Regions Financial Corp (RF) — Q2 2022 Earnings Call Transcript

Thank you, Christine. Welcome to Regions' second quarter 2022 earnings call. John and David will provide high-level commentary regarding the quarter. Earnings documents, which include our forward-looking statement disclaimer and non-GAAP information, are available in the Investor Relations section of our website. These disclosures cover our presentation materials, prepared comments, and Q&A. With that, I’ll turn the call over to John.

Thank you, Dana, and good morning, everyone. We appreciate you joining our call today. Once again, we are very pleased with our quarterly results. Earlier this morning, we reported earnings of $558 million, resulting in earnings per share of $0.59. Importantly, our second quarter adjusted pretax pre-provision income represents the Company’s highest level on record. We continued to successfully execute our strategic plan and delivered strong results. Sentiment among our business customers today is cautiously optimistic. They’re rebuilding inventories and looking for opportunities to expand their businesses. Loan commitments and pipelines remain strong, and utilization rates continue to increase. The consumer remains healthy. Net population migration inflows into our markets remain robust, and the majority of our footprint has returned to equal or better than pre-pandemic employment levels. In fact, unemployment rates in 6 of our top 8 deposit markets are essentially at all-time lows. To date, broad segments of consumers still maintain substantial cushion in their deposit accounts. For example, consumers with less than $1,000 on average in their checking accounts prior to the pandemic are averaging a balance today that remains approximately 6 times higher than pre-pandemic levels. Overall asset quality remained strong during the quarter, with most metrics remaining substantially better than historical levels. However, we’ll continue to closely monitor early warning indicators for any signs of deterioration. Our capital ratios remain strong. In fact, earlier this week, our Board approved an 18% increase to our common stock dividend to $0.20 per share. We have a strong balance sheet deliberately positioned to withstand an array of economic conditions. Investments we’re making across our businesses continue to pay off. In the Corporate Bank, we continue to invest in talent, technology, and strategic acquisitions to expand our products, capabilities, and expertise. Excluding acquisitions, we have added over 200 new positions in the Corporate Bank since 2019, with approximately 85% in revenue-generating or supporting roles. Our most recent acquisitions, Sabal Capital Partners and Clearsight Advisors are contributing to overall capital markets revenue growth in 2022. We’re also strengthening our credit product capabilities for small businesses. Ascentium Capital is exceeding our expectations as a provider of essential equipment financing. We recently restructured our SBA organization and continue to invest in key talent to build out our non-restaurant franchise lending division, positioning Regions as a trusted resource for franchisees within our footprint. We’ve been investing in our Treasury Management and Payments business for several years and are experiencing strong revenue growth. Today, we offer a comprehensive and competitive suite of solutions positioned to meet the complex needs of any client. We continue to invest in these businesses, rolling out new products and enhancements across our iTreasury platform, including real-time payments and fraud mitigation, as well as APIs and new cash flow analysis tools. Within the Consumer Bank, we continue to make advancements to become the premier lender to homeowners. In recent years, we’ve expanded our mortgage loan origination team, upgraded our mortgage contact relationship management platform, and continued to simplify the overall sales process. We also continue to invest in our mortgage servicing portfolio. Year-to-date, we’ve completed bulk purchases for the rights to service approximately $13 billion in mortgage loans. EnerBank, a leader in the prime and super-prime home improvement point-of-sale space, helps us meet customer needs while generating quality asset growth. Within Wealth Management, we continue to invest in talent and technology to optimize the client and associate experience. Since 2019, we’ve added 44 new revenue-generating positions in our Wealth group, primarily in private wealth management and investment services. Last month, we launched our digital investing product, which combines the ease of a self-directed digital tool with the option of support from a financial advisor. These investments contributed to a strong performance in the first half of 2022. So wrapping up, we have a solid strategic plan, an outstanding team, and a proven track record of successful execution. While sentiment across both business and consumers remains generally positive, we will continue to monitor our portfolios for indicators of stress. We have a robust credit risk management framework and a disciplined dynamic approach to managing concentration risk, which has positioned us well to weather any economic environment and continue to deliver consistent sustainable long-term performance. Now David will provide some highlights regarding the quarter.

Thank you, John. Let’s start with the balance sheet. Average loans grew 3%, while ending loans grew 5% during the quarter. Average business loans increased 5%, reflecting broad-based growth across all businesses and industries. A majority of the growth this quarter was driven by existing clients accessing and expanding their credit lines to rebuild inventories and expand their businesses. While still below pre-pandemic levels, commercial line utilization ended the quarter at approximately 44.4%, increasing 50 basis points over the prior quarter. Loan production also remained strong with linked quarter commitments up approximately $5.5 billion. Importantly, being into this commercial loan growth, we’re maintaining a very high asset quality portfolio. In fact, balances considered investment-grade equivalent are up 30% compared to a year ago, and approximately 44% of our total commitments are also considered investment-grade equivalent, representing its highest level on record. Similarly, our overall probability of default in this portfolio has improved approximately 35 basis points since mid-2019. Average consumer loans remained relatively stable, while ending loans increased 3%. Growth in average mortgage and other consumer loans was offset by declines in other categories. Within other consumer, EnerBank loans grew approximately 7% compared to the first quarter. As a reminder, EnerBank has a track record of well-controlled loss rates throughout multiple cycles and primarily originates prime and super-prime loans to homeowners who tend to be lower risk borrowers. Looking forward, we currently expect to hold total loans relatively stable over the remainder of the year, which would result in full year 2022 average loan growth of approximately 8% compared to 2021. This assumes a slowing rate of growth compared to the second quarter, but also assumes increased capital markets activity in the back half of the year. So, let’s turn to deposits. Deposit balances acquired throughout the pandemic remained mostly stable early in the Fed’s tightening cycle. Importantly, seasonal patterns related primarily to the income tax payments returned to those experienced before the pandemic. While average deposit balances grew, ending balances declined. Ending consumer deposits were mostly stable, while Corporate and Wealth Management balances decreased approximately $1 billion each. In addition to seasonal patterns and in line with our expectations, the declines also include certain commercial and wealth clients beginning to reduce some of their excess balances. We continue to expect a range of $5 billion to $10 billion of overall balance reduction for the full year of 2022, resulting from tightening monetary policy. The combination of our legacy deposit base, along with the more stable components of surge deposits, represents a significant opportunity for us as rates continue to increase. Let’s shift to net interest income and margin. Net interest income grew $93 million or 9% linked quarter, evidencing strong balance sheet growth and asset sensitivity in a rising interest rate environment. Cash averaged $22 billion during the quarter, and when combined with PPP, reduced the second quarter’s reported margin by 38 basis points. Our adjusted margin was 3.44%. The reduction in cash this quarter resulted mostly from strong asset growth, both loans and securities, as well as seasonal deposit outflows. Average loan balances grew $2.9 billion or 3% in the second quarter. Additionally, $1.2 billion of securities were added. The recent increase in rates has certainly validated our decision to wait on a better rate environment to deploy cash into securities. While not included in our current outlook, additional security purchases would provide incremental benefit. The primary driver of net interest income growth this quarter was higher interest rates and our decision to remain exposed to rates in the near term. Importantly, deposit balance and yield outperformance, including a 5% cycle-to-date deposit beta, allowed net interest income to grow by more than our previous guidance. Total net interest income is projected to increase 8% to 10% in the third quarter, as expectations for rate hikes have been pulled forward, so has our outlook for NII. Fourth quarter net interest income is now expected to be approximately 23% to 25% higher than our first quarter. Regions’ balance sheet remains well positioned to benefit from continuing increases in interest rates. Incremental 25 basis point increases in the Fed funds rate are projected to add between $40 million and $60 million over a full 12-month period as deposit betas are projected to increase into the 25% to 35% range. This NII benefit is supported by a large portion of stable deposit funding and a significant amount of earning assets held in cash, which compare favorably to the industry overall. Over a longer horizon, a more normal interest rate environment or roughly a 2.5% to 3% Fed funds rate will support a net interest margin range of approximately 3.75% to 3.8%. This target incorporates the execution of recent hedging activity at higher rate levels than originally contemplated. While we have purposefully retained leverage to the higher interest rates during a period of low rates, we have begun to manage a more normal interest rate risk profile as the interest rate environment normalizes. This includes the addition of $8.3 billion of forward starting received fixed swaps and $1.2 billion of spot starting securities during the quarter. Through the first half of 2022, we have added $15 billion of swaps and securities. The swaps become effective in the latter half of 2023 and 2024 and have a term of generally three years. This represents approximately 75% of the total hedging amount expected this cycle. With a sizable amount of hedging complete, we will balance market rate levels and potential risk as we decide the appropriate time to finish the program. Now, let’s take a look at fee revenue and expenses. Adjusted noninterest income increased 10% from the prior quarter, primarily due to improvements in capital markets and card and ATM fees. Within capital markets, growth was driven by higher fees and M&A advisory and real estate loan syndications, as well as a $20 million benefit from CVA and DVA. We continue to expect capital markets to generate quarterly revenue of $90 million to $110 million, excluding the impact of CVA and DVA. While we expect to be on the lower end of the range next quarter, we do anticipate activity will pick up in the coming quarters. Card and ATM fees reflect seasonally higher interchange on both debit and credit cards. Spend was up 3% year-over-year as inflation has impacted several categories, including a 30% increase in fuel, while discretionary categories such as retail goods, department stores, and apparel are actually down. Mortgage and wealth management income remained relatively stable during the quarter despite unfavorable conditions. Seasonally higher mortgage production overcame first quarter gains associated with the sale of previously repurchased Ginnie Mae loans. While we anticipated a decline in mortgage income relative to 2021, mortgage, as well as wealth management, will remain key contributors to our overall fee revenue. Service charges declined during the quarter as seasonal increases were offset by NSF and overdraft policy changes. The second phase of previously announced NSF and overdraft policy changes were effective at the end of the second quarter and the remaining changes will be implemented in the third quarter. These changes, when combined with previously implemented changes, are expected to result in full year 2022 service charges of approximately $600 million. We also expect to implement a grace period feature sometime in 2023 and now expect full year 2023 service charges of approximately $550 million. We expect 2022 adjusted total revenue to be up 7.5% to 8.5% compared to the prior year, driven primarily by growth in net interest income. This growth includes the impact of lower PPP-related revenue and the anticipated impact of NSF and overdraft changes. Let’s move on to noninterest expense. Adjusted noninterest expenses increased 2% compared to the prior quarter. Salaries and benefits increased 5%, primarily due to annual merit increases, which became effective on April 1st, higher variable-based and incentive compensation associated with increased financial performance and better credit experience, as well as one additional workday in the quarter. These increases were partially offset by a decrease in payroll taxes and lower HR asset valuations. We will continue to prudently manage expenses while investing in technology, products, and people to grow our business. As a result, our core expense base will grow. We expect 2022 adjusted noninterest expenses to be up 4.5% to 5.5% compared to 2021. Importantly, this includes the full year impact of recent acquisitions, as well as anticipated inflationary impacts. With the changes in revenue and expense guidance, we expect to generate positive adjusted operating leverage of approximately 3% in 2022. Overall, credit performance remained strong. Annualized net charge-offs decreased 4 basis points to 17 basis points. Nonperforming loans increased modestly during the quarter but remained below pre-pandemic levels at 39 basis points of total loans, while business services criticized loans and total delinquencies continue to improve. Provision expense was $60 million this quarter and included a modest build to our allowance for credit losses, attributable primarily to strong loan growth and, to a limited degree, general macroeconomic uncertainty, as well as some early signs of normalization within select commercial sectors. Our allowance for credit loss ratio is 1.62% of total loans, while the allowance as a percentage of nonperforming loans remains very strong at 410%. Our annualized year-to-date net charge-off ratio was 19 basis points, given increasing expectations for a slowing economy, combined with inevitable normalization, we are maintaining our full year net charge-off expectations in the 20 to 30 basis point range, but currently expect to be towards the lower end. Based on the recent stress test results, our preliminary stress capital buffer requirement for the fourth quarter of 2022 through the third quarter of 2023 is expected to remain at 2.5%, once our supervisory results are confirmed in August of 2022. We ended the quarter with our common equity Tier 1 ratio at an estimated 9.2%, reflecting continued strong loan growth, particularly during the last week of the quarter. While loan growth remains our top priority for capital deployment, we expect to manage to the midpoint of our 9.25% to 9.75% operating range over time. Also, as John mentioned, our Board of Directors declared a quarterly common stock dividend of $0.20 per share, an 18% increase over the prior quarter, which reflects strong earnings growth. So wrapping up on the next slide are our updated 2022 expectations, which we’ve already addressed. In closing, we have delivered strong year-to-date performance despite volatile economic conditions. We will continue to be a source of stability to our customers, but also remain vigilant with respect to any indicators of potential market contraction. Pretax pre-provision income remains strong. Expenses are well controlled, credit risk is relatively benign and capital and liquidity are solid. With that, we’re happy to take your questions.

Thanks. Good morning. I wanted to start off on the net interest income. Just based on the guidance, it looks like it’s going to end the year about $1.26 billion. So, the question is, if the Fed were to stop raising rates at year-end, it seems like you have a lot of strong momentum for growth into next year. Could you just talk about some of the big picture trends that you see for next year?

Yes, sure. Peter, this is David. So, we do have an expectation that the Fed continues to raise rates probably finishing the year in a 3.25 to 3.50 range. And they could go past that. They could stay there for a while. We do believe there is risk that the economy slows to a point where they have to become more accommodative in the latter part of 2023 and 2024, hence why you started to see us play some forward starting swaps in those positions to protect us to the extent that that happens. Clearly, rates could not come down, and they may stay flat or go even higher. But at that point, we’re generating the kind of NIM that we talked about that’s on our slide. I don’t have the page number, but a very strong net interest margin and, more importantly, a very good return on tangible common equity profile. So, the benefit is through our deposit base. We think we’re going to continue to have a lower beta through the cycle than our peers. It may be higher than last time for everybody. But nonetheless, we think that’s our competitive advantage, even if the Fed stops at year-end without any further increases.

Got it. And then, just as a follow-up. Just could you give a little bit more color on the loan growth guidance in the second half of the year with it slowing? I’m just surprised given the momentum on a period-end basis.

Sure. So one, we have to acknowledge we had pretty strong loan growth. I think the industry had pretty good loan growth in the first quarter. Obviously, things are slowing down a bit. We think we’re going to have a lot of opportunities to grow. But this is when you need to be very cautious, very careful and make sure your client selectivity is robust and ensure that you get paid for the risk that you’re taking. And so, we may be a little conservative in terms of our loan balances from here on out. What we wanted to make sure is we don’t want to send the message that we’re going to grow at the pace we just did in the first quarter. We don’t think that would be appropriate for us. We still see good demand in a lot of sectors, financial services, utilities, wholesale durables, just to name, and elements of transportation are strong. And we think even in investor real estate, there are some places that we’ve been able to grow in the multifamily sector, in particular, as well as in the industrial area. So, I think it’s a bit of a cautious tone is all we’re sending. And we will grow as the market gives us permission with the right metrics.

Peter, this is John. I want to mention that the recent volatility has clearly disrupted the capital markets. Consequently, our larger customers have been leaning on the pro rata bank market for their funding needs. We anticipate that in the future, there will be more clarity regarding the economy. As a result, we believe that issuers with pent-up demand will start engaging with the capital markets again, which should lead to pay-downs in some of the larger credit exposures we've had over the past couple of quarters. This expectation is part of our overall projection. As David mentioned, it might lean towards a conservative perspective, but we are confident that it will happen in the next few quarters.

I guess, David, just following up on your comment around the margin. I think you mentioned, if I heard you correctly, a 3.75 to 3.80 normalized margin for Regions. One, if you could tell us like what the Fed fund needs to get to in order for you to get to that level for the net interest margin. And once we get there based on the hedging strategy that you have, do you think that becomes something that’s relatively stable, absent a big change in the rate backdrop and obviously the protection that you have on the downside?

Sure. So, if you look at our slide deck on page 8, we try to lay that out that gives you at least some parameters on where we think the margin could be in different scenarios. So, if the Fed is going to get close to 3% at the end of the day and stay there for a while, we think we can have a margin profile that’s in that 3.80 range. And if the Fed doesn’t move any further, it doesn’t reverse course and come back the other way, that’s probably where we’ll be. If the Fed starts to come the other way, our margin will decline some, but we think we can protect. Today, we can protect about 3.60. As rates continue to move up and we finish our hedging program, we’re about three quarters of the way through, we have another 25% to do. If we are patient enough, if we kind of understand where the economy is going, perhaps we can lock in a downside protection a bit higher than the 3.60. And that’s really what our goal is, and we think 3.60 is a great level today. But can we get another few basis points on top of that if we’re patient? We think so.

Great. That’s helpful. And I think just tied to that, you mentioned deposit betas versus the core customer base could be higher relative to the last cycle. Wondering if anything that you’ve seen so far in the last two to four weeks that would imply that customers’ conversations around higher rates have picked up and you could actually see a higher beta this cycle versus last.

The answer to that is no. We’ve been somewhat surprised by the betas and balances for the industry. Our cumulative beta so far is 5%, making us one of the lowest among our peers, as the median is about double that. We expect deposit balances to decline by approximately $5 billion to $10 billion, with the main factor being corporate deposits, which we believe will seek higher returns over time. We are beginning to see some movement in that regard, though we are surprised it hasn't happened more rapidly. If the Fed increases rates by 75 basis points at the end of July and then by another 50 basis points in September, we think those balances will start shifting off balance sheet. We intend to facilitate that for our customers, as it allows us to earn a fee while providing them with a better return. This has already started to occur. When looking at corporate customers, their deposit balances with us or off balance sheet that we have facilitated are actually a bit higher than they were at the end of last year. Overall, we’re pleased with our deposit base and betas so far.

You’ve all demonstrated your ability to manage risk effectively. I’d like to know your thoughts on the risks associated with the ongoing strength in labor markets, the balances in consumer accounts, and overall strong liquidity and spending. All of this seems positive, but we understand that the effects of interest rate hikes take time to manifest. Unemployment may continue to rise even after the last rate hike, and we’ve started to notice initial claims remain elevated. Could you share how you perceive this dynamic might influence the decisions you are making across the business, even if it’s not yet visible at the micro level?

Yes. Bill, it’s a great question, and it’s one we challenge ourselves with constantly, as a team. In our discussions with others in the industry, including our regulatory supervisors and the Fed, in particular, about where they really want to go, I think we all believe there’s an expectation of getting to “neutral” as fast as they can, is what they would like to do. But I think every time there’s a move, there’s a need to pause and see what impact that’s going to have on the economy. We do have inflation that can get addressed by slowing the economy down, which is taking effect now. But as much as they want to get to “neutral,” I don’t think the Fed wants to direct the economy either. So what we’re trying to do is read all the tea leaves, look at all the data that we can, study our customers, whether it be consumers or corporate customers to try and get an understanding of what they’re thinking, how their business is, how they’re managing their personal money, to gather an understanding of the slowdown in the economy and what the Fed may or may not do. We believe that the Fed is going to get to 3.25 to 3.50 by the end of the year. I don’t know if they’ll move exactly like the market thinks, but we think that’s going to be a place where they’d likely stop and let things play out over time. But, we have to be prepared for them to keep going. And if that’s the case because inflation is not under control, there could be some ramifications to that long term, which is why we’re cautious on extending credit, while we want to manage our bank as efficiently as we can because you have to have scenarios for anything that could possibly happen as we seek to continue to have appropriate returns on capital to our shareholders.

That’s great color, very helpful response. Thank you. If I may follow up on EnerBank, can you remind us how growth math dynamics impact EnerBank? What’s the interplay between the need to build reserves on the strong loan growth that you’re seeing versus the timing of the revenue benefits? And then more broadly, if you could also speak to the trajectory of the reserve rate from here.

Okay. I’ll start on EnerBank. So, EnerBank, we said represented 1% of an industry that was about $175 billion. So call that $1.7 billion of annual production for them. That generates growth in the double digits. We’ve seen that play out. We don’t think about the provisioning getting ahead of earnings because if we did that, we would not make any loans ever. That’s why it’s a terrible standard, but I won’t go into that. It is what it is. So, what we want to do is be there for our clients to extend credit, regardless of the fact that we have to set up a reserve in advance. So, it doesn’t come into play. We’ve had nice growth with EnerBank. We’re very excited about that, getting paid for the risk we’re taking, and it’s worked exactly like we thought it would be.

You asked about the growth factors of our return in relation to fee versus interest income. What was his question?

Net interest income is the biggest contributor to our profitability. It comes from two sources: the rate paid by the customer and the discount from the vendor providing the service, such as an HVAC contractor. We combine these two elements for our yield adjustment, which should average around 9% over time. This is the main source of profitability you will see from EnerBank.

That’s very helpful. And the broader trajectory of the reserve rate from here that we should be thinking about?

Yes. So, we set the reserves under CECL based on the economic forecast at each quarter end. We have to look out through the life of the loan to do that. We have a reserve of 1.62%. We think it’s very robust. And based on the risk that we see in the portfolio, we feel very good about that. The biggest driver of the increase in our reserve this quarter by far was loan growth. And so, we aren’t seeing broad-based deterioration in credit at all. As a matter of fact, we think it’s actually pretty good. We did have an increase in NPLs, primarily attributable to one particular customer. But overall, we feel really good about credit. We do think there’s going to be some normalization. I mean, we’re at 17 basis points of charge-offs this quarter. That’s lower than “normal.” And we think over time, it will get back to normal. I don’t know that it will get there in 2022. We’re forecasting charge-offs in the range of 20 to 30 basis points, and actually towards the lower end of that. 2023, you could see losses pick up as the economy slows as certain industries start to struggle a bit more than others. And I think you’ll see it manifest itself first in really small businesses that will have bigger challenges than a larger business and certain consumer groups might struggle more than others.

David, can you elaborate a little further on your comments about the capital market fees that you expect to be at the lower end of the range? I think you said in your prepared comments in the upcoming quarter. What type of capital markets environment are you contemplating for that kind of guidance? Is it currently what we just had this quarter, or is it an improvement? And then, within the capital markets, obviously, you guys are ECM players. Where are you seeing or do you think you’re going to see the strength in the upcoming quarters?

Yes. We believe that when excluding CVA and DVA, we're positioned at the lower end of our range, which we expect to maintain in the short term. The capital markets activity isn't particularly strong, as observed across the industry, especially among money center banks with greater ECM involvement, which we do not have. We anticipate that M&A, advisory, and loan syndications will remain solid for us. It’s unfortunate that we won’t reach the upper end of that range, as we’ve had to lower our expectations from the start of the year several times. Nevertheless, we feel that this is still a good position to be in. Additionally, our involvement in real estate capital markets and the acquisition of Sabal Capital Partners last year is beneficial. However, we must acknowledge that the current environment is proving to be more challenging than we had hoped due to the overall capital markets not meeting our expectations at this time.

Very good. As a follow-up to your comments about lending and the strength of your lending practices, you have a lot of experience dealing with issues from the downturn in 2008 and 2009. So, there's an expectation that you won't make similar mistakes. Can you share more about your client selection, as you mentioned it is robust? What measures are in place if we are nearing the end of the economic cycle? It's debatable, of course, but with the growth trend not only for you but for the entire industry, as many are reporting good loan growth towards the end of an economic expansion, how can you assure us that you have the right metrics in place to avoid the problems that other banks might face?

Yes, Gerard, this is John. We gained significant insights from the 2009/2010 period, particularly regarding the value of balance and diversity. While these are favorable times, it's important to remember that some of the worst loans can occur during prosperous periods. Therefore, we're being very careful with our lending practices. A significant 83% of our new production has gone to existing customers. Over the past 2.5 years, especially during the pandemic, we have been closely collaborating with these customers and have a strong understanding of their business environments. For several years, we have focused on recycling capital based on risk-adjusted returns and have exited portfolios and relationships that did not yield adequate returns for us. This reflects the discipline within our company; we have established strong metrics and key performance indicators across all our business areas, coupled with a commitment to a solid concentration strategy to maintain balance and diversity. We consider a range of scenarios when stress testing our credits and portfolios. Consequently, we have confidence in our credit risk management culture developed over time, and we believe our portfolios will perform well regardless of how economic conditions progress.

David, you talked about the $5 billion to $10 billion of potential deposit outflows starting to pick up. And if we were to assume they exit over the next quarter or so, can you maybe just talk about your expectations for deposit growth? And given John’s comments regarding what you guys think about loan growth in the second half, how do you think about the trade-off between growing deposits versus optimizing the mix and the cost of deposits?

We anticipate that the excess deposits from our corporate clients will seek better, higher-yielding options. Additionally, we acquired approximately $1.8 billion in brokered deposits from the EnerBank transaction. We focus on building quality relationships in deposits and treasury management, and we grew our treasury management segment by 14% this quarter, which is encouraging. From a consumer perspective, we are located in a favorable region that should attract more people into our banking footprint, allowing us to grow core checking accounts. While inflation is affecting consumers, our analysis shows that those with $1,000 or less in their checking accounts before the pandemic now hold six times more cash than they did then. Although this cash accumulation may decrease if inflation accelerates, our strategy to attract more customers should help us sustain solid deposit levels. Our loan-to-deposit ratio stands at around 67%, which is among the lowest in our peer group, and we are efficiently managing our deposits. Growing our deposit base is crucial to our profitability. We are not concerned about relying on wholesale funding like some competitors, as our strong deposit base is our competitive advantage. We plan to continue expanding our deposits and ensuring customer satisfaction.

Got it. And then second, David, you’re targeting 300 basis points of positive operating leverage, and I know it’s early to think about 2023, but maybe just to follow up on Peter’s question from earlier. If you think about just reaching the NII run rate and assuming no further growth, that would give you about 8% revenue growth into next year. So, how do you think about investing, and this obviously is a tricky environment with the potential for an economic slowdown, but do you expect that we could potentially see accelerating positive operating leverage in that type of environment?

Well, I think you answered that question upfront. It’s a little early to get into 2023. But, let me help you here. We have a continuous improvement program where we are constantly focusing on how to get better at what we do. We had a pretty strong efficiency ratio this quarter of, call it, 54% on an adjusted basis. We’d like that to be lower. We’re substantially below the median, which is 400 basis points higher than we are. And I think that at the end of the day, if we could get closer to 50%, that would be great. And we’re going to figure out how to try and do that. We cannot count on revenue growth just being the only driver of how we continue to be efficient. So, if we stay focused on that, Ryan, I think we can generate pretty solid positive operating leverage. Now, there’s a caveat. We have to continue to take our winnings, if you will, and reinvest those in our company to grow. That means we have to reinvest in talent, we have to reinvest in technology, we will reinvest in our transformation we’re going to go through on the deposit side, primarily, in other areas, and we do that while continuing to control our cost increases, which I told you earlier in the year, the vast majority of our increase earlier in the year was really related to acquisitions. So, we’ve been good expense managers, and I think you’ll see that continue into 2023.

Got it. I’ll make sure we hold you to that 50%. Thanks, David.

Okay. Target. Target.

Good morning. Dana, great job on slide 8. David, I wanted to revisit slide 8. Can you clarify your plans for the security book and your cash balances moving forward? Clearly, if IOER remains aligned with Fed funds, your cash will have to work much harder by the end of the year.

I'm glad you mentioned that. We see a full opportunity there, and we currently have a 1.65% reserve. We've been careful with our cash and didn't need to place it in the securities book to boost net interest income, as our hedging program has effectively managed that for us. We've been patient, and it has proven beneficial. We have invested a small portion in the securities book because the spreads reached a point where the duration warranted it, and this investment aligns with our hedging strategy. This quarter, we utilized our cash to support our loan growth, and we ended with about $18 billion in cash. Typically, we maintain around $500 million to $2 billion at the Federal Reserve. We need to retain some of that to accommodate potential deposit outflows, whether from corporate or brokered deposits like EnerBank. We also have enough cash for loan growth, so we don't find it necessary to tap into alternative funding sources like the FHLB or issue any bank debt right now. Our cautious approach has proven effective. The securities we invested in this quarter are yielding around 330 basis points, and our decline in tangible common equity has been significantly smaller compared to our competitors.

So, I just wanted to make sure we’re taking away the right message here. From second quarter NIM, 3.06% can hit a net interest margin of 3.70% to 3.80%, right, from higher beta to base case at a Fed funds rate of 3%. And if the Fed starts cutting rates, your swap program has protected you to 3.60%.

That’s correct.

Okay. And my other question for you, David, is if we were to prepare for a technical difficulty, how should we think about how more ACL build there may need to be from that 1.62%?

So you cut out on the first part of that, but I think your question was how do we see the reserve build from here from 1.62 in a mild recession?

Yes, in a mild recession.

Yes. So, we’re having to forecast out through life of loan today, which has elements of a slowdown already built into it. So, it really is dependent on how severe it is relative to our expectations already. And we kind of went through that, I guess, in the pandemic. You saw our adjustment quickly. Right now, we don’t see that changing a lot because we think we’re covered. And the real change to the allowance are just two things: whatever charge-offs have, reducing it, and then the provision primarily for loan growth, which is what you saw this quarter. Our credit quality metrics are stable net-net, all in, and we feel good about where we are. But, if the economy starts to slip, then we’re going to have to have higher provisioning going forward. And every quarter stands on its own. So, we’ll have to reassess at the end of September.

Just two quick closeouts here. Just one question, David, on the C&I loan yields, just not up as much, of course, as the NIM, and I’m sure some of that is the hedging. Just wondering if you can kind of just help us understand how much of that is the hedging impact, how much of that might just be mix and pricing, et cetera? Thanks.

Yes. I would say most of that is related to hedging. Our old hedges that we had protecting us, those start to roll off. We have some still protecting us that are still in place. So we’re not expanding it quite the pace that maybe others that didn’t hedge are, but we still have pretty good loan yields net-net. And if you look at adjusted net interest income that’s after charge-offs, we’re one of the leaders in the peer group. So, that’s a good indicator of telling us we’re being paid for the credit risk that we’re taking.

Yes. Got it. Okay. And then, on capital, 9.2% CET1, you’re mentioning you want to get back to the middle of the 9.25% to 9.75% net-net. And presuming that’s to give room for loan growth, just wondering, obviously, that probably applies that no buybacks for now, can you just talk us through capital return expectations versus RWA? And then also just there’s just a little bit more conservatism about the environment.

Yes. So, the reason we want to be in that range is to give us flexibility to make investments when we see opportunities. In this particular quarter, it was loan growth. So, we had really robust loan growth, and you could see our capital, our common equity Tier 1 declined. The primary use of that was, in fact, RWA growth through the loans. We’re generating, call it, 50 basis points of common equity Tier 1 each quarter or at least we did this past quarter. We’ll use a third of that to pay a dividend, and then the rest of it is for investment. First off, it’s for loan growth. We’ve already sent the message that we don’t expect loan growth at the pace we just saw in the first quarter. We think that will level off a bit. Therefore, we can accrete back from the 9.2% where we are, closer to the 9.5%. Probably can’t get there at the end of the third quarter, but take us into the fourth quarter. But we use share repurchase as the last item to control our capital level. We think that 9.25%, 9.75% still is a great range for us based on the risk we see in our book taking into account all the macro factors that exist today. So you’ll see us accrete back up towards that 9.50% before we get into share repurchases.

Two questions. One on securities book. I know we just had a bit of a chat on that. But, I wanted to understand what the kind of repricing speed is, duration, like how quickly should we be thinking about the back book migrating to the front book of 3.3 that you just talked about?

Well, if you look at all-in growth, so the 3.3 I just mentioned was an element of what we invested primarily as part of our hedging program. We did have other security purchases. So, all-in yield going on was about 3.13. That’s replacing 2.23. So, we’re picking up about 90 points on that. As we think about duration, we’re looking at, call it, right at five years today. And we don’t think that extends a whole lot on us based on what we’re buying. So, I think that got what you wanted, Betsy.

Yes. So, like 20% roll rate annually?

That’s right.

Okay. And then, on page 22 of the deck, you have your base R&S economic outlook. So, is this giving us the base case? And then you’ve got a probability assigned to the base case, you’ve got a probability to sign to the bull and the bear, and that’s what’s feeding into the CECL reserve analysis, or would you say this page 22 discloses your probability-weighted scenario?

Yes. So, we do ours a little different. We use a scenario, and as our CECL provisioning, we do run stress testing, obviously, using very different scenarios. But we don’t probability weigh different things. So, what you’re seeing here on ‘22 is the driver of our CECL provisioning.

Just a clarification. Do you expect your liquid assets to actually go down to $750 million? Because you’re obviously much higher today. But is that realistic?

No, I was saying that in normal circumstances, we could reduce our cash to a level much lower than the current $18 billion we have. This would occur over time, and we don't plan to reach that point soon, as we want to maintain ample liquidity to manage deposit flows. We experienced about $40 billion in what we're referring to as surge deposits. Our estimates suggest that around $13 billion to $14 billion of that may have a very high beta or seek better alternatives, which means we need to be prepared with cash if that happens. In normal conditions, we could be looking at a range between $500 million to $2 billion. Additionally, we would utilize the FHLB to address other liquidity needs.

Okay. And one more, which commercial sectors are you seeing early signs of normalization?

From a credit risk standpoint, Vivek?

Yes.

I think, David talked about small business. We have some concern around the transportation, particularly on the lower end of the sector where you have transportation companies who are involved in less than truckload hauling and the impact of diesel fuel, inflationary cost, and labor. We have been following office for some time and senior housing as well are portfolios that we’re keeping an eye on. I wouldn’t say in those two instances that we’re seeing any normalization, but we do have a watchful eye on them.

Okay, great. Thank you, David. Thanks, John.

Thank you.

Thank you. Well, I appreciate everybody’s participation in today’s call. Thanks for your interest in Regions. If you have any follow-up questions, please contact Dana and the Investor Relations team. Have a great day.