the bulk of those forward starting hedges become active on January 1, 2020. In addition, these forward starting hedges have maturities of approximately five years from their respective starting points. These longer tenures provide better support to future net interest income to the extent rates remain low for an extended period. Because a significant portion of our hedging program is forward starting, many of you may be modeling a negative impact to our future net interest income that will look markedly different six months from now. To illustrate the benefit of our future dated hedges, we have provided the estimated impact to annual net interest income associated with a standard 100 basis point gradual, parallel shock for each future period presented. The table highlights this inverted relationship. As our forward starting hedges become effective, our asset sensitivity is reduced. The key takeaway from this slide is that our forward starting hedges will stabilize our interest rate sensitivity profile in 2020 and beyond. So let's move on to fee revenue. Adjusted noninterest income increased 2% compared to the first quarter. Service charges, card and ATM fees, and mortgage reflected seasonally higher revenue combined with continued customer account growth and an increase in transaction activity. Wealth management income increased primarily due to sales and market-driven revenue from investment management and trusts, combined with higher sales volumes from investment services. Within mortgage income, our net MSR hedge impact remained relatively consistent quarter-over-quarter. However, as expected in a declining rate environment, we are beginning to experience an increase in prepayment decay. Partially offsetting these increases were declines in capital markets, like on life insurance and other noninterest income. The declining capital markets were primarily due to lower M&A advisory fees and customer swap income. The decline in customer swap income was almost entirely due to market-related credit valuation adjustments tied to customer derivatives. Excluding these market-based adjustments, total capital markets income would have increased approximately 5%. Let’s move on to noninterest expense, which continues to be a really good story for Regions. Adjusted noninterest expense increased 1% compared to the first quarter. Furniture and equipment expense, outside services and professional fees increased this quarter, but were partially offset by a decline in salaries and benefits. A decline in staffing levels of just under 300 full-time equivalent positions combined with a favorable reduction in benefits expense contributed to the decline in salaries benefits. The adjusted efficiency ratio was 58.3%, unchanged from the prior quarter. Despite success in managing our costs, the challenging revenue environment necessitates even more focus on expense management. One area with expense save opportunity is within corporate real estate. This quarter we took advantage of market opportunities and sold a large office building in excess of 100,000 square feet. We also made a decision to market the sale of another large office building in excess of 300,000 square feet. These transactions will benefit future occupancy expense and are expected to help us exceed our goal to reduce over 200 million square feet of space by 2021. Additionally, we continue to make significant progress in the digital space. Digital checking account openings are up 53% and digital card production is up 43% year-to-date. The effective tax rate was 19.4% and was impacted by excess tax benefits associated with invested equity awards. So let's shift to asset quality. Asset quality continues to perform in line with our expectations this quarter and reflects stable performance within a relatively benign credit environment, while some normalization of certain credit metrics continued. Overall credit results remained well within the acceptable range of our established risk appetite. Net charge-offs increased to 0.44% of average loans, in line with our expected range of 40 to 50 basis points for 2019. Provision matched net charge-offs, resulting in an allowance equal to 1.02% of total loans and 160% of total non-accrual loans. Non-accrual loans increased modestly while Business Services criticized loans remained relatively unchanged. Total troubled debt restructurings decreased 7%. While overall asset quality remains stable and within our stated risk appetite, volatility in certain credit metrics can be expected. So let me give you some brief comments related to capital and liquidity. During the quarter, the company repurchased 12.8 million shares of common stock for $190 million and declared $141 million in dividends. In June, we announced details related to our 2019 capital plan. We intend to reach our 9.5% common equity Tier 1 ratio target in the third quarter and managed at that approximate level going forward. Our capital plan includes the ability to repurchase up to $1.37 billion of common stock. However, the exact amount and timing of repurchases will be determined by actual loan growth and our overall financial performance. We also expect to increase the quarterly dividend within our stated range of 35% to 45% of earnings. The Board will consider this increase at their meeting next week. Our full year 2019 expectations are presented on slide 11. Assuming the market forward curve at quarter end, we would expect to be at the lower end of our 2% to 4% full-year adjusted revenue growth target. Given the certain revenue environment, we are increasing our focus on expense management and expect full-year adjusted noninterest expense to be stable to down slightly. We expect to generate positive operating leverage for the year. As John noted, we remain focused on the things we can control. We are responding to the changing market dynamics as we have in the past. So in summary, we are pleased with our second quarter financial results. We have a solid strategic plan designed to deliver consistent and sustainable performance throughout any economic cycle. With that, we're happy to take your questions, but we do ask that you limit them to one primary and one follow-up question.

Good morning, everyone. It seems like you've noticed a change in deposit costs, which are at around 29%, and this is one of the lowest cycles we've seen so far. We're looking at our net interest margin approaching 3.40% and expected to rise. Could you share your thoughts on your ability to reduce deposit costs across retail, wealth, and commercial sectors? Also, considering the sensitivities you've mentioned and the shifting dynamics on the balance sheet, how do you view the sensitivity to short versus long-term interest rates? I have another question after that.

Okay. This is David. So we're encouraged by the reaction of our teams on deposit cost. We are clearly competitive, and in the month of June through our actions, we took down deposit cost a couple of basis points. We expect that to have already peaked, and to the extent that we continue to get short-term rates down, that will give us even more ability to reduce deposit costs. We have about 10% of our deposits indexed, and another 10% of our interest-bearing deposits have been exception priced, which really allows us to react quickly as the market changes, giving us confidence that we can continue to hold our margin at that 3.40% level for the remainder of the year, even if we get the two or roughly three cuts that the forwards imply.

Got it, and maybe as my follow-up, you talked about the environment being challenging, and it might be hard to hit some of your targets. I guess if the rate environment does improve, do you think you could still approach the low end of your efficiency and ROTC targets? And then second, do you expect to continue to be able to generate positive operating leverage, even if you don't hit the target? Thanks.

Yes. So we made a commitment at Investor Day that we would generate positive operating leverage each year of our three-year plan. Clearly, the rate outlook puts some pressure on that, but we are still committed to generating positive operating leverage. If you recall the last three-year plan that we had, the market didn't behave quite like we thought it would either, and we pulled whatever it took to make sure we met those targets. So we have confidence in that. Clearly, if we have a persistent low-rate environment for this whole three-year period, that does put pressure on certain of those metrics. But I would like to point out that we're six months into our three-year plan. There are many things that can happen, and so we're confident we have a good plan that allows us to do what we need to do to continue to improve our financial performance. We will do that; it was the commitment that was in our prepared comments from both John and me.

Good morning, John. On the expense topic still, I guess longer-term, you had an expectation for below 55% efficiency ratio in 2021, or by 2021. Can you just think, just let us know how you are thinking about that level and if it's still attainable despite the rate backdrop just given your hedging, et cetera? Thanks.

Yes. As I tried to mention to Ryan, three years is a long time. If you just did the math on this rate persisting for that entire three-year period of time, it would be pretty hard to get to a 55% efficiency ratio because what we don’t want to do is cut our expenses so much we damage our franchise. We can get pretty close to that even in that rate environment because of all the hedging that's in place. But could we hit 55%? It would be, again, this rate environment persisting the entire time would be pretty tough.

But I would say, John, I mean we're going to remain focused on effective expense management while investing in our business. You can expect us to continue to deliver on our commitment to maintain expenses flat or down slightly while investing in our business and hopefully growing revenue despite what is a challenging interest rate environment.

Let me add to that, John, because we are talking about the interest rate environment. If we have a low-rate environment with slope to the yield curve, that's very helpful. If we have a higher rate environment with slope, that's ideal. A low and flat rate environment is where we have pressure on that 55% margin.

Got it, okay. That's helpful color.

I'm sorry, efficiency.

Right, right, got it. Okay, and then my follow-up is around credit. Just wondered if we can get a little bit more color on the increasing charge-off on the commercial front? Where did they come from? And then also, your non-performers still saw a moderate increase in the quarter despite the higher charge-off. So, implying that we are seeing a pickup in flows here. Can you talk about what is driving that? Thanks.

Sure, it's Barb. Relative to charge-offs, they were driven by one loan, which was in the healthcare sector, something that we've been working on for quite a while and finally came to a resolution. We don't see anything systemic in there. Relative to the NPLs, it was three loans that really drove those numbers, of which one has since been paid off. The other two, we don't expect any loss from them at this point. So, again, nothing systemic. We are still seeing credit is being stable in our outlook going for the balance of the year, and we are committed again to the 40 to 50 basis points range for the balance of the year.

Hi. There are puts and takes on the balance sheet kind of outside of loans. You talked about loans and securities, reinvesting them. Just as we think about earnings assets, ex loans, are those kind of relatively stable going forward with the restructuring? I just want to make sure I got all the puts and takes there.

Yes, Matt. I would tell you that some of those investment transactions were toward the end of the quarter. So if you look at our average, our average is below with ending was, so we're going to feel a little bit of pressure on earning assets from that trade into the third quarter. So it's really not as much on growing net interest income and margin on earning assets as it is the mix and being able to react to deposit pricing should we have rate reductions.

Are the non-loan earning assets expected to decrease slightly on average for the third quarter compared to the second quarter?

In particular, in the investment security portfolio because that trend happened at the end of the quarter.

Yes, okay. And then just following up on the line of credit discussion right before me, the early-stage delinquency numbers also moved up. Did that relate to the healthcare loan or the commercial inflows, one of which paid off, or was that driven by something different?

Yes. Part of that is seasonal in our 30-day buckets; 90-day buckets were down, and the 30-day was up marginally. There's nothing systemic in there at all. That is just part and parcel of our seasonality.

Thank you. Good morning. Question for you on M&A. Could you just give us an idea of what your interest level is at this point in bank and non-bank M&A?

Yes. Thank you. Our interest in bank M&A hasn't changed. We remain focused on the execution of our plans. We don't see any material change in the economic analysis of M&A and bank M&A. So we're going to continue to watch the market. We're going to continue to pay attention to what's occurring, but our position hasn't changed. With respect to non-bank M&A, we continue to look for opportunities to add capabilities to help grow and diversify revenue to meet customer needs. We recently announced the acquisition of Holland, which is a wealth management capability that is complementary to our healthcare business, and one that we're excited about. It's a smaller transaction like the others that we've done, but it's meaningful in that it helps us, we think grow and diversify revenue and meet a customer need by adding some capabilities. We have been actively looking at mortgage servicing rights acquisitions, but with the rate environment, those transactions have become more challenging to find. But we'll continue to do that, and within our other businesses, we're again always looking for opportunities to add to our capabilities and will remain active there.

Good morning. You guys are putting a little bit more emphasis on the expense side. I was just wondering if you could talk about some of the levers because it certainly doesn't seem like you're in a slowdown in investment.

Yes. Peter, that last statement is really important because we are continuing to look for ways to make banking easier for our customers, looking to make investments in talent and technology. We have to pay for that, and a way to do that is to continue to focus on our expenses and leverage our simplifying growth continuous improvement program that we started a little over a year and a half ago. If we're going to control our expenses, we have to really have an intense focus on our top three categories, salaries and benefits being number one. We have reduced staffing levels by just under 300 positions this quarter, and continue to look for opportunities to streamline operations by leveraging technology. Most of that gets handled through attrition. We've looked at occupancy, our next biggest category; as we have in our prepared comments, we had some 400,000 square feet of space that we're exiting. Some of it we have exited; some of it we just put in held for sale and will be getting out of that space to save us on run rate occupancy. Also furniture, fixtures, and equipment, our third category as we have here, we have a smaller space where we can save there as well. Our fourth category would be kind of purchasing or vendor spends, if you will. We have implemented procurement that has put a lot of rigor in helping us from a demand management standpoint on controlling what we need from a purchasing standpoint, whether it is consulting hours or products or whatever the case may be. In this type of challenging revenue environment and a commitment to positive operating leverage, we have to pull every string that we can in terms of controlling expenses.

And I'd add, Peter, we're, as we've said a few times, we're really pleased with our simplify grow initiative and we're really only beginning to see the benefits of the continuous improvement work that's occurring. I asked John Owen, who has led that initiative, to briefly talk about a couple of other opportunities that we see through the use of our digital capabilities to drive improvement. John?

Yes. Good morning, everybody. We added about 17 new initiatives to our simplify and grow list in the second quarter, bringing that number up to about 62 initiatives. We've already completed 13 year-to-date and will complete another 11 initiatives in the second half of 2019. When I think about some of the things we point to, let's go back to Investor Day; we talked about launching our digital lending platform on the consumer side of the house. That has really taken traction. We're seeing 38% of our applications today come in through that digital channel. On the e-side, e-close part of this, we're up to about 58% of our direct loans closing through e-signs showing really good traction of digital lending capabilities. On the account opening, we're in a digital front. I think I'd point you to the team, as part of simplify and grow working now for about a year, to streamline account opening and make the credit card process smoother and quicker. I would revise the application, we've streamlined, and we now are getting about a 53% increase in our digital account opening and checking accounts. About a 44% increase in credit card production through that digital channel, so really good traction there. On the AI front, we continue to look for use cases on how we can roll out AI across the bank. You're all familiar with what we've done in the contact center. We've expanded a couple of things in the contact center with AI. One of those is now where we launch password resets, which is one of our top calls into the center. We launched that this month, and we're seeing really good traction with our AI virtual agent handling those password resets. The last thing is we're having good success with AI in our quality assurance functions, where we're actually having the AI virtual agent quality assurance call type categorizations and really going through and making sure that our reps are following the right disclosures and right scripts, reducing our expenses in that QA area by about 70%. So we're seeing good traction with AI as well.

And then if I could ask with the hedging strategy really starting to kick in beginning next year, and you gave the outlook for the margin in the first quarter. Should we expect the margin going forward next year to be kind of flat to up?

Yes. I think to the extent, so we're all assuming that the forwards actually work their way through for next year. As you can see on the chart, I think of slide 6, where we are trying to show you more and more hedging, more and more of the derivatives actually become effective, which helps us stabilize margin. What we're trying to do through the hedging program is just neutralize the impact of insurance policy on lower rates, which prevents us from having to grow net interest income and margin from coming out of a hole. Now you can have organic growth and the balance sheet and put on good earning assets to give you the kind of growth that you want. We're not having to work against a headwind like we think many others might have. We do have the ability to grow depending on what we put on in terms of earning assets in 2020.

Good morning, everyone. Thank you. I would like to follow up on the previous question. The scenario you presented on page 5 is very useful as it outlines three possible interest rate cuts in the forward curve. I am curious to know how the potential savings would change if the Federal Reserve only implements one cut. Would the outcome be similar but achieved through a different path, or could you explain how the timing might be affected if we do not receive all three cuts?

Yes. Ken, a couple of things to think about our sensitivity. We really have two things working. First is, to your point, the short end of the curve. The short end of the curve is where our derivatives are tied to generally speaking one-month LIBOR. We have received fixed in those so cuts in short term with the protection on the other receive fixed derivatives and our ability to reduce deposit cost in that 35% deposit beta we are talking about gives us the confidence that we have in 2020. Even if you have one, two, or three cuts in the short end, we have protection under any of those scenarios. The second part is what happens to the long end of the curve. If we have slope to the curve, even in a lower rate environment, if we have slope, we are protected as well because the reinvestments coming off the investment portfolio are tied to the long end. We don't want to have a lower and flatter yield curve, which is horrible for our industry as you know. So we're not as concerned about whether it's one, two, or three because we'll react appropriately as long as we can get the long end to at least stay where it is and maybe even increase a bit.

Got it. So regardless of the pacing, then you feel pretty good that Q1, 2020 loaded mid-3.20s can happen in most any circumstance except for a meaningfully flatter curve environment?

That's exactly right. We've started putting this on over a year and a half ago with the expectation that we were going to be in this environment. We just thought it would be beginning in 2020, which is why we did forward starting. We did, we thought there were going to be rate increases through 2019, and we wanted to stay asset sensitive, so we've been caught a little bit exposed in the latter part of 2019 as have every peer of ours. But we're feeling pretty good about what can take place in 2020 going forward; we have duration on those swaps and floors of five years beginning in 2020. So we have really good protection then.

I understand. Lastly, could you clarify the forward charting swaps with the fixed-rate strike? Are there significant differences among them? The average rate is 2.48% for the swaps and 2.08% for the floors mentioned on page six. Are they all generally around that average, or do they vary significantly in or out of the money across the portfolio?

Yes. The averaging that we've given you, so we went to disclose a lot more this time to give you the ability to do your models. We think the averaging is going to be representative enough. There will be 25 basis points here and there, but nothing that's really going to skew that from using the averages.

Good morning. I just wanted to clarify the response to Ryan's earlier question. As we think about the 35% deposit beta, is that given that deposit costs already peaked in May? Or is that for the initial 25 basis points? And as we think about 2020, what do you think, and if the forward curve is right and we get three cuts and then maybe not anymore, what could the ultimate sort of reverse deposit beta be on those 75 basis points of cut?

Yes. I think we're going to start at 35. I think over time we're at 29 cumulatively going up. So if you're starting at 35, you'd expect that to drift down a bit as time goes through. I think that's what you're asking.

So the initiative to clarify the initial impact is immediate regarding the 35%, particularly concerning the 20% of your interest-bearing deposits that you're classifying as either quite expensive or indexed. The repricing, I assume, would taper off in terms of the percentage of cuts rather than accelerate.

Yes, you're right. It begins at 35, and by the end of the day, it will drop from that 35 down into the higher 20s. The reason for this is the 10% indexing at the exception pricing engine, along with our deposits being compared to our peers. We benefit from our floors and our receive-fixed swaps.

Yes. And just to clarify, we are loud and clear that 55% and below on efficiency is indeed more difficult in this rate environment. You did something earlier as an answer, a reply to a question that's flat to down slightly on expenses still a commitment. Is that what we should think about over this three-year period regardless of the rate environment?

Yes. So this is David. The flat to slightly down was in response to changing our guidance for 2019. I think your question is then what does it mean for the next three years? If we're in this challenging revenue environment, we clearly have to bake in 2% to 2.5% inflation into our expense base every year. We have to continue to see cuts; if we want to keep expenses relatively stable. We have to find ways to cut that 2.5%. If we want to make investments on top of that, we need to find even more. Our commitment is that we would generate positive operating leverage under any of those environments, each of those three years. Clearly, a lower rate environment and a flatter yield curve makes that very tough. But that's what we seek to do. We will do whatever it takes to meet our expectations that we've laid out. The commitment was 55% three years from now; we're only six months into it. So we're not giving up on 55% by any stretch.

Hey. Good morning, everybody. So I guess I'm still a little bit confused on the 35% deposit beta and either glide path thereafter for future cuts. Are you saying that on the first 35 or the first 25 basis point cut, you'll see a decline in your interest-bearing deposit cost of 35%?

Yes. We felt like ours are going to happen a little quicker because of the indexing that we have on 10% of our $60 billion of interest-bearing deposits, and another 10% exception-priced that we can move quickly on. So we think that can be pretty high early on. We think that could be maintained for a couple of quarters. At some point, though, that has to taper off. We're only up 29, so if you start at 35, some point it has to taper off as you get to an absolute floor in terms of deposit cost. So does that help?

Yes, I think so. But the 35% then you're saying is pretty immediate?

That's correct.

Okay. I guess just more of a conceptual question then on NII and how to think about net interest income growth in 2020 and 2021. I'm not certainly not asking for guidance. I know it's too early for that. But the extent to which you have stabilized your rate sensitivity, you've neutralized it to a large degree. When we think about NII growth beyond this year, should we be thinking net interest income grows more in line with loan growth average earning balance growth and mix shift and that occurs not necessarily independently of rates, but that being a much bigger driver of net interest income growth regardless of what the rate environment does?

That's exactly what we are trying to communicate. Our hedging program gives us the opportunity to not have to climb out of a hole to grow NII margin. Rather, it neutralizes that; it was insurance protection from a low-rate environment, not to give us a tailwind but to keep us from having this massive headwind. Therefore, we could participate in growing NII and margin as we continue to grow earning assets while watching our deposit cost. Our deposit franchises still are our number one competitive advantage, and we think that's going to help us continue to grow NII with appropriate balance sheet growth.

Okay, no, that's helpful. If I can sneak one quick final one in. I don't know if I missed it, but the outlook for indirect auto and indirect other consumer, now that you guys have exited or not renewed the commitment there. How do we think about, can you remind us what your expectations are for balances there and how much fines and what the other consumer line balance should do?

If you look at in our supplement on page 21, you'll see our indirect vehicle decline this past quarter some $350 million. So we're kind of on that run rate. We're not renewing that. It'll take some time. The average for the year will be about $800 million on the indirect auto decline. I'm sorry that's not auto; I mean GreenSky.

Yes, GreenSky, okay. Thank you.

Yes. We need to clarify that. I think it's $800 million on average on the indirect auto portfolio full year, right, that's right. And then the runoff with respect to the indirect unsecured portfolio, it will top out over the next month or two as that contract expires, and then we kind of expect 2 to 2.5 year sort of weighted average payout on that portfolio.

Thanks. Good morning. I wanted to ask about the environment later this year or next year about hiring teams of producers. Is this the environment where you invest in that or perhaps a few new markets come into the Regions' footprint because of external opportunities?

Yes, all of our business leaders, along with our commercial corporate real estate team, are continuously recruiting. Our consumer business is also engaged in this effort. It's important for us to always identify the top bankers in their markets as well as adjacent areas and specialized sectors. We are actively recruiting and have seen positive results already this year, especially in key markets where we are investing, such as St. Louis, Atlanta, Houston, and Orlando, and we plan to keep this momentum going.

Good morning. I was hoping you can give us a little more color on the 9.5% CET 1 ratio target for the third quarter? It would seem that would imply a pretty aggressive buyback this quarter. Can you help us out with the cadence of the buyback in the near term and then through the cycle?

Yes. Kevin, you're exactly right. We put into our prepared comments that we were going to get to our 9.5% in the third quarter. Obviously, we have loan growth that uses up some of that and dividends, and then buying back to get us to that 9.5%. It will be exactly that every single quarter. But we're going to do what we can to keep it at that level because that's a level of capital we think we need to run the company based on our risk profile. That does imply a quicker buyback or more of a buyback here in the short term, and it will moderate after that, and we will use the repurchase ability. We have authorization for our board up to $1.37 billion of stock buyback, and how we think about capital allocation is, first and foremost, we will pay a dividend of 35% to 45% of our earnings. Then we're going to use some for organic loan growth, and then we'll use the rest to buy back stock to keep us at that 9.5%. Should loans grow faster, buybacks will be smaller and vice versa, if loans don't grow, buybacks will increase so that we can keep the capital optimized in the company.

Okay. So given the authorization that you have for this cycle, it would imply that, or it would seem better imply that we keep the loan growth relatively low single digits or somewhere very close to that or maybe even closer to stable in the near term. Is there anything you're doing within the balance sheet in order to decrease risk-weighted assets or some other way to keep the ratio at 9.5% given the buyback authorization you have in place?

No. Our teams are out there growing loans when it makes sense from a risk-adjusted return standpoint. We grew the first quarter a little quicker than we had expected. We slowed that down a bit this quarter. We still have the low to mid-single digit growth expectation for the year. Any given quarter you can see a pace change. The third quarter for us over the last couple of years hasn’t had as strong growth even though our pipelines look pretty good. The fourth quarter, on the other hand, has actually been pretty strong. We're sticking to our commitment to loan growth. My point is that we use 9.5%, and we toggle between loan growth and share buyback. We're not trying to manufacture one or the other. We want both. We would much rather use our capital to grow organically than to buy our stock back. But we also want to have appropriate risk-adjusted client relationship type returns on the loan side. If we don't get those and we can't use our capital to grow appropriately, then we will buy our stock back if that makes sense.

Question. Can you guys share with us we've seen a lot of commentary on the strength of the consumer business and we all know how low the unemployment rate is in this country. The wage growth seems to be accelerating. But there seem to be some cross currents in the business side of our economy with what's going on with the trade negotiations, et cetera. So can you give us some insight into what your business customers are sharing with you about their business? Could you tie that into the forward curve of 325 basis points rate cuts in 2019? It just seems like the forward curve has been a little aggressive on those rate cuts. I'm curious to see what you guys think.

To answer the second half of your question, no, we cannot tie it into the forward curve. I would tell you that our business customers are still cautiously optimistic. Over the last 90 days or so, I sense more caution on the part of our business owners, but they are still optimistic. Their 2018 results were very good, and most are having good 2019 results. As we look at our credit quality across a variety of industry sectors, we really don't see any significant issues other than within the restaurant sub-sector, which we've called out before. Fast casual doesn't appear to be any other stresses of consequence that we see. Customers have good pipelines, and I think I said in my prepared remarks, the primary constraint we see on the economy is the availability of skilled labor. That’s the thing that tends to constrain businesses from investing, not the interest rate environment. I really can't tie our view of the economy through our customers' eyes to the forward rate curve.

Sure, Gerard. Our teams have been working diligently to prepare for the adoption in January 2020. We plan to include some information in our 10-Q that will provide an update on our status as we approach Day 1. As previously mentioned, consumer portfolios are significantly affected compared to commercial portfolios, with about 40% of our loans being consumer loans rather than business services loans. Seasonal adoption tends to impact mortgages, HELOCS, credit cards, and unsecured credit much more than it does the commercial side. Please stay tuned for updates in our 10-Q filing.

Well, thank you, everybody, for your interest. I hope you can tell we think we had a solid quarter despite the volatility in the market. We're focused on things that we can control: client selectivity, sound underwriting, credit servicing, effective expense management, resource allocation, and risk-adjusted returns. We have a good plan that we think neutralizes our interest rate sensitivity. We believe we're well positioned to continue to execute on our plans, and we stay focused on that. So thank you for your interest in Regions, and have a great day.