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Edited Transcript of RF earnings conference call or presentation 22-Oct-19 3:00pm GMT

Q3 2019 Regions Financial Corp Earnings Call

BIRMINGHAM Nov 5, 2019 (Thomson StreetEvents) -- Edited Transcript of Regions Financial Corp earnings conference call or presentation Tuesday, October 22, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Barbara Godin

Regions Bank - Chief Credit Officer

* Dana Nolan

Regions Financial Corporation - EVP & Head of IR

* David Jackson Turner

Regions Financial Corporation - Senior EVP & CFO

* John B. Owen

Regions Financial Corporation - COO & Senior EVP

* John M. Turner

Regions Financial Corporation - President, CEO & Director

* Ronald G. Smith

Regions Financial Corporation - Senior EVP & Head of Corporate Banking Group

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Conference Call Participants

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* Betsy Lynn Graseck

Morgan Stanley, Research Division - MD

* Brian D. Foran

Autonomous Research LLP - Partner & US Regional Banks

* Christopher William Marinac

Janney Montgomery Scott LLC, Research Division - Director of Research and Banks & Thrifts Analyst

* Erika Najarian

BofA Merrill Lynch, Research Division - MD and Head of US Banks Equity Research

* Gerard S. Cassidy

RBC Capital Markets, Research Division - MD, Head of U.S. Bank Equity Strategy & Large Cap Bank Analyst

* John G. Pancari

Evercore ISI Institutional Equities, Research Division - Senior MD & Senior Equity Research Analyst

* Kenneth Michael Usdin

Jefferies LLC, Research Division - MD and Senior Equity Research Analyst

* Matthew D. O'Connor

Deutsche Bank AG, Research Division - MD in Equity Research

* Ryan Matthew Nash

Goldman Sachs Group Inc., Research Division - MD

* Saul Martinez

UBS Investment Bank, Research Division - MD & Analyst

* Stephen Kendall Scouten

Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research

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Presentation

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Operator [1]

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Good morning, and welcome to the Regions Financial Corporation's quarterly earnings call. My name is Shelby, and I'll be your operator for today's call. (Operator Instructions)

I will now turn the call over to Dana Nolan to begin.

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Dana Nolan, Regions Financial Corporation - EVP & Head of IR [2]

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Thank you, Shelby. Welcome to Regions' Third Quarter 2019 Earnings Conference Call.

John Turner will provide highlights of our financial performance and David Turner will take you through an overview of the quarter. Earnings related documents, including forward-looking statements, are available under the Investor Relations section of our website. These disclosures cover our presentation materials, prepared comments as well as the Q&A segment of today's call.

With that, I will now turn the call over to John.

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John M. Turner, Regions Financial Corporation - President, CEO & Director [3]

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Thank you, Dana, and thank you all for joining our call today.

This morning, we reported earnings from continuing operations of $385 million, a 9% increase over the third quarter of last year, resulting in earnings per share of $0.39, an increase of 22% over the prior year. This quarter, we also have delivered the highest pretax pre-provisioned income that we've produced in nearly a decade, while generating 3% adjusted positive operating leverage year-to-date. All in all, despite lower interest rates and significant market volatility, it was a very solid quarter.

Over the last 2 years, our core messaging has reflected our intention to generate consistent and sustainable long-term performance through all phases of the economic cycle. We've been planning for the time when we would no longer benefit from a rising rate environment and when credit would begin to normalize.

Since late 2017, we began taking incremental actions to reduce our interest rate risk, build a stronger and more resilient balance sheet and improve returns on capital. We executed a robust hedging strategy that will protect us in a declining rate environment and allows us to maintain a healthy and stable margin without having to stretch for loan growth. With respect to credit, our team has spent the better part of the last 10 years fundamentally changing and improving our credit risk management framework.

Today, we have a robust and dynamic process, centered on an appropriate concentration risk, sound underwriting, rigorous client servicing and early identification of potential problems. We've also intensified our focus on risk-adjusted returns and appropriate capital allocation, balance sheet optimization, derisking and repositioning. Just as important, we launched our continuous improvement initiative called Simplify and Grow, focusing on our desire to make banking easier for our customers and associates, accelerating revenue growth and driving efficiency and effectiveness. We've already benefited significantly from these efforts, and we have much more to do.

We have completed 16 of 67 initiatives and expect to complete 7 more by year-end. These efforts have allowed us to make significant investments in technology to better serve our customers, and we're seeing the benefits of those investments. For example, through our digital platform, year-to-date checking and credit card production have increased 24% and 91%, respectively. Loan applications have increased 55% and with mortgage in particular, approximately 60% of all applications are completed online. Mobile deposits have increased 60%, and now represent 13% of all deposits. These efforts are paying off and positively impacting the performance of our businesses.

Simplify and Grow has allowed us to make investments in talent, improve services and capabilities and enter markets, all while prudently managing our expense base. And these investments are also paying off. We continue to grow consumer checking accounts and households as well as wealth assets under management. We're also succeeding in our priority growth markets, Atlanta, Houston, Orlando and St. Louis. Consumer deposits and checking accounts in these markets are growing more than 2x faster than the Consumer Bank average. Similarly, corporate bank revenue and loans are growing faster than the corporate bank average. Although it's relatively early, we are very pleased with the performance of these markets as we are delivering results above our expectations.

With respect to the economy, our customers are still generally optimistic about their businesses. But they're becoming more cautious given continued market volatility and uncertainty regarding trade and tariffs. Many are taking a wait-and-see approach when it comes to business investments. However, pipelines remain steady; good but not great.

So in summary, we have a lot of positive momentum and feel good about how we're positioned. Our plan is to remain focused on the things we can control, meeting the needs of our customers with best-in-class service while leveraging technology and making it easier for our customers to bank with us. We're also focused on the fundamentals of our business, generating positive operating leverage through disciplined expense management, while making prudent investment decisions. We're focused on soundness, profitability and growth in that order of priority. We believe our efforts will keep the company positioned to deliver consistent, sustainable results through every economic cycle.

Thank you for your time and attention this morning. I will now turn the call over to David.

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David Jackson Turner, Regions Financial Corporation - Senior EVP & CFO [4]

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Thank you, John. Let's start with the balance sheet. Adjusted average total loans decreased approximately 1%. Adjusted average consumer loans increased modestly led by residential mortgage and indirect other consumer lending. Adjusted average business loans decreased 1% and were impacted by our continued focus on client selectivity and overall relationship profitability. Average business loans also reflected lower line utilization and elevated paydown activity during the quarter, including increased capital markets activities.

We continue to focus on risk-adjusted returns and are not interested in pursuing nominal loan growth for short-term benefit. And as John noted, due in part to our hedging program, we are not pressured to stretch for growth. With that said, we continue to expect full year adjusted average loan growth in the low to mid-single digits.

Turning to average deposits. Despite interest rate decreases on deposits and seasonal declines in public fund accounts, average deposits decreased less than 1% during the quarter, exhibiting the strength of our deposit franchise. So let's look at how this impacted net interest income and margin. Despite lower rates, net interest income was down just slightly compared to the second quarter, and net interest margin declined only 1 basis point to 3.44%.

Net interest margin and net interest income were negatively impacted by lower market interest rates and lower average loan balances, partially offset by declining deposit cost and the benefits of repositioning strategies in the investment portfolio that were executed in the second quarter. Net interest income also benefited from 1 additional day in the quarter, which negatively impacted net interest margin. As expected, total deposit cost declined 4 basis points compared to the second quarter to 49 basis points, and interest-bearing deposit cost declined 5 basis points to 77 basis points, one of the lowest in the industry.

The deposit beta associated with declining interest rates was 25% this quarter, and we expect to experience a deposit beta in the 25% to 30% range in the fourth quarter. In an effort to reduce net interest income sensitivity to long-term rates, we repositioned out of approximately $1.2 billion of mortgage-backed securities into prepayment-protected securities this quarter. These reallocations reduce our exposure to mortgage-backed securities by approximately 7% and our related book premium by approximately 8%. We're also exploring additional opportunities to further reduce sensitivity to long-term rates. In fact, we added additional hedges subsequent to quarter end that are intended to reduce the impact of lower long-term rates on 2020 loan originations.

Assuming two 25-basis-point reductions in the Fed funds rates by year-end, we expect some near-term pressure on net interest income and net interest margin in the fourth quarter, which we can partially mitigate through reductions in deposit costs. Net interest margin is expected to move in the high 3.30s in the fourth quarter. However, we expect the first quarter margin to expand into the low 3.40s as the benefits of our hedging strategy begin.

Now let's take a look at fee revenue and expenses.

We delivered strong results this quarter with adjusted noninterest income increasing 9% compared to the second quarter led by growth in service charges, wealth management and mortgage as well as favorable market value adjustments on employee-benefit assets. The increase in wealth management income includes a modest benefit from the recent acquisition of an institutional investment firm, Highland Associates. Total mortgage income increased significantly, driven primarily by increasing hedging and valuation adjustments on residential mortgage servicing rights.

Additionally, mortgage production and sales income also increased consistent with elevated production, highlighting the benefit of our strategic focus and our decision to add mortgage loan originators earlier in the year. Partially offsetting these increases were declines in capital markets income and card and ATM fees. The decline in capital markets income was attributable primarily to decreases in M&A advisory services and loan syndication revenue. Customer swap income was also negatively impacted by CVA adjustments during the quarter.

Looking ahead, we expect capital markets to finish this year on a strong note with fourth quarter revenue exceeding this quarter's reported results. The decline in card and ATM fees reflected the impact of favorable commercial interchange rebate adjustments recorded in the prior quarter that did not repeat. We continue to expect full year adjusted revenue growth of approximately 2%.

Let's move on to noninterest expense. Adjusted noninterest expense increased less than 1% compared to the prior quarter, driven primarily by higher salaries and benefits, partially offset by decreases in professional fees and outside services. The increase in salaries and benefits was driven primarily by an increase in the market value on employee-benefit assets as well as higher production-based incentives, 1 additional weekday in the quarter and the addition of Highland Associates.

These increases were partially offset by continued overall staffing reductions. The decreases in professional fees and outside services were primarily due to lower legal cost and our continued success in reducing overall third-party spend. The company's third quarter adjusted efficiency ratio decreased 90 basis points to 57.4%, and the effective tax rate was approximately 20.6%.

As John mentioned, we continue to benefit from our continuous improvement process and several Simplify and Grow initiatives are exceeding our initial expectations. For example, at Investor Day, we committed to reducing our total square footage by 2.1 million square feet and our third-party spend by $60 million to $65 million by 2021. We also told you we plan to consolidate 100 branches during the same period. We are proud to say that we are on track to exceed our targets in each of these areas, and we'll continue to look for opportunities to pull forward or expand on initiatives where we can.

These efforts exhibit our commitment to achieving positive operating leverage. Based on our results for the first 9 months and our expectations for the fourth quarter, we expect full year 2019 adjusted expenses to be relatively stable with 2018. With respect to our effective tax rate, we tightened the full year 2019 range to 20% to 21%.

So let's shift to asset quality. Overall credit results remained in line with our risk expectations during the quarter. We saw improvement in several categories, while experiencing some normalization in others. Net charge-offs were unchanged at 44 basis points, in line with our expected range of 40 to 50 basis points for 2019. The allowance for loan losses amounted to 1.05% of total loans and 188% of total nonaccrual loans. Nonperforming loans decreased 13%, while delinquencies and total troubled debt restructured loans decreased 4% and 7%, respectively.

Business services criticized loans increased 9%, driven primarily by increases in classified loans, partially offset by reductions in nonaccrual and special mention loans. The largest increases to classified loans were attributable to energy, retail trade and manufacturing sectors. As a reminder, our third quarter credit metrics also include the results of the most recently completed Shared National Credit exam.

Provision exceeded net charge-offs during the quarter primarily due to these downgrades as we've begun to see some stress within the energy and tariff-related sectors. However, potential losses associated with these credits are expected to be modest and within our expectations. Moreover, we anticipate several will cure in full over the next few quarters.

Let me comment briefly on CECL. In our second quarter 10-Q, we disclosed an expected increase in our allowance for credit losses of approximately $400 million to $600 million due to the implementation of CECL. As we get closer to adoption, we expect subsequent disclosures to include a tighter range of impact and will reflect evolving macroeconomic conditions and forecast as well as any appropriate updates to loan composition and quality.

So let's take a look at capital and liquidity. During the quarter, the company repurchased 39.7 million shares of common stock for $589 million and declared $150 million in dividends. Our Common Equity Tier 1 ratio was estimated at 9.6%, in line with our target level of 9.5%, and we anticipate managing at this approximate level going forward. The loan deposit ratio at the end of the third quarter was 88%. And as of quarter end, we remained fully compliant with the liquidity coverage ratio rule.

Wrapping things up, in light of the challenging and changing economic backdrop, we are pleased with our third quarter financial results. We have a solid strategic plan, designed to deliver consistent and sustainable performance throughout any economic cycle. With that, we're happy to take your questions. (Operator Instructions)

We'll open the line for your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Ryan Nash of Goldman Sachs.

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Ryan Matthew Nash, Goldman Sachs Group Inc., Research Division - MD [2]

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So I wanted to ask a handful of questions. Maybe just first on deposit costs. So we saw them come down nicely on the high end of peers, 25% to 30% decline next quarter, I just wanted to double-check to make sure that's based on September and the potential for in October? And I guess you're one of the only banks where we saw a top quartile performance on the way up and now you're outperforming on the way down. So can you maybe just talk about what you're seeing in both -- across both consumer and commercial and if the Fed is to cut in October beyond a couple of times next year, is there further room to bring down deposit costs?

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David Jackson Turner, Regions Financial Corporation - Senior EVP & CFO [3]

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Yes. Ryan, this is David. So we've talked an awful lot about how to manage net interest income and margin and changing rate environments and deposit cost being a key input is important to manage both. So let me start with consumer. We've done a really good job of adjusting our deposit cost, while staying competitive in the markets that we are competing in. And that's been a big driver of our deposit cost declining. I think what you'll see going forward is probably more contribution coming from the commercial side. They've done a pretty good job.

A lot of those deposits are [in] indexed. If you recall in the first quarter, we increased deposit cost because we have above-average loan growth that we had to use deposits to fund that loan growth. That's clearly subsided, and we're looking at adjusting those deposit costs on the way down. So we have a beta of 25% to 30% that we are giving you guidance for, and we think that will apply to the 2 potential rate cuts that we see for the remainder of the year.

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Ryan Matthew Nash, Goldman Sachs Group Inc., Research Division - MD [4]

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Got it. And then if I could follow up on expenses. I mean clearly the revenue environment has been challenging. You guys are doing a better job than others to defend the margin. David, you talked about completing 16 of 67 initiatives for Simplify and Grow and you're going to have a handful more done before the end of year and you talked about upside some of the areas that the 3 big areas that you're saving on cost. So as you think ahead, you're clearly holding cost stable this year. But are there enough levers for you to continue to invest in things like technology and grow the business and continue to hold expenses flat beyond 2019?

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David Jackson Turner, Regions Financial Corporation - Senior EVP & CFO [5]

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So I won't comment quite on '20 yet but the way we think about it is, we are continuing to make investments in talent, mortgage loan originators, commercial RLs, wealth advisors. We've continued to make investments in technology, 42% of our $625 million is spent on new things that we need to have to continue to make banking easier for our customers. We have to do that, and we will continue to do that. But in order to make room for that and control costs, we have to get better at literally everything we do.

So John has asked all of us, all 20,000 people that work here, how do we get better at whatever we do tomorrow than we did yesterday so that we can continue to make room for investments that we want to make. We have inflation in our expense base of about 2.5%. So we have to overcome that inflation plus the investments to be able to hold our cost relatively stable, like we've done for the last couple of years.

We will continue to seek to hold our cost down, and we have a goal of efficiency to get to the 55% range. We've mentioned that at Investor Day. We're at 57.4% today. Obviously, it's very challenging in a low rate environment. But we are not giving up. We're going to continue to seek becoming more efficient as we go forward. So there's still room to control cost into 2020.

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Operator [6]

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Your next question comes from Matt O'Connor of Deutsche Bank.

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Matthew D. O'Connor, Deutsche Bank AG, Research Division - MD in Equity Research [7]

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I was wondering if you could just talk about, kind of big picture of how you think about balancing, protecting the profitability ratios versus growing the balance sheet? You've been keeping deposits relatively stable, it's helping NIM. You're obviously seeing good growth in service charges. So there's some puts and takes, but talk about the trade-off between the focus -- protect the profitability but then also thinking about trying to grow the balance sheet?

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John M. Turner, Regions Financial Corporation - President, CEO & Director [8]

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Yes. I think it is a great question and it is very much a balance. We are focused on building a business that's going to be consistently performing, that's going to be resilient, that's going to be sustainable. And that means we've got to build a balance sheet that is resilient through every economic cycle. We've clearly traded off some growth for quality. And we'll continue to do that, Matt, as we focus on -- we think it's a period of time in the economic cycle when we need to be thoughtful, careful. Client selectivity is really important to us, early identification of problems, exiting relationships that may become problematic, really important to our future.

So we talk often about the importance of soundness first then profitability and growth last. We are not going to grow just to grow. We don't need nominal growth. We think the balance sheet is positioned to deliver consistent and sustainable performance and a profitability that we believe will adequately reward our shareholders, and that'll continue to be our focus.

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David Jackson Turner, Regions Financial Corporation - Senior EVP & CFO [9]

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Yes, now I add, Matt, that we do expect to grow, as we said we would grow low to mid-single digits in terms of loans for the year. We are up about 4.8% year-to-date on an adjusted basis. And so what we're saying is, we do expect to grow. We're just not going to force growth on the balance sheet to generate nominal revenue and nominal income if the return gets harmed.

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Matthew D. O'Connor, Deutsche Bank AG, Research Division - MD in Equity Research [10]

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And just following up. I mean you obviously had really nice loan growth in the first half of the year, little bit of runoff this quarter. And I think one of your other portfolios might start to run off by the end of the year. It's just that if you kind of put it all together in the comments you made, what's kind of the more medium-term outlook in terms of grow loans? And then also just comment on deposits as well.

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John M. Turner, Regions Financial Corporation - President, CEO & Director [11]

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Yes. Well, with respect to loan growth, I think what we've said is that we anticipate growing low single digits typically with the economy plus a little, in the markets that we operate in. We think that that's appropriate. If you look at year-over-year business services loan growth has been about 7.5%. We do have some runoff portfolios in consumer, in particular. We're seeing some declines in equity lending and indirect auto. We're capping our exposure to indirect, unsecured lending. But we believe that our focus on continuing to build out the consumer business at the same time our commitment to business services lending, particularly middle market, commercial lending will drive an appropriate amount of loan growth and allow us to continue to grow the assets out the balance sheet.

And with respect to deposits, we're focused on core relationships. And when you look at our consumer business, we believe that 93-plus percent of our customers maintain their primary operating account with us. We're continuing to grow consumer checking accounts at a rate we think faster than most of our peers, the consumer demand deposits and consumer low-cost deposits growing over time. Similarly, with a focus on small- to medium-size businesses, winning their operating business, we think we can still continue to grow low-cost deposits, which is really the core of our business and the strength of our franchise.

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Operator [12]

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Your next question comes from Ken Usdin of Jefferies.

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Kenneth Michael Usdin, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [13]

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David, could you talk a little bit about the balance sheet protection a little bit more? I was just reading in the deck, you added a little bit more on the hedging side, to impact the impact of lower long-term rates. So if you say the program's largely completed. I guess can you just help us understand the math of -- the magnitude of the step up that helps get the NIM up as you look from fourth to first and then how that'll cascade on its own throughout the year?

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David Jackson Turner, Regions Financial Corporation - Senior EVP & CFO [14]

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Yes. So I'll start kind of with the end in mind. We talked about -- going into next year. We think our margin could increase into the low to mid-3.40 range. We have a chart with regards to our sensitivity, our short-term sensitivity is take it close to 0% by the beginning of the year through all the hedges that kick in and starting little bit in the fourth quarter, but primarily the first part of the year. What we want to do is we have more exposure on the long end than a lot of our peers. So we wanted to kind of neutralize that a bit.

So we've entered into a couple billion dollars worth of hedges that would really be -- that kind of got tied in when the 10-year was in the mid-low 1.70 range to help us from the long end and that's really manifest itself in reinvestment of cash flows that come off the business every month. So that's baked into the guidance that we're giving you. And we believe that we're not going to have a disproportionate correlation to the 10-year relative to our peers after this.

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Kenneth Michael Usdin, Jefferies LLC, Research Division - MD and Senior Equity Research Analyst [15]

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Okay. Got it. And on the left side of the balance sheet, can you just discuss the MBS repositioning that you did? And what premium am was and how does this change that magnitude that you'd expect?

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David Jackson Turner, Regions Financial Corporation - Senior EVP & CFO [16]

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Yes. So premium amortization was relatively stable in the quarter, about $28 million in the quarter. What we did is, we took some low yielding investments, securities that we could sell, we took those and we repositioned those into longer -- a little more duration and a little more carry to help us just again boost a little bit from an NII standpoint. But they were really lower-yielding mortgage-backed securities that we sold and reinvested.

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Operator [17]

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Your next question comes from Betsy Graseck of Morgan Stanley.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [18]

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Okay. So couple of questions. The background for the question just has to do with the longer-term outlook for ROTC, which I know you put out at, I think it was like 15% to 18%, is that right, at the Investor Day?

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John M. Turner, Regions Financial Corporation - President, CEO & Director [19]

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No, it's actually 18% to 20%.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [20]

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Sorry, 18% to 20%. Yes, 18% to 20%. Sorry.

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John M. Turner, Regions Financial Corporation - President, CEO & Director [21]

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Little different interest rate environment.

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Betsy Lynn Graseck, Morgan Stanley, Research Division - MD [22]

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Yes. Exactly. So the question that I have is, how are you thinking about that -- what I'm looking at and I'm hearing, okay, you've got a lot more opportunity on the expense side and maybe that expense operating leverage improves as we go through the next couple of years. But then I'm also wondering about the capital side of the equation here and how you're thinking about that. I know you have your 9.5% target but given the tailoring rule that came out and everything else that's been happening for banks in your size, is 9.5% is still the right number for you?

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David Jackson Turner, Regions Financial Corporation - Senior EVP & CFO [23]

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Yes. So I'll start with your last question. And we calculate the amount of capital we need to have based on our models, not -- it's not regulatorily driven. And yes, we're encouraged by the tailoring relief that we have. But does not change one iota the amount of rigor that we put into capital planning and management. We still have every other year of CCAR submission. So for the time being, 9.5% was our target. We tried to put that in our prepared comments to -- even though our math really says we could get to 9%, we've added 50 basis points of cushion to enable us to take advantage of opportunities, should they arise, as the market uncertainty and the economic conditions continue to decline a bit.

As it relates -- and the 9.5% was going to allow us to get to the kind of returns we think are appropriate given the circumstances that we're under. Now the 18% to 20% was -- as John was saying in the middle of your question that we had -- and that was a very different rate interest environment. We all thought rates were going to go up this year and they clearly are down and they are forecasted to be down through the period of time we have covered by that Investor Day.

So getting to 18% to 20% would be very difficult to do without taking some unusual risk, which we will not do. So we're going to come out and we'll update the exact targets for you later. But clearly, there's been some decline in terms of return expectations. I think that's what's our -- the stock prices in our industry have reflected. But exactly where those will be, we need to get a little better handle where we think rates will go. We have 2 baked in for this year, there's probably another 1 coming in '20 as well. So more to come, Betsy.

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Operator [24]

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Your next question comes from John Pancari of Evercore ISI.

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John G. Pancari, Evercore ISI Institutional Equities, Research Division - Senior MD & Senior Equity Research Analyst [25]

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I wanted to see if you could talk a little bit more on the investments you're making in IT. I believe you're currently evaluating replacing your core deposit system, and so I wanted to see if you can give us some details around that, in terms of what's the timeframe around that type of project, what's the cost impact that we should be considering here, could it impact next year's numbers? And then is there other systems? Are you looking at the core system on the loan side as well, or is there just the deposit system issue?

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John M. Turner, Regions Financial Corporation - President, CEO & Director [26]

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That's a -- John, that's a great question. We just had our strategic planning offsite meeting with our Board, spent a lot of time talking about the topic.

And so I'll ask John Owen to address it.

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John B. Owen, Regions Financial Corporation - COO & Senior EVP [27]

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Yes. Just to go back to Investor Day, we spend about $625 million a year on technology. Have about 1,600 plus technology professionals at the bank. And every year at our strategic annual planning process, we go through about a 3 to 5-year view and find out and we'll talk about what systems need to be upgraded, consolidated or replaced, and each year there's about 15 systems that we identify that we'll need to go out and either upgrade or replace. So this is just a normal case of business, normal cause of business today.

You mentioned some of the core systems around deposits, we are going to have an RFP that will go out in the first quarter for our deposit system. We'll get those results back probably midyear, and we'll make a choice on what's the right platform for us. The timeframe for that is probably a 3 to 6-year journey for this. What you'll find with us when we do upgrades, we don't do very many Big Bang upgrades. This will be an incremental approach over a multiyear time period.

So again, this is a -- probably a 4 to 6-year system exchange in this particular case. What I would tell you, we do about 15 of these a year. This would be a larger one, of course. But again, if you go back to our Wealth Platform, we did SEI a couple of years ago, we consolidated 14 systems into 1. We're fortunate to operate on 1 consumer platform and we're in the point of implementing nCino at this point in time. So what I would tell you, it is large. We are in the RFP process but this is nothing that we don't do 15 to 17 of every year.

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John M. Turner, Regions Financial Corporation - President, CEO & Director [28]

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And our analysis, John, would indicate that we can complete the work within the context of our current technology spend. So we don't see any outsize sort of allocation to expense associated with any of the core system changes.

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John G. Pancari, Evercore ISI Institutional Equities, Research Division - Senior MD & Senior Equity Research Analyst [29]

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Okay. That's helpful. And then one -- I apologize, this is a little bit off the radar, a little bit, this question. But on Friday, you issued an 8-K that you announced that you're expanding your change of control provisions to an additional component of the management team beyond the C-suite executives. Can you give us just a little bit of color of what that relates to and how common is it that you are refining your change of control?

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John M. Turner, Regions Financial Corporation - President, CEO & Director [30]

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Yes. Thank you for the question. I guess we really did 2 things: both were intended to standardize. As you can imagine with the Truist announcement, there's a lot of concern about what our future is, what our intentions are, a lot of questions about what may happen going forward. It caused us to look at our change of control agreements. And because the bank was the combination of a lot of banks over a long period of time, what we quickly concluded was we had a fair amount of inconsistency in our agreements, both with respect to change of control and severances.

So we asked our Board to consider a change in the -- or modifications to both the change in control and severance to make them more consistent so they applied to both an appropriate group and they applied similarly to that group. And so it simply was a housecleaning sort of initiative for us to get everything in order. No real significant change for our shareholders or frankly for our associates but it does create some consistency.

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Operator [31]

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Your next question comes from Erika Najarian of Bank of America.

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Erika Najarian, BofA Merrill Lynch, Research Division - MD and Head of US Banks Equity Research [32]

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Given your outlook for continued low to mid-single digit loan growth, and clearly you laid out a very specific path for net interest margin, is it too optimistic to think that net interest income could be flat next year?

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David Jackson Turner, Regions Financial Corporation - Senior EVP & CFO [33]

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Well, we don't want to give guidance yet on what next year's -- we still have things that we don't know about, what will the rate environment look like. Clearly, that puts pressure on growing net interest income. We do think that -- and we've talked a lot about being able to grow the balance sheet consistent with GDP and then some, then a little. Now we've also done a lot of capital recycling to make sure that we're getting good relationship business on the books and so you've seen some pressure on absolute loan growth there. But we expect to grow. We -- and our teams have that expectation. So we have that piece of it we feel good about. Let's just see what the rate environment gives us going into next year, lower rates obviously put some pressure on us.

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Erika Najarian, BofA Merrill Lynch, Research Division - MD and Head of US Banks Equity Research [34]

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Got it. And as I think about your earlier responses, clearly, the ROTCE range is potentially out of reach with -- given the interest rate outlook. But you did say you're not giving up on 55%. And as we think about the context of revenue challenges and potentially on the -- because of rates and fees potentially peaking this year, I guess, is there room for expenses on an absolute basis to actually be down to get to continued efficiency improvement?

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David Jackson Turner, Regions Financial Corporation - Senior EVP & CFO [35]

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Well, so our commitment has been and continues to be generating positive operating leverage in any environment. So we are seeking to grow revenue faster than the expenses. So where revenue continues to be challenged, we'll continue to work even harder on expense management and feel that we can do that. So I think that -- clearly, revenue is going to be challenged. And kind of back to the last part of the last question is, revenue will be challenged because 65% of our revenue comes from spread and we had higher rates in the first half of the year versus the back half.

And so on a comp '19 to '20 it would be very hard to grow revenue in that, at least NII. So loan growth will help us there a bit, and we'll see what the rate environment is. But we have good NIR, we have good investments that we've made, we expect that to continue to grow. And as we just talked through, our continuous improvement program, by helping control expenses, we believe we'll generate positive operating leverage and continue to work our efficiency ratio down at the same time.

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Erika Najarian, BofA Merrill Lynch, Research Division - MD and Head of US Banks Equity Research [36]

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Got it. And I just want to be clear. Even in an environment that you mentioned where it's very hard to grow revenues, Regions is still committed to deliver positive operating leverage.

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David Jackson Turner, Regions Financial Corporation - Senior EVP & CFO [37]

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That's correct.

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Operator [38]

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Your next question comes from Saul Martinez of UBS.

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Saul Martinez, UBS Investment Bank, Research Division - MD & Analyst [39]

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Couple of questions. First, more of a clarification. So the 25% to 30% deposit beta in the fourth quarter, is that -- what's the denominator on that? Is that on 2 -- is that on 2 cuts and hence it's a 12 to 15 basis point reduction in deposit cost, it's not -- I'm just trying to make sure it's not on an average Fed funds rate because obviously you had a July and September cut that's fully in the fourth quarter. I just want to make sure I understand the numerator and denominator there.

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David Jackson Turner, Regions Financial Corporation - Senior EVP & CFO [40]

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Yes. So it's based on 2 rate cuts that are baked in, in October and December right now.

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Saul Martinez, UBS Investment Bank, Research Division - MD & Analyst [41]

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Okay. So it would be a -- the 12 to 15 basis point reduction?

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David Jackson Turner, Regions Financial Corporation - Senior EVP & CFO [42]

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Round numbers, that's right.

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Saul Martinez, UBS Investment Bank, Research Division - MD & Analyst [43]

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Okay. Got it. I guess more important question on loan growth. I hear what you're saying that under -- over the long run -- under normal conditions you can grow your balance sheet in line with [EM] and hopefully then some. But if I look at the -- your loan growth this quarter, period end it was up, I think about 1% year-on-year. Going forward, you have indirectly, both rolling off this 2 and maybe a few hundred a quarter, you have GreenSky as a headwind, home equity still little bit of a headwind, your CRE book isn't really growing. It's contracting, I think, on mortgage owner-occupied.

How -- I mean I'm struggling with how you get loan growth and interest-earning asset growth next year? Can you just help me understand where you see the offsets, where -- I know you're not giving guidance for 2020, but how do I think about it conceptually given -- you have pretty material headwinds from -- in multiple loan lines?

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David Jackson Turner, Regions Financial Corporation - Senior EVP & CFO [44]

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So there's lot of stories inside the loan book. Let's just kind of start at the top. So our big driver of loan growth has traditionally been our C&I book. Those can be lumpy from time to time. It depends on access to capital markets. It depends on line utilization and you've seen some of that happening this year. I mean it's -- we had a lot of growth in the first quarter and no growth in the second and the third quarter.

We feel good about our pipelines. We feel good about our conversations we're having with our clients. They are cautious. They're optimistic but they're watching this uncertainty with regards to trade and tariffs, clearly put some pressure and downward sentiment in terms of wanting to make the next dollar fixed capital investment.

But that being said, we still think there's going to be some growth there. From an investor real estate standpoint, we've -- we probably have the second lowest concentration of investor real estate of our peers. We have some opportunities there. We're being very careful and selective with clients. So from time to time, you'll see that move up and then payoffs will move it back down. But I think investor real estate is an opportunity. Resi mortgage continues to be an opportunity.

We had a little bit of growth this quarter, production was up, about 1/3 of that was refinance and 2/3 of it was purchase. And we keep about almost half of what we produce. So I think that'll be a plus, our direct consumer we think is going to be a plus. We've making investments in unsecured -- even though GreenSky is running off, we have other avenues. I think John mentioned, we're going to cap unsecured but we continue to see opportunities for a little bit of growth there.

Now home equity has been on quite a bit of decline over time. And we think that'll slow down a bit. So I think that when you -- and you had mentioned indirect vehicles as being down. Those are really the key drivers. Again, we're not looking for a lot of loan growth. But I think we'll have solid loan growth that'll be profitable for the company.

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Saul Martinez, UBS Investment Bank, Research Division - MD & Analyst [45]

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Can you remind -- the GreenSky is roughly $2 billion -- and I believe; and how quickly does it -- what's the average -- the weighted average life of that?

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David Jackson Turner, Regions Financial Corporation - Senior EVP & CFO [46]

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Yes. It's about $1.9 billion, actually, and it has a little over, right at 2 years in terms of duration. There will be pieces of this that linger for a while, but the bulk of that is 2 years.

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John M. Turner, Regions Financial Corporation - President, CEO & Director [47]

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And Saul, while it's -- it begins to run off we've modestly increased our commitment to SoFi, to grow that portfolio and we are investing in our own unsecured lending capabilities. And we believe that we can match the timing of the runoff and the increase in SoFi with unsecured lending capabilities, all of which should help us on the consumer side in addition to growing mortgage, growing bankcard and to growing direct lending.

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Operator [48]

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Your next question comes from Gerard Cassidy of RBC.

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Gerard S. Cassidy, RBC Capital Markets, Research Division - MD, Head of U.S. Bank Equity Strategy & Large Cap Bank Analyst [49]

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Can you guys share with us -- we hear -- and you guys already touched on your technology spend. I think you had mentioned $625 million is what is expected to be expense this year. How can we as outsiders, we hear a lot of stories about the big banks taking market share from the smaller banks. How do you guys measure whether you're keeping -- I know the dollars you're spending. But how do you measure whether you're keeping up from a digital, technological standpoint that you can remain competitive with the bigger banks? What are some of the metrics should we outsiders look to, to determine whether you're keeping up with these bigger banks?

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John B. Owen, Regions Financial Corporation - COO & Senior EVP [50]

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Yes. Just real quick on that. This is John Owen. Like I said earlier, we spend about $625 million, about 42% of that is based on new initiatives and new projects and looking forward into new things, which digital would be a big part of that. About 48% is around how we maintain the bank, maintain systems and really our infrastructure going forward. About 10% is on cyber and risk.

The way we think about are we keeping up and keeping pace, we use a few external factors, number 1 would be J.D. Power's, J.D. Power's ranks, all the top -- top 23 banks are on their list and they come out with a quarterly ranking. They rank everything from how we perform in the branch, all the way through to our online banking and mobile banking. And so that's a data point we use. Consistently, we're in the top quartile for branch and online. Mobile moves between top quartile and second quartile.

So again, that's an area where we're trying to always keep that in the top quartile. The other source would be Gallup. Gallup also gives us good insights from our customers on how we're performing in digital and areas where we need to advance.

And the other thing I would point to, is just the rapid growth of our digital at the bank. Over the last 3 years, our digital logins to our online and mobile properties were up 90%. You heard John talk about earlier on digital sales. Our digital sales are up 90% year-over-year in credit card, our digital sales in savings accounts were up 35% and checking accounts about 24%. So we kind of look at it from a couple of factors. How do our external parties validate what we're doing and also our internal growth rates.

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John M. Turner, Regions Financial Corporation - President, CEO & Director [51]

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Yes. I'll just add, Gerard. The other thing I look at is, are we growing consumer checking accounts, are we growing low-cost deposits and who are our new customers. And roughly half of our new customers are under the age of 30. And so all of those things for me are indicators that we are in fact competing and having success offering compelling technology to our customers.

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Gerard S. Cassidy, RBC Capital Markets, Research Division - MD, Head of U.S. Bank Equity Strategy & Large Cap Bank Analyst [52]

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Very good. And David, you talked a bit about the CECL increase. You mentioned you guys put out the number in the second quarter Q, I think you said $400 million to $600 million, which if you compare that to your existing level of reserves, it's over a [50%] increase. Everybody can -- appears to be able to handle, yourself included, the day-1 impact that you just described. How can you frame out for us, if you can, what the day 2 impacts are going to look like? Should we as outsiders assume that we're going to see loan loss provisions of similar increases to what the day-1 impact was for everybody? Or how are you guys looking at that at this stage?

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David Jackson Turner, Regions Financial Corporation - Senior EVP & CFO [53]

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Yes. I would not say that day 2 would be anything remotely close to day 1. Day 1 just kind of level sets, and we'll see what other peers are coming out and what their numbers are. Really it's dependent on portfolios, those with consumer or longer-dated loans are going to have higher CECL charges than those that are business services-oriented that have shorter terms in the duration of their loan books.

Day 2, you need to think about -- you still have charge-offs that come through. You have to provide CECL reserves and provisioning on loan growth. Those have a tendency to be somewhat higher than we have today under the incurred model. And again, very dependent on what type of loans you're growing. So mix makes a big difference.

So if you're growing mortgages versus commercial real estate, mortgages are going to carry a higher provision than commercial real estate, as odd as that sounds. And then the last key factor is, what's the economic outlook. How is that changing from time to time, and that's why we've put in our prepared comments. We've given you $400 million to $600 million, but it's really dependent on what it looks like December 31/January 1, what do we think the forecast looks like going forward. That makes a big difference.

And day 2, when that change occurs, things getting better or worse, you see, in particular, when they get worse or are forecasted to get worse, you can see much bigger provisions then than you do under the incurred model and that's what the standard was supposed to do. It was trying to have you reserve much quicker. And that's why we've talked about procyclicality, and the standard is as procyclical as you can get because in a down rate cycle, you're going to be reserving more for loan growth, which is -- which causes one to be concerned about the cost and availability of credit in a downturn.

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Operator [54]

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Your next question comes from Brian Foran of Autonomous.

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Brian D. Foran, Autonomous Research LLP - Partner & US Regional Banks [55]

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I guess I actually had a couple of questions on your slide appendix. First of all, thank you for this level of detail on the commercial loan portfolio where some of the key areas you're highlighting, it is quite a lot. I guess as I look through Slide 14 or really maybe 15 through 17 because the energy you've talked about before.

The restaurant, the retail, the manufacturing, transportation, how are you positioning this? Is this just being responsive to investor questions, or are these areas you are actively concerned? Are there any sub portfolios where you see an opportunity to maybe take some market share? I guess how should I interpret all this detail, why are you highlighting restaurant, retail, manufacturing and transportation?

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Barbara Godin, Regions Bank - Chief Credit Officer [56]

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Brian, this is Barb Godin. On that note, we do have some concerns in the restaurant portfolio that we've seen some softening in the restaurant portfolio, there's certainly been some softening in the energy portfolio, little bit in manufacturing. But by and large, we decided to be much more transparent providing you with information on our portfolios, so that all of you have an opportunity to look and say, look we see what's in their portfolio, we feel good about their portfolio. We feel good about our portfolios and our ability to manage it. And we just felt that now was the time to be, as I said much more transparent particularly as we go into what potentially looks like a credit cycle that'll happen in the next couple of years.

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Brian D. Foran, Autonomous Research LLP - Partner & US Regional Banks [57]

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And then maybe in a similar vein on Slide 12. I mean I almost hate to ask this but it's -- it always a little bit of a lightning rod for investors, the leveraged loan balances. Certainly recognizing the $6 billion is much a bigger number than the standard definition of what would produce $2.5 billion, which you highlight in the slides. But I think when you first gave this it was about $5.5 billion.

So why has it kind of crept up a little bit over the past 6 to 9 months? Is that you participating more or is that just some credits tripping into your leverage definition? Why has the number gotten a little bigger?

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Barbara Godin, Regions Bank - Chief Credit Officer [58]

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Yes, we do have a number of credits that, again, based on the way we define it, will become leveraged even though they started off as not leveraged.

Additionally, we've got Ronnie Smith here who runs that portfolio and I'm going to ask him to make a couple of comments on it.

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Ronald G. Smith, Regions Financial Corporation - Senior EVP & Head of Corporate Banking Group [59]

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Yes. Just a couple of comments and one of your responses is exactly on target. We had a couple of really long term relationships, publicly traded companies that had positive credit events that pushed it over into our definition of leveraged lending. And if you combine those 2, it was just over $400 million. We feel good about those particular companies and we'll see at least one of those resolved within a very short period of time. The other will resolve given a little bit more intermediate period of time. But there's not really a focus on growing that portfolio other than continuing to support our existing relationships where we can build broad and deep relationships outside of a lending transaction only.

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John M. Turner, Regions Financial Corporation - President, CEO & Director [60]

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I'll just add. We actually manage it as a concentration risk, like we do every other part of our portfolio.

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Operator [61]

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Your next question comes from Christopher Marinac of Janney Montgomery Scott.

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Christopher William Marinac, Janney Montgomery Scott LLC, Research Division - Director of Research and Banks & Thrifts Analyst [62]

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I wanted to ask further on the credit explanation that you just gave. Should we see a higher level of total criticized than we do now? Or will that number kind of vary? I know you had the spec change dropping a lot at this quarterly shift.

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Barbara Godin, Regions Bank - Chief Credit Officer [63]

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Yes. It's Barb again. In the criticized portfolio, in particular the classified, I think is what you're pointing to, which drove that number up. Let me first start with saying, despite all that, our credit metrics for the quarter were within our broader risk expectation. We experienced improvement in several areas as you know, delinquencies were down 4%, TDR is down 7%, NPL is down 13% and charge-offs were flat. So we feel good there. And as well as you mentioned, or David did, our Shared National Credits were included and just to comment on the Shared National Credits, we weren't agent on any of those credits by the way.

If I speak specifically to our classified loan category, I'm going to categorize what happened this quarter as follows, which is really over half of the increase came from 5 energy credits that moved into the category. But since quarter end, one of these credits has been totally resolved and the other 3 credits are to a large energy services customer that stays with us for well over 50 years and they have the proven ability to perform through the cycle.

But for energy, in general, I'll make a comment that our book right now is only 13% oil field services, and we also have gone through and stressed our price deck on which we both lend as well as service our accounts down to $39.20. And that's against today's price, last I looked this morning it was about $54 a barrel, give or take. So based on all of this, we've done a lot of work. We believe our energy losses will stay somewhere within a really manageable range of about $30 million to $50 million over the next year. In addition to energy -- next 3 years, sorry.

In addition to energy, we also had some asset-based loans that we moved to classified this quarter with all of them currently being well within their asset values. So as such, we anticipate minimal to no loss on those credits. And lastly, we also reviewed the top 80% of credits that moved to our classified category this quarter.

And again, based on this, we're comfortable with both our loss range of 40 to 50 basis points for this year and 40 to 65 over the next year based on a falling economy. So I'd summarize by saying, we don't see what happened this quarter as being a systemic issue. We are however, coming off a period of historically low numbers. And as such, we believe that some increase was to be expected.

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David Jackson Turner, Regions Financial Corporation - Senior EVP & CFO [64]

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I'll add, Barbara, the 40 to 65 loss rate was over the next 3 years.

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Barbara Godin, Regions Bank - Chief Credit Officer [65]

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3 years. I'm sorry, it's 3 years.

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Christopher William Marinac, Janney Montgomery Scott LLC, Research Division - Director of Research and Banks & Thrifts Analyst [66]

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Okay. Great. That's helpful background. And again, with the inclusion of the additional categories, does that imply that restaurants and ABL and others had deterioration in the quarter, or again are you just giving more transparency to those in general?

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Barbara Godin, Regions Bank - Chief Credit Officer [67]

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Well, there's some marginal deterioration but we really are just trying to give much more transparency.

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Operator [68]

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Your final question comes from Stephen Scouten of Sandler O'Neill.

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Stephen Kendall Scouten, Sandler O'Neill + Partners, L.P., Research Division - MD, Equity Research [69]

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I just had a follow-up question, maybe to Betsy's earlier question around the ROTCE guidance and kind of just maybe more specifically why that would move down. I just remember from your Investor Day, you guys had a pretty -- not negative but maybe muted view on the economy, kind of where GDP was going to go, Fed funds reverting to a 0% range policy, and even the 10-year I think around 1.50. So granted, a lot of what we're seeing today is kind of what you guys predicted. So I'm wondering what specifically is driving the change in expectations relative to what you said then.

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David Jackson Turner, Regions Financial Corporation - Senior EVP & CFO [70]

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Yes. I think, Stephen, our expectation is that 10 year was closer to 3% than the 1.50 at the time we gave that out. So there are 2 things that drive return, it's the numerator and denominator and that denominator impact on lower rates is pretty tough. When you have a falling rate environment, clearly, the fair value of the investment portfolio and therefore book value increases and that's the same thing in all the derivatives that we've added, the fair value of those have obviously increased, putting pressure on the denominator. So that's a -- that's more meaningful than you might think when you go through the calculation.

From a net income standpoint, clearly, we had rate expectations and margin guidance that had been as high as 3.70, down to a low of 3.40. That's where we are. And so 18% to 20% wasn't predicated on being at the low end of the range. So I think if you look at our industry and you think of just good core commercial banking, a 20% return on capital can get -- you can get there when you have a rising rate environment and margins are continuing to expand.

We don't have that. We have low rates, a relatively flat yield curve and no -- at least the market is saying, no real expectations for rates to change over the next couple of years. So it's really hammering out net income growth and return through making good investments to grow NIR, watching expenses, keeping your -- tabs on credit quality. And that's what we're doing. But it's -- you can't get to those type of returns in this environment, if it persists.

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John M. Turner, Regions Financial Corporation - President, CEO & Director [71]

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Okay. Since we have no further questions, thank you all for your interest today. I appreciate it very much. Have a good day.

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Operator [72]

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This concludes today's conference call. You may now disconnect.