Regions Financial Corp (RF) — Q3 2020 Earnings Call Transcript

Thank you, Shelby. Welcome to Regions’ third quarter 2020 earnings call. John and David will provide high-level commentary regarding the quarter. Earnings documents, including forward-looking statements, are available under the Investor Relations section of our website. These disclosures cover our presentation materials, prepared comments, and the Q&A segment of today’s call. With that, I will now turn it over to John.

Thank you, Dana, and thank you all for joining our call today. Before we get started, I want to mention that we’re taking a slightly different approach to our call today. Rather than walk you through our results in detail, we’ll speak to the key highlights we think are most important, and then open it up for your questions. Hopefully, you’ll find this approach to be a little more efficient use of your time. We’re very pleased with our third quarter results. We reported earnings of $501 million, resulting in earnings per share of $0.52, a 33% increase over the prior year. We continued to experience nice revenue growth while prudently managing expenses, generating the highest adjusted pretax pre-provision income in over a decade. Our core banking operations remain strong. We achieved record levels of deposits with growth across all three business segments. We continued to see growth in consumer and small business checking accounts. And despite the uncertain environment, our customers appear to be relatively healthy and are appropriately adapting their spending habits. As a result, most credit metrics improved. And we’ve been very pleased with a significant decline in loan deferrals. Our customer assistance program appears to have worked as intended with the vast majority of customers who previously received deferrals now returned to a normal payment schedule. Our results also reflect the success of simplifying growth, our Continuous Improvement initiative. We continued to carefully manage expenses while making strategic investments to grow our business. Our third quarter adjusted efficiency ratio was the lowest in 12 years, and our investments in mortgage and digital are paying off. Year-to-date mortgage production is more than double that of last year. Our focus on enhancing the digital experience is also resonating with customers. Digital logins are up 22%, mobile deposits are up 50%, and digital account openings are up 24%. Our recently redesigned iPhone app currently has a 4.7-star rating. Thus far, the Southeast seems to have fared generally better economically during the pandemic than other areas of the country. States across our footprint were among the last to shelter in place and the first to reopen. As a result, the unemployment rate has generally been around 200 basis points below the national average, contributing to a relatively stronger GDP. We remain cautiously optimistic about the pace of economic recovery in our footprint, and client sentiment continues to improve. As a result, given what we know today, we believe the credit risk in our loan portfolio is appropriately reserved and losses will be manageable. Before I turn the call over to David, I want to recognize Barb Godin. Earlier this quarter, Barb announced her plan to retire by the end of the year. So, this will be Barb’s last earnings call. Barb will retire after 45 years in banking. She joined Regions in 2003 and was named Chief Credit Officer during the height of the financial crisis. Over the last 10 years, as Chief Credit Officer, Barb has done a terrific job leading our credit risk organization through a period of tremendous change. Over that time, Barb’s contributions were recognized by the American Banker as one of the most powerful women in banking. She’s truly done a great job for Regions, and we’ll miss her presence every day. I hope you all will join me in thanking Barb for all she’s done and congratulating her on a well-deserved retirement. Thank you, Barb. With that, I thank you for your time and attention and will now turn it over to David.

Thank you, John. Let’s start with the balance sheet. Average adjusted loans decreased 3%. While commercial pipelines remain healthy, business customers continue to deleverage and repay their defensive draws taken earlier in the year. While commitments have not changed appreciably, line utilization is at historic lows. Consumer growth was driven by very strong mortgage production, which has been more than double year-to-date versus the prior year. With respect to deposits, balances increased to record levels again this quarter. Growth in corporate bank deposits was driven by clients consolidating their liquidity as well as increased benefits from supply chain efficiencies and declines in working asset levels. Consumer deposits also increased as we continue to grow consumer checking accounts, and customers have adjusted spending and saving behaviors. Let’s shift to net interest income and margin, which remains a source of stability for Regions, despite a challenging market interest rate backdrop. Linked quarter, net interest income increased 2%, aided by our hedging program, the deployment of excess cash into securities and a number of items that may not repeat, which are described on the slide. These benefits were offset by lower loan balances. Elevated cash levels impacted net interest margin, which declined to 3.13%. Strong deposit growth drove cash levels at the total reserve higher, averaging roughly $10 billion. This, coupled with $4.5 billion of average low spread PPP loans reduced the margin by 28 basis points within the quarter and 9 basis points linked quarter. We continue to work on reducing elevated cash levels and added approximately $3 billion of agency mortgage-backed securities and agency commercial mortgage-backed securities. Additionally, we reduced wholesale borrowings through a $1 billion bank debt tender and the early extinguishment of approximately $400 million of FHLB advances. Given that the majority of our hedges are now active and our ability to further reduce deposit costs, our balance sheet is largely insulated from the low short-term rate environment. In fact, additional income from lower short-term rates helped to offset some of the long-term rate degradation. Loan hedges added approximately $94 million to net interest income and 30 basis points to the margin. Recall our hedges have roughly five-year tenors and a quarter-end pretax unrealized market valuation of $1.8 billion, an important differentiator and source of regulatory capital in the coming years. Lower long-term interest rates negatively impacted net interest income and net interest margin for an increase in securities premium amortization and the continued reinvestment of our portfolio of fixed-rate loans and securities. Premium amortization was $46 million and included the impact of Ginnie Mae buyouts that aren’t likely to repeat at the same level. Looking ahead to the fourth quarter, uncertainty about the timing of PPP loan forgiveness and the related fee acceleration may create volatility in net interest income. After level-setting for third quarter items that may not repeat and excluding PPP loan forgiveness, we expect net interest income to be relatively flat to modestly lower as hedging benefits and further declines in deposit costs will help to offset continued pressure from long-term rates, asset remixing, and runoff. Excluding PPP and excess cash, our core net interest margin is expected to stabilize in the 3.30%s. Notably, our shift to deploy $3 billion of cash into securities will reduce the normalized margin by 6 basis points but benefit net interest income. Now, let’s take a look at fee revenue and expense. Adjusted noninterest income increased 6% quarter-over-quarter. We achieved record mortgage income and had another solid quarter in capital markets. Service charges increased 16%, but remained below prior year levels. While improving, we believe changes in customer behavior could keep service charges below pre-pandemic levels. We estimate consumer service charges will remain approximately $30 million to $35 million per quarter behind prior year levels. Card and ATM fees have recovered compared to the prior year, primarily driven by increased debit card spend. However, credit card spend continues to be slightly behind prior year levels. Let’s move on to noninterest expense. Adjusted noninterest expenses were $889 million and represented a 1% decrease quarter-over-quarter. Excluding COVID-related expenses and the impact of changes in market valuation on employee benefit accounts, adjusted expenses were $872 million. We have a proven track record of prudent expense management. Since announcing our Continuous Improvement initiative in 2016, we’ve held adjusted expenses relatively flat while continuing to invest in technology, products, and people to grow our business. Continuous Improvement is ingrained in our culture. We have completed approximately 50% of the current list of initiatives and are continuing to identify new opportunities every day. We are facing an uncertain operating environment. And to the extent revenue is challenged, we will look for additional efficiency opportunities. From an asset quality perspective, overall, credit remains generally in line with our expectations from the second quarter. The credit loss provision totaled $113 million, resulting in an allowance equal to 2.74% of total loans and 316% of total nonaccrual loans. Excluding PPP loans, our allowance for credit losses increased to 2.9% of total loans. Nonperforming loans increased 19 basis points to 0.87% of total loans, primarily attributable to downgrades in retail, investor real estate, and energy. Business services criticized loans and total delinquencies decreased 12% and 11%, respectively, while troubled debt restructured loans increased 3%. The improvement in criticized loans were generally in retail where we noted improvements due to strong anchor tenants. Additionally, some improvements were experienced in aspects of energy and manufacturing. Annualized net charge-offs were 50 basis points, a 30 basis-point improvement over the prior quarter. We are cautiously optimistic about the pace of the economic recovery in our footprint. However, we also recognize we remain in a highly uncertain environment. Assuming positive trends continue, we do not believe further increases to the allowance are necessary. Reductions in the allowance will depend on the timing of charge-offs and greater certainty with respect to the path of the economic recovery. While charge-offs can be volatile, we currently expect the fourth quarter to range from 55 to 65 basis points. This range reflects the historical pattern of elevated consumer charge-offs in the fourth quarter. Predicting the timing of net charge-offs depends on many variables, including any additional stimulus. However, based on what we know today, we would expect charge-offs to peak around mid-2021. We continue to refine our view of high-risk portfolios through ongoing conversations with customers and market observations. The portion of our portfolio considered to be at the highest risk of potential loss due to the pandemic declined from $8.4 billion at the end of last quarter to $6.6 billion at September 30th. A roll-forward of the high-risk portfolios is included in the appendix. Wrapping up with capital, our common equity Tier 1 ratio increased approximately 40 basis points to an estimated 9.3%, and capital ratios are expected to continue increasing over the next several quarters. So, in summary, we feel really good about the quarter. Pretax pre-provision income remains strong. Expenses are well-controlled. Credit quality is showing resilience. Capital and liquidity are solid. And we are optimistic on the prospect for the economic recovery to continue in our markets. With that, we’re happy to take your questions.

Good morning, everyone. Congratulations and best wishes to Barb on behalf of everyone. Regarding the loan sector, it's clear that customers, as you mentioned, are building liquidity, and we noticed a continued decline in the C&I as the industry has experienced. Can you elaborate on the point about the footprint performing better compared to other regions? What are your thoughts on the balance between customers maintaining liquidity while also starting to see increased activity and borrowing needs, particularly concerning the C&I portfolio? Thank you.

Yes. Ken, this is David. So, as we think through generally our bank in terms of loan growth, we’ve been kind of a GDP-plus a little bit has been our expectation. Clearly, with the liquidity sitting in the hands of customers, they’re going to use that first before they’ll tap into committed lines of credit if you’re a business or spending or borrowing money if you’re on the consumer side. What we’re looking at is our production. Our production continues to be robust on the commercial side. But, our utilization is very low, and it’s low for everybody. We don’t know when that will bottom out. Some have called it already. We’re not real sure. But, we think given the commitment there that it’s just a matter of time. When you start getting infrastructure spending and a little momentum going in the economy, we could see a loan growth picking up in 2021. We’re probably not going to see that in our fourth quarter, which is why we’ve given you the guide on NII that we have.

Yes. I would just add, Ken. I think when we get past the election, I think we’ll get a little more sense about the direction of the economy. There are a number of our customers who have adapted their operations to the COVID environment, are doing fine, and are thinking about potentially expanding their business, or they are seeing a need to increase inventories because they’re at generally all-time low levels, and yet, they’re not in a hurry to do that until there’s a little more uncertainty about what happens post-election. So, I think it will be, as David said, early in 2021 before we have a better feel for whether we see loan growth exceeding GDP.

Okay. Got it. And a follow-up question on the swaps portfolio. Just looking back at a slide you showed last quarter, there’s still like $1.25 billion to still come online, correct, that aren’t live yet? So, versus the $94 million that you saw in NII this quarter, how much more incremental add do you still expect to come from the additional swaps that haven’t gone live yet? Thank you.

Yes, Ken. So, you’re right. The last tranche will come due in the fourth quarter. Getting the full run rate from what we did last quarter and benefiting the next look coming into the fourth quarter. We think that $94 million goes to $95 million to $97 million. So, we’ll get a couple of million dollars more per quarter. And of course, all these are five-year tenors from the date they become active. So, a couple of million dollars, I guess, is the answer.

Hey, good morning. Can you hear me?

Yes, we can.

Hey, how are you? So, I’m sorry if I missed this. I got on a little bit late. But, can you walk through some of the deposit repricing opportunities you may have in coming quarters? And how should we think about the loan-to-deposit ratio as you move into a more normalized backdrop, hopefully later next year? Is there a certain level that you guys would want to run at? I know excess liquidity tends to stick around in the zero interest rate environments, but just looking for ways that you can potentially deploy some of that excess liquidity.

Our deposit growth remains very strong, fueled by an increase in consumer checking accounts and business operating accounts. Businesses are bringing cash back to Regions, leading to deposit growth that has exceeded our expectations and may continue into the fourth quarter. While our deposit cost is currently at 11 basis points, we believe there is potential to reduce it by a few basis points over time. Our interest-bearing deposit costs are at 19 basis points, and we see more room for improvement there compared to the past. Many of our peers have also significantly lowered their deposit costs, and we believe we can do the same. We will challenge ourselves to make progress on this as we head into the fourth quarter and into 2021. Was there another part to your question?

Loan-to-deposit ratio.

Mike, we really don’t fall for that. That’s kind of an outcome. We’ve historically run a lower loan deposit ratio than our peers because of our deposit franchise, which is really our competitive advantage. If we could be perfect deploying it, I think being in the low 90% range would be great, but we’ve kind of been in that middle 80% for a long time. Of course, everybody is lower today. And so, we have the liquidity to make all the loans to creditworthy borrowers today. We’re excited about that. It’s just good loan growth is hard to come by at this point. But, we’re like a cold spring ready when we believe that infrastructure spending happens.

That’s very helpful. Maybe just one follow-up. The deposit service charges came back a little bit further than I would have thought this quarter. I think some of that obviously has to do with some of the deposit growth. But, can you just give us an update on how the normalization of service charges and maybe credit card usage has ramped up here and how you expect it to play out into next year?

Yes. So, our service charges did come back a bit. We’re seeing strength still in the consumer. We’re seeing spending pick up a bit. Our debit card spend is ahead of where we were last year, not so much on credit card spend, it’s still 2, 3 percentage points behind where we’ve been in the past. Right now, our run rate, and we put in our comments, is probably $10 million to $12 million a month behind pre-pandemic levels, which is $30 million to $35 million per quarter. We don’t forecast that improving appreciably at this juncture. We’ll have to see. We got a new potential wave of stimulus, which will continue to put that pressure and maintain that pressure at that run rate level. So, I would not count on that at this point, coming back to the pre-pandemic level.

We’re seeing a change in customer behavior, which I think ultimately is a good thing. So, we’re depending upon growth in consumer checking accounts as a real catalyst for driving additional fee income. And the good news is that consumer checking accounts are growing. And as a result of that, we’re seeing a pickup in fee income associated with those accounts.

Good morning.

Good morning, Michael.

On the credit front, I understand your guidance and you've mentioned that losses are likely to continue increasing. With that expectation, if charge-offs keep rising, do you anticipate that this could lead to additional reserve releases based on what you currently know?

Let me begin and then Barb can add her perspective. I want to be cautious with the term reserve releases. We believe that our allowance is set at the right level to cover losses in our portfolio throughout the life of the loan. As we move forward, we will experience charge-offs. If our assessment is accurate, those charge-offs will be fully reserved. Consequently, you will see a decrease in the reserve due to that event. The real question then is what to do with the remaining reserve and whether it is adequate for what is left. Currently, we believe it is adequate. We will need to reassess this at the end of each quarter, considering various factors, including whether there is loan growth and how the mix of the portfolio might have shifted with changing macroeconomic conditions. Many factors contribute to this evaluation. When we mention reserve release, it suggests that if our reserve is $100 today and it turns out I only need $90 tomorrow, I would move $10 million to income. We do not expect that kind of movement at this time, as there is still uncertainty. We need to be very cautious and ensure that we have established loan loss reserves at the appropriate levels, which we believe we have achieved.

Got it. Thanks, David. That’s helpful. I should have really said all else equal. So, barring a change in the outlook and aside from reserves for new loan production, just as charge-offs go against what you’ve reserved, that should imply that you’ve already reserved for that and there could be reductions for that, like you said. That’s fine. My other question on the credit front was whether the reserve already factors in the likelihood of incremental credit migration into criticized assets. In other words, if we do see a continued upward trend there, do you expect that could drive incremental additions, or is that already factored in?

Yes. So, when we look at life of loan, we obviously have a lot of migration studies and analysis we’ve looked at. So, we can tell you when things start to age what’s going to happen and they’ll go into special mention and substandard, doubtful, loss. And so, we contemplate that as we establish our reserve level. So, unless there’s a change over what we’ve already estimated, we wouldn’t have incremental reserves for that migration.

And then, if I could just ask one more. Sorry. On the loan growth front, does your comment to Ken regarding the loan growth outlook near term imply that we could potentially see some incremental declines in loan balances near term, or do you expect more stable?

I think that in the short term, we’re taking a few actions. The question is whether the repayment of the lines has reached its lowest point. Some believe it has, but we’re uncertain. That's a part of the risk related to loan growth. Our production is good, and we do have some runoff portfolios, as you know. Overall, I don’t expect to see much loan growth, possibly even some declines, which suggests that our net interest income may be flat to modestly lower. All of this is taken into account.

I just want to follow up on the comments about the timing of net charge-offs speaking, maybe mid-next year. We’ve heard kind of a similar theme from other banks mid-next year, back half next year. Is that more just like a placeholder since you don’t expect a material increase in the near term, or is there something kind of in the kind of what you’re seeing in the commercial and consumer side that gives you confidence in that mid-next year?

Matt, it’s Barb. I’ll take that question. Yes, the reason that we say mid-next year is given all of the deferral programs that are out there. And again, we have that uncertainty as to what’s going to happen, will we get a second set of relief from the government or not relative to the programs they have, et cetera? But based on what we know and just the way that things roll through the various delinquency buckets, we would think that mid-next year, sometime in the second quarter, probably toward the end of the second quarter, could even push into the third quarter. So, there’s just a lot of uncertainty and volatility. And that’s the reason we think based on all of that, it’s probably a midyear event next year.

In the commercial and industrial sector, it tends to be more predictable. However, even in the small business segment, due to the relief currently circulating through the economy, it's still challenging to make accurate predictions.

That’s right.

And then, on the commercial real estate, does that end up being longer-tailed than maybe traditional C&I and consumer, just given some of the dynamics with real estate? And, I think a lot of the commercial real estate out there is kind of pretty low LTV. So, there should be some patience on the part of the bank to help work that out?

There is, and we’re spending a lot of time with our customers on a one by one basis, making amendments where we need to, helping them get through what is a rough period. We don’t want to be fair-weather bankers by any stretch. But, we are taking a very prudent approach in our discussions with our customers. If we see that at the end of the day, there isn’t a light at the end of the tunnel, then we’re having those hard discussions with them now. But in general, the discussions have been very, very good relative to all of us working together to get through the other side of this.

And I would say, the thing that comes through in our commercial real estate portfolio is, since the financial crisis, we’ve remade that business. We’ve significantly reduced the amount of exposure we have. We’ve rebuilt the teams that are originating commercial real estate loans. We’re banking very experienced regional and national developers that have good access to capital, a lot of liquidity. They’re involved in quality projects in really solid markets. Strong loan-to-value, it’s a combination of all those things comes together. We feel good about our investor real estate portfolio.

First, Barb, congratulations. It’s been great working with you all these years. I really appreciate it. I have a question for you. I might have missed it in the prepared remarks, but the NCO guide for the fourth quarter is in the 55 to 65 basis points range. I thought last quarter I was looking for 80. I'm curious if this change in expectation for NCOs is something you believe is temporary, considering everything we've discussed about the stimulus, or do you think the run rate will be a bit lower than what you had anticipated previously?

Thank you very much, Betsy. Firstly, I thought growing old would take a lot longer than it did, but I guess it’s come. Secondly, relative to your question, yes, we started off the quarter. We had a different view of the quarter. We thought that things would not turn out as they did with our customers. Our customers have made a lot of changes to the way in which they’re managing their finances, et cetera. They seem to be holding up better than what we thought. Having said all of that, there’s still a lot of volatility. And so, our issue is more one around timing. And so, as we look at that and we look at the impacts of these deferral programs and other things are. We do think that there’s still going to be an impact, but it’s just going to be pushed out sometime into ‘21 now.

Okay, no, that’s helpful. Thanks. And then, just a follow-up is just a question about the footprint and what you’re seeing. You’re in a warmer part of the country. I’m wondering if you’re seeing any kind of in-migration. Are you seeing business trends in the southern regions accelerate or retain faster speeds than what you see in the northern parts of your region? And maybe you could give us some color on that. I’m just asking the question with the backdrop of when you could start to see some loan growth pick up as well and should you be advantaged, given your footprint? Maybe you could speak to that. Thanks. Yes. It’s a great question. I would say specifically regarding the southeastern states, where approximately 86% of our deposits are located, these states were among the last to implement shelter-in-place orders and the first to reopen their economies. In fact, seven of the ten states we operate in were among the first ten to reopen. Consequently, the unemployment rates in those states were about 200 basis points lower than the national average. While overall unemployment was still high, the percentage of small businesses that closed was around 50% to 60% compared to a higher figure for the national average. Currently, we expect that 85% to 90% of small businesses have reopened. The economies appear to be performing better than in the Northeast, where, from what I gather, the pace of small business reopenings has not been as swift as in the South or even the Midwest where we operate. We are cautiously optimistic, acknowledging that the economy remains fragile. There are numerous uncertainties related to health, social, and economic issues, as well as the political climate. However, we are noticing an influx of people moving into the Southeastern markets, leaving larger cities in the North and Midwest for the South. As a result, while real estate values are increasing, they are stable without dramatic price increases, but there is a strong demand. Job availability is robust in the South. Overall, we feel cautiously optimistic about the economy, while also recognizing the existing uncertainties.

I wanted to follow back around, maybe thinking about the loan loss reserve and the kind of CECL methodology. Appreciating not wanting to call it releasing reserves, but I’m wondering how we could think about what’s maybe elevated due to the pandemic? And what would be a more normalized level if we didn’t have maybe some elevated allocations to expected losses here in the near term? And where that could kind of normalize over time?

One thing to consider is our allocation in the fourth quarter for our allowance by major loan category. You can compare that to the allowance that was in place before the pandemic, which will indicate where we are seeing higher loss expectations. The challenge with the Current Expected Credit Loss (CECL) model is that it requires estimates over the entire life of the loan. We use a two-year period that is considered reasonable and supportable, but we are in the midst of a pandemic, which brings significant volatility in macroeconomic factors and certain industries like quick-service restaurants, energy transportation, and hospitality. All of these factors require careful consideration when determining the allowance. If you observe our high-risk areas, you'll see an improvement from $8.4 billion in the higher risk category to $6.6 billion. You can refer back to the allocation of the reserve to understand where that reserve stands for us now and where improvements might arise in the future. Until we gain more clarity regarding the economy, we do not see the need to adjust the reserves that we have already established, although that could change from quarter to quarter.

Right. Okay. But, if the pandemic weren’t occurring, instead of 270 in a CECL environment, would you think the reserve would be more in the 170 sort of range, or is that just too difficult to say?

It's challenging to provide a precise answer, but you can look at our pre-pandemic levels as an indicator. Our implementation of CECL at the beginning of this year should give you some insight into our thinking at that time when the pandemic had not yet occurred in the United States. That's where we believed the actual reserve level should be.

Perfect, helpful. And then, one last question. Just on the excess liquidity, you talked about you might see additional deposit growth this quarter, but how are you guys, I guess, thinking about that and the stickiness of that excess liquidity maybe over the next year? And what you might do in the fourth quarter and beyond in terms of uses of that liquidity much as you did this quarter?

Yes. This relates to an earlier question. I believe our deposit growth is primarily driven by increases in checking and operating accounts, along with existing customers who had cash off balance sheet seeking better returns than what we were offering at that time. With interest rates declining, there really aren't many options, so that cash has returned to us as deposits. Furthermore, our commercial customers are generating income and not spending at the same pace as before, leading to an accumulation of cash on their balance sheets. They've been improving their working capital and rapidly turning receivables and inventory, which enhances the cash cycle and results in deposits for us. The key question is when they will start utilizing that excess cash. I think it will happen when there's a more positive outlook on the economy, prompting them to invest in fixed capital or spend that cash, followed by a growth in loans for us. One reason we're not deploying the excess cash at the Federal Reserve, which is about $10 billion, is that taking on duration risk now doesn't yield much more than 10 basis points at the Fed. However, we see potential for the yield curve to steepen, regardless of the election outcome, and higher inflation could give us a better chance to use that excess cash. If deposits continue to grow quickly, we'll increase our investments in the securities portfolio, as we did with the $3 billion this past quarter. It's a balancing act; while our liquidity is strong, we're focused on optimizing yield and opportunity costs to deploy our resources effectively.

You guys have obviously done a great job managing expenses, and growing. I know it’s early, but would you expect to hold expenses relatively flat again next year? And what are some of the things that you’re looking at for additional expense initiatives?

It's a great question. We've done a good job of keeping our expenses stable over the past few years, with an increase of less than 1%. We plan to continue this approach as we move into 2021 and will provide clearer guidance toward the end of the year. Our focus is on leveraging the Continuous Improvement process that John Turner implemented, which encourages us to enhance our operations daily through process improvements and technology. The main driver of our cost structure is our salaries and benefits, which account for 55% of our expenses. Therefore, managing our headcount is crucial. Almost half of our workforce is in our branch network, and we've consolidated many branches, which has significantly contributed to our cost savings. We're continually assessing our branches for further consolidation opportunities and understanding the impact of these moves on revenue and customer retention. Our consumer team is actively reviewing each branch to maximize efficiency, allowing for reductions in headcount. We are analyzing spans and layers within every department and considering how to use technology to replace roles with attrition instead of backfilling. Occupancy costs are another area of focus, linked to both our branches and back-office operations, and we're pleased with our progress in reducing square footage. As we lower headcount, costs for furniture, fixtures, and equipment will also decrease. Our Head of Procurement is stringent with our vendors and prompts us to critically assess our need for consultants and other expenditures, holding us accountable throughout the company. We're also closely monitoring travel and entertainment expenses, which have decreased due to COVID. While we have various options to manage expenses, it's challenging as we need to invest in technology, digital advancements, and personnel to continue expanding revenue and our customer base. We're committed to keeping our expenses flat while focusing on the cost-saving strategies we've outlined.

Yes. Our views about M&A haven’t changed, Peter, to this point. I mean, we continue to focus on bank M&A. We’ve made a number of successful acquisitions of smaller firms that provide additional capabilities in wealth management and capital markets and the mortgage business, acquiring mortgage servicing rights, low-income housing tax credit syndicator, M&A advisory firm, things that you’re aware of. And we continue to have aspirations to do that. Having said that, we believe that we are still in an environment where it’s in our best interest to just focus on executing our plan with respect to bank M&A. If we do that, then we believe that our shareholders will benefit. That will be reflected in our share price, the multiple that we trade at. And then, we can talk about whether or not we have some interest in bank M&A. But today, our focus is still on executing our plan.

So, David, just one follow-up question for me. As we think about a starting point on the net interest margin estimate in nonrecurring items of 3.11, how should we think about as so that margin of 3.3%? Clearly, you’re doing a great job in terms of defending the margin. And I guess, how should we think about the excess cash and what you need to see in the marketplace to more aggressively deploy that excess cash or that your GAAP NIM more reflects that core NIM that you point out?

Yes. So, it’s a good question. It’s a balancing act that we’re trying to make with regards to being paid for duration and putting that excess cash to work there or waiting for the yield curve to steepen a bit, which we think if we’re just a little bit patient, we can actually have a better earning asset. We understand every day we wait though, we’re trading off 1% change for 10 basis points. We did put some of that excess cash to work as we mentioned and kind of perversely, when we give you our core NIM, right anything that’s sitting at the Fed and the Fed account, we’re carving out from our margin. But when we deploy some of that, as we did our $3 billion, it’s earning 1%, that weighs on our core NIM. So, whereas we were in the high 3.30s before we decided to deploy the cash, we think we’re going to be in that 3.30-ish range. So, that deployment actually cost us 6 basis points of NIM, but it helped our NII. So, I wouldn’t get too wound up on the NIM calculation just yet. I would look at the ability to grow net interest income and having the dry powder to deploy and better loan growth when that comes along or a steeper yield curve when that happens.

Got it. Thank you. Congratulations, Barb.

Thank you.

Maybe you can share with us, and congratulations to Barb on her retirement and her insights over the years. My first question is about credit. The government’s actions have been quite impressive in terms of stimulus relief. The Federal Reserve has moved aggressively to influence spreads in the open market, and we have the forbearance program. Can you share what the significant differences have been in credit, considering the economy’s collapse and the metrics we have become accustomed to, such as the unemployment rate, which has led to higher consumer net charge-offs? These relationships haven’t held up in this downturn, and I'm curious what, aside from the programs I mentioned, might explain the differences in this downturn compared to what we experienced in 2006 and 2007 leading into 2008 and 2009?

Yes, I believe the stimulus relief is a crucial factor. It's the most significant element. Additionally, consumers and businesses have changed their spending habits. For consumers, we're observing that they are not spending on big-ticket items like expensive vacations. Instead, that money is being saved for future uncertainties. They are being very cautious with their finances, and the stimulus has contributed to that, enabling them to build some savings for better times ahead. We definitely see this trend on the consumer side. Interestingly, we expected to see more draw-downs in areas like home equity lines or cash-out refinances on mortgages, but that hasn’t happened. Consumers are being very responsible with their spending. On the business side, businesses are also being cautious. They've had several years of good profits and are now determining what changes are necessary for their operations. I've been quite impressed with the resilience of our economy, especially in the South, where businesses and consumers have adapted well. This situation is different compared to previous downturns. During the last crisis, there was a collapse in the housing market, which hasn’t occurred this time. In fact, the mortgage market is quite active for both purchases and refinances, largely due to low interest rates. This is another aspect we're monitoring closely.

Gerard, let me add to that. When considering the Southeast and Regions specifically, the landscape of commercial real estate has changed significantly. First, our commitment to it is far less than in the past. Additionally, real estate values have not plummeted. As Barb pointed out, there was a dramatic shift in values that affected not just consumers and mortgages but also homebuilders and similar areas. We aren't seeing that now. If you examine disposable income, it continues to rise for consumers. The financial obligation ratio, which represents the portion of disposable income allocated to debt payments, remains very low. Part of the reason for this is that total leverage for consumers is actually higher, but their ability to pay is lower due to the favorable interest rate environment. Lastly, unemployment is not uniformly distributed. As John noted, our unemployment rate is significantly lower in our markets compared to other regions of the country. Major metropolitan areas are experiencing higher unemployment, whereas the second-tier markets where we operate are performing better.

Thank you. I appreciate the color. And then, as a follow-up, David, can you share with us your margin and your net interest income? You guys have done a very good job in managing it, as you’ve described for us. What kind of interest rate environment in, let’s say, 2021 or 2022 would be less favorable to the way you’re positioned today? What are you kind of on the lookout for in terms of rates going forward that could be less favorable than what you’re seeing today?

A flat yield curve is quite challenging for us and most banks. We don't expect short rates to change significantly, and honestly, it doesn't concern us because we're fairly protected against low rates. Our main concern lies in the middle to the end of the curve, as we need to reinvest our maturing fixed-rate loans and securities, totaling about $12 billion over the next year. Reinvesting those cash flows in the current environment, where the 10-year rate is around 70 basis points, makes it hard to generate profits. We hope for a steepening of the yield curve, which could be influenced by infrastructure spending, regardless of the election outcome. A steepening curve is what we prefer, while a flat curve is detrimental.

Very good. And Barb, I hope your going away part already is a main loss to David and John.

Thanks, Gerard.

A couple of quick follow-ups. First, I know you’re not assuming any acceleration in PPP forgiveness income in the fourth quarter. But, can you just tell us what your best guess is currently for forgiveness rate? And what the timing of that forgiveness could be over the first half of ‘21 and maybe even into the second half of ‘21. If you could just kind of give us what your best estimate is right now?

As we consider the fourth quarter, early indications led us to believe there would be a reasonable level of forgiveness. While we have seen some forgiveness, it hasn't been substantial enough to discuss in detail, and it seems to have been deferred to the first quarter. After the election, we might gain clearer insight. A new forgiveness form has been introduced, which is quite structured and could prove beneficial. However, we haven't witnessed borrowers actively requesting forgiveness; they appear to be content for now since there are no immediate costs involved. If we experience some urgency in this area, we may see an increase in forgiveness requests. It’s uncertain whether this will happen in the first, second, or third quarter. Currently, we earn just under 2% from the PPP loan, which includes the interest rate and a portion of the fees recognized through the effective interest method. This impacts our margin, which is why we exclude it from our analysis, and we've shared that the dollar amount is approximately $30 million. The timing of when forgiveness might occur is unclear, but it is likely to be around the middle of 2021.

Right. But just to be absolutely 100% clear, your guidance for the fourth quarter, that’s not assuming any acceleration in PPP fee income and?

That’s correct.

Okay. I'd like to shift the conversation to your reserving and specifically your ACL waterfall. Your reserve levels remained unchanged, which suggests that the portfolio risk and balances are offsetting charge-offs, potentially reflecting an improved economic outlook. I am interested in what is included in that portfolio risk and balances. Given the environment with controlled loans, it isn't clear if your loan mix has become riskier, particularly regarding high loss content loans. Maintaining flat reserves implies that you are reserving more for your existing loans and projecting higher losses on them. Should we interpret this as a signal that you believe it is not yet appropriate to reduce reserves? Additionally, what factors would give you the confidence to see declines in ACL levels and lower absolute reserve amounts?

Yes. There is currently a lot of uncertainty regarding the economy, and we really don’t know what to expect. Given this heightened level of uncertainty, we don’t feel comfortable releasing reserves. The volatility that accompanies uncertainty makes us believe it's not wise to reduce our reserves at this point in the economic cycle. That’s the reasoning behind our stance.

Yes. We do have production of new loans every quarter. Even though the gross number may not change, we do have production. We do have some of our, as you mentioned, bad book. We do have some that we’ve increased reserves on. We have certain loans we look at loan by loan, some we look at portfolios, and there are certain of those that we add into this particular quarter. And as I said, it’s just hard to tell what will happen next quarter. We have to get to the end and see what the facts and circumstances are at that time.

Yes. I mean, it’s just simply a function of you’re just feeling confident that the economy is on a more sound footing. And at that point, you would feel comfortable reducing reserves. Because effectively, it almost seems like reducing reserves is almost calling the end of the credit cycle right now. And so, I’m just like curious if that’s the way you look at, or it’s just really simply a function of having a more-clear outlook on the glide path of the economy is feeling more strongly about it?

If you overlook the decrease in reserves resulting from charge-offs, which is expected, then any further reduction in reserves would need to be based on a clearer understanding of the economy and the performance of our loan portfolios over their remaining lifespan. That's correct.

I wanted to ask about the return on tangible common equity trajectory, when we pull all the pieces together that you’ve all discussed on the call. So putting up the lowest efficiency ratio in over a decade in this environment obviously stands out, then layering in the expense savings that you discussed, branch optimization and everything else, and then the NII benefits from noninterest-bearing deposit mix rising to the highest level we’ve seen at 42%. And it seems like we can kind of see your ROTCE continue to rise to all-time highs as we look ahead. It feels a little bit unusual to be talking about high ROTCEs in a recession where we haven’t even seen losses rise yet. But, I was hoping you could give a little bit of color around when we pull all the pieces together and think about ROTCE, how you see that trajectory?

Yes. I think, if you were to look at generally commercial banking in this environment, normalized provisioning for this environment, it is a low rate environment. So, we think returns are in that 12% to 14% range. You can get a given quarter that would be outside of those boundaries. But, if you kind of look all in, we think that’s a reasonable return. I think, banks can earn more than their cost of capital and generate shareholder value, just not at the level we would have if we had a much higher steeper yield curve where we could have margins that are in that 3.50% to 3.75% range we talked about at our Investor Day some years ago that drove returns up much higher than that 12% to 14%. So, I think that’s probably where we are at the moment, but we’re continuing to work hard to make it better. And that’s what our Continuous Improvement is all about.

Understood. Following up on your earlier comments about a steepener and the benefits there. Can you give a little bit more color on your exposure to the short versus the long ends of the curve? And any sensitivity in terms of benefit to NII would be really helpful.

On short rates, we do not have any exposure. We have effectively mitigated that risk. The primary risk comes from the long end and the middle of the curve. This is largely due to the $12 billion in cash flows we have to reinvest from our fixed-rate loan and securities portfolios, which presents the biggest challenge for us. The difference between what’s rolling off and what we can reasonably reinvest today is about 1 percentage point. That is where our risk lies.

Operator, do we have any more questions?

Good morning. Congratulations, Barb. We’re going to miss working with you.

Thank you so much, Jennifer.

My question is on mortgage banking fees. They’ve obviously been at record levels the couple of quarters. What are you guys seeing in terms of production trends in the fourth quarter and beyond as this home buying frenzy continues?

Yes. So, we’ve been very pleased. We hit a record this quarter in terms of mortgage. If you go back to the list of these earnings calls, we say mortgage is strong and it should be strong next quarter. It got even stronger and really benefiting from the consumer banking group’s decision to hire mortgage loan originators a couple of years ago in preparation for a low rate environment like we anticipated. So, we’re benefiting from that. We think the fourth quarter, based on what’s in the pipeline is going to be strong. Whether it could be as strong as the third quarter? Don’t yet know. But, we think it’s set up for a very strong 2021. And a big reason for that confidence is that as you know, historically, we’ve been a purchase shop, mainly 70% to 30%. Today, our mix is about 50-50 in terms of refi and purchase. Both of them are strong. Refis won’t continue forever. We understand that. But, we’ve been a pretty strong purchase job, unlike others who had actually 70% refi, 30% purchase. So, we think the fourth quarter will be good. We think all of 2021 will be pretty good too. Will we meet the levels we’re at right now? I don’t know.

Okay. Well, I think that’s the last call we had. So, really appreciate your interest and thank you for participating in the call today.