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Regions Financial Corp (RF) Q2 2019 Earnings Call Transcript

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Regions Financial Corp (NYSE: RF)
Q2 2019 Earnings Call
Jul 19, 2019, 11:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

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.

Dana W. Nolan -- Executive Vice President and Head of Investor Relations

Thank you, Shelby. Welcome to Regions Second Quarter 2019 Earnings Conference Call. John Turner will provide highlights of our financial performance and David Turner will take you through an overview of the quarter. The slide presentation, as well as our earnings release and earnings supplement are available under the Investor Relations section of our website.

Our forward-looking statements disclosure and non-GAAP reconciliations are included in the appendix of today's presentation and within our SEC filings. These cover our presentation materials, prepared comments as well as the question and answer segment of today's call.

And with that I will now turn the call over to John.

John M. Turner -- President and Chief Executive Officer

Thank you, Dana, and thank you all for joining our call today. Let me begin by saying, in the phase of significant market volatility, we are pleased with our second quarter results. We reported earnings from continuing operations of $374 million, a 3% increase over the second quarter of the prior year and earnings per share of $0.37, an increase of 16%.

We also delivered solid pre-tax, pre-provision income growth compared to the prior year and generated 4% adjusted positive operating leverage. This quarter's results demonstrate our core business remained strong and our focus on meeting client needs is producing sustainable growth. We grew revenue, average loans and deposits and new customer relationships across our markets, while reducing expenses.

We're also experiencing success in our priority markets, which included Atlanta, Houston, Orlando and St. Louis. For example in Atlanta, the pace of new account and deposit growth is approximately two times better than that of the total company. Further, we are outperforming the general market in terms of household account growth in each respective location.

Shifting to the corporate bank, in just six months we've added a significant number of new clients across these same markets. Commercial banking growth has been particularly strong in Houston, where pipelines for credit and deposits are an all-time high. Although it's early, we believe these facts provide evidence that our investments for growth are paying off. We remain focused on those things we can control, and we continue to feel very good about our future. We are largely complete with our hedging strategy that we began about 18 months ago. These instruments will provide stability to our net interest income and net interest margin. Dave will spend some time discussing the details of that strategy in just a moment. We also remain well positioned to prudently through the next credit cycle because of our ongoing risk mitigation activities including client selectivity, sound underwriting, rigorous credit servicing and appropriate concentration limits.

We remain focused on appropriate capital allocation, balance sheet optimization and risk-adjusted returns. This work led to our exit of indirect auto and insurance and the decision to exit a point of sale relationship earlier this year. It also informed our strategic decision to achieve better balance between construction and term commercial lending within our real estate business. Another meaningful example of our commitment to build a business that's sustainable over the long term.

This quarter we repositioned a portion of our investment securities portfolio, continue to focus on clients selectivity and relationship profitability within our loan portfolios and improved our funding mix. These actions will help support net interest income and the net interest margin going forward. Despite recent market uncertainty, the economy still feels pretty good. Our customers are more cautious than they were just a few months ago, they maintain a positive outlook and most continue to expect better performance this year than last.

Many of our customers have a backlog of orders, with the biggest challenge being an insufficient supply of skilled labor. Fundamentally, the domestic economy remains solid and credit quality continues to reflect relatively stable performance with some continued normalization. And while lower interest rates support continued economic expansion, they will certainly pressure future revenue growth. To respond, we will continue to build on the momentum we've established through our Simplify and Grow initiative, to make banking easier, accelerate revenue growth and importantly become more efficient and effective.

Should the markets current pad for lower interest rates persist, with short rates declining in the second half of 2019 and remaining at lower levels into 2020, and the economy soften faster than we expect achieving some of our long-term financial targets will be challenging. That being said, we remain committed doing all we can to appropriately adjust our plans and to respond. So to summarize, this was another solid quarter for Regions and despite the market volatility and uncertainty, I feel good about where we are today and believe we're well positioned to generate consistent and sustainable long-term performance throughout all phases of the economic cycle.

With that, I'll now turn it over to David.

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

Thank you, John. During last quarter's call we spent time talking about certain balance sheet optimization efforts that were either under way or actively being developed, and today I want to spend a few minutes highlighting the results of those efforts. When we say balance sheet optimization, we're referring to the strategies we execute every day to challenge the efficiency of our balance sheet in order to maximize net interest income and margin as well as overall profitability and returns.

This quarter adjusted average loans grew approximately 1%. As you may recall, late last quarter we experienced loan growth from certain large corporate customers that while high and quality, generated thinner spreads. We anticipated some of these customers, which used refinance in the capital markets, although we have experienced some movement, the moderation in loan growth this quarter was primarily due to our continued focus on client selectivity and overall relationship profitability.

As John mentioned, loan demand in our markets remain reasonably healthy, but maintaining our disciplined approach impacted overall balance growth. We remain focused on risk adjusted returns and are not interested in trying to outgrow the economy by pursuing nominal loan growth for short-term benefit. With that said, we continue to expect full year growth in average adjusted loans to be in the low to mid single digits.

During the quarter we also executed strategies to better optimize our securities portfolio, reduce the overall size by approximately $1.5 billion through a combination of maturities and sales. We also sold another $2.8 billion of lower yielding securities and reinvested those proceeds into higher yielding securities, improving our yield run rate by 8 basis points, while recognizing approximately $19 million of net losses. The new securities were selected to ensure appropriate prepayment protection with a focus on improving performance in a declining rate environment.

Turning to the liability side of the balance sheet, average corporate segment deposits decreased 3% during the quarter and included seasonal declines within public fund accounts as well as an intentional exit of approximately $700 million of higher cost deposits that were added during the first quarter to support loan growth. Despite this reduction, total average deposits still increased approximately 1% driven primarily by growth in consumer. Exhibiting the strength of our core deposit franchise average consumer deposits increased $1.3 billion and importantly average non-interest bearing consumer deposits increased almost $600 million. These optimization strategies also triggered a reduction in wholesale funding needs during the quarter, average FHLB advances are down approximately $1 billion compared to the prior quarter .

So let's look at how this impacted net interest income and margin. Net interest income was down slightly compared to the first quarter and net interest margin totaled 3.45%. As expected continued deposit pricing pressure was the largest driver of this quarter's margin. What is important to note, however, is we did see deposit cost peak within the quarter in May and subsequently trend down in June. Our total deposit costs remain one of the lowest in the industry and our cumulative deposit beta for the recent tightening cycle is 29%. Assuming the Federal Reserve begins to ease an orderly increments of 25 basis points, we currently expect an initial deposit beta of approximately 35% at the beginning of a down rate cycle.

In addition to deposit cost and after normalizing for days, another driver to this quarter's margin was declining market interest rates. This includes the decline we saw in LIBOR in anticipation of potential rate cuts by the Federal Reserve, as well as the decline in long end rates. Currently, the market is pricing in further interest rate declines over the second half of 2019.

So let's spend a few minutes looking at how this could impact our results. While reducing deposit costs would provide some relief using the June 30 market forwards, which include roughly three 25 basis point reductions, we would expect full year net interest income to be modestly higher than the prior year, while fourth quarter margin would approach 3.40%, the low end of our long-term range . However, we would expect the first quarter's margin to expand into the low to mid 3.40%s as the benefit of our forward starting hedges begin.

Now, I want to take some time and walk you through our hedging strategy and its expected financial benefit. Slide 6 contains additional details regarding our use of forward starting swaps and floors along with their anticipated impact to our future asset sensitivity profile. The chart provides a cumulative build of the notional value of our hedges broken out by the quarter in which they become effective.

We are substantially complete with our hedging program and importantly, the bulk of those forward starting hedges become active on January 1, 2020. In addition, these forward starting hedges have maturities of approximately five years from their respective start dates. These longer tenors provide better support to future net interest income to the extent rates remain low for an extended period. Because the preponderance of our hedging program is forward starting, many of you may be modeling a negative impact to our future net interest income that will look markedly different six months from now.

To illustrate the benefit of our future date in hedges, we have provided an estimated impact to annual net interest income associated with a standard 100 basis point gradual parallel shock for each future period presented. The table highlights this inverted relationship. As our forward starting hedges become effective, our asset sensitivity is reduced. The key takeaway from this slide is our forward starting hedges will stabilize our interest rate sensitivity profile in 2020 and beyond.

So let's move on to fee revenue. Adjusted non-interest income increased 2% compared to the first quarter. Service charges, card and ATM fees and mortgage reflected seasonally higher revenue combined with continued customer account growth and an increase in transaction activity. Wealth management income increased primarily due to sales and market-driven revenue from investment management and trust, combined with higher sales volume from investment services.

Within mortgage income, our net MSR hedge impact remain relatively consistent quarter-over-quarter. However, as expected in a declining rate environment, we are beginning to experience an increase in pre-payment decay. Partially offsetting these increases were declines in capital markets, bank-owned life insurance and other non-interest income. The decline in capital markets was primarily due to lower M&A advisory fees and customer swap income. The decline in customer swap income was almost entirely due to market related credit valuation adjustments tied to customer derivatives. Excluding these market based adjustments, total capital markets income would have increased approximately 5%.

Let's move on to non-interest expense, which continues to be a really good story for Regions. Adjusted non-interest expense increased 1% compared to first quarter. Furniture and equipment expense outside services and professional fees increased this quarter, but were partially offset by decline in salaries and benefits. A decline in staffing levels of just under 300 full-time equivalent positions, combined with a favorable reduction and benefits expense contributed to the decline in salaries and benefits. The adjusted efficiency ratio was 58.3% unchanged from the prior quarter. Despite success in managing our cost, the challenging revenue environment necessitates even more focus on expense management. One area with expense save opportunity is within corporate real estate.

This quarter we took advantage of market opportunities and sold a large office building in excess of 100,000 square feet. We also made a decision to market to sale of another large office building in excess of 300,000 square feet. These transactions will benefit future occupancy expense and are expected to help us exceed our goal to reduce over 2 million square feet of space by 2021. Additionally, we continue to make significant progress in the digital space. Digital checking account openings are up 53% and digital card production is up 43% year-to-date. The effective tax rate was 19.4%. It was impacted by excess tax benefits associated with invested equity awards.

So let's shift to asset quality. Asset quality continued to perform in line with our expectations this quarter and reflected stable performance within a relatively benign credit environment, while some normalization of certain credit metrics continued, overall credit results remained well within the acceptable range of our established risk appetite. Net charge-offs increased to 0.44% of average loans in line with our expected range of 40 basis points to 50 basis points for 2019. Provision match net charge-offs resulting in an allowance equal to 1.02% of total loans and 160% of total non-accrual loans. Non-accrual loans increased modestly while business services criticized loans remained relatively unchanged and total troubled debt restructured loans decreased 7%. While overall asset quality remained stable and within our stated risk appetite, volatility in certain credit metrics can be expected.

So let me give you some brief comments related to capital and liquidity. During the quarter, the Company repurchased 12.8 million shares of common stock for $190 million and declared $141 million in dividends. In June, we announced details related to our 2019 capital plan. We intend to reach our 9.5% common equity Tier 1 ratio target in the third quarter and manage at that approximate level going forward. Our capital plan includes the ability to repurchase up to $1.37 billion of common stock. However, the exact amount and timing of repurchases will be determined by actual loan growth and our overall financial performance. We also expect to increase the quarterly dividend within our stated range of 35% to 45% of earnings. The Board will consider this increase at their meeting next week.

Our full year 2019 expectations are presented on Slide 11. Assuming the market forward curve at quarter end, we would expect to be at the lower end of our 2% to 4% full year adjusted revenue growth target. Given the uncertain revenue environment, we are increasing our focus on expense management and expect full year adjusted non-interest expense to be stable to down slightly, and we expect to generate positive operating leverage for the year.

As John noted, we remain focused on the things we can control and we are responding to the changing market dynamics as we have in the past. So in summary, we are pleased with our second quarter financial results. We have a solid strategic plan designed to deliver consistent and sustainable performance throughout any economic cycle .

With that, we're happy to take your questions. But do ask that you limit them to one primary and one follow-up question. We will now open (Technical Issue)

Questions and Answers:

Operator

[Operator Instructions] Your first question comes from Ryan Nash of Goldman Sachs .

John M. Turner -- President and Chief Executive Officer

Hi Ryan.

Ryan Nash -- Goldman Sachs -- Analyst

Hey, good morning guys. So it looks like you've seen an inflection in deposit costs, although -- at 29% you had one of the lowest beta cycle to date. So you're talking about the NIM approaching 3.40% and then increasing, can you just talk about how you feel about your ability to bring down deposit cross -- deposit costs across most of -- across retail wealth and commercial? And then as you think about the sensitivities you've outlined, given all the changing dynamics on the balance sheet, how do you think about the sensitivity to short versus long-term rate? And then I have a follow-up.

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

Okay, this is David. So -- we are encouraged by the reaction in our teams on deposit cost. We clearly are competitive, but we are -- we're able in the month of June through our actions. We took the month before that to reduce deposit costs a couple of basis points and if we put that in a chart to show you that we expect that to have already peaked, to the extent that we continue to get short-term rates down, that will give us even more ability to reduce deposit cost.

We have about 10% of our deposits are indexed -- 10% of our interest bearing deposits are indexed, but we also have another 10% of our interest bearing deposits that are -- have been exception price that are really money market type deposits that we get to address as rates change. So we can move pretty quickly as the market changes, which gives us some confidence that we continue to hold our margin at that 3.40% level for the remainder of the year even if we get two, roughly three cuts as the forwards imply.

Ryan Nash -- Goldman Sachs -- Analyst

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

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

Yes, so we made a commitment at Investor Day that we would generate positive operating leverage each year of our three year plan. Clearly, the rate outlook put some pressure on that, but we still are committed to generating positive operating leverage. If you recall the last three year plan that we had, the market didn't behave quite like we thought, it was going to either and we pulled whatever it took to make sure we met the targets and so we have confidence in that. Clearly, if we have a persistent low rate environment for this whole three-year period that does put pressure on certain of those metrics .

But I would like to point out, we're six months into our three-year plan. There are a lot of things that can happen and so -- we're confident we have a good plan, that we have the ability to toggle and do what we need to do to continue to improve our financial performance and we will do that and that was the commitment that was in our prepared comments, both from John and from me.

Ryan Nash -- Goldman Sachs -- Analyst

Got it. Thanks for taking my question.

John M. Turner -- President and Chief Executive Officer

Thank you.

Operator

Your next question comes from John Pancari of Evercore ISI.

John M. Turner -- President and Chief Executive Officer

Good morning, John.

John Pancari -- Evercore ISI -- Analyst

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

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

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

John M. Turner -- President and Chief Executive Officer

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

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

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

John Pancari -- Evercore ISI -- Analyst

Got it. Okay now that's helpful color.

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

I'm sorry efficiency.

John Pancari -- Evercore ISI -- Analyst

Right, right. Got it. Okay and then my follow up is around credit. Just wondering if you can give a little bit more color on the increase in charge-offs on the commercial front where they came from. And then also your non-performers still saw a moderate increase in the quarter despite the higher charge offs. So implying that we're seeing a pickup in inflows here, can you talk about what is driving that? Thanks.

Barbara I. Godin -- Deputy Chief Risk Officer and Chief Credit Officer

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

John Pancari -- Evercore ISI -- Analyst

Okay, great. Thank you.

John M. Turner -- President and Chief Executive Officer

Thank you.

Operator

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

John M. Turner -- President and Chief Executive Officer

Good morning, Matt.

Matt O'Connor -- Deutsche Bank -- Analyst

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

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

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

Matt O'Connor -- Deutsche Bank -- Analyst

Okay, so those are the bucket of kind of non-loan earning assets will be down a bit on average 3Q versus the 2Q level?

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

In particular the investment securities portfolio because that trade happened during the quarter.

Matt O'Connor -- Deutsche Bank -- Analyst

Yeah, yeah, OK. And then just following up on the line of credit discussion right before me. The early stage delinquency numbers also moved up and did that relate to the healthcare loan or the commercial inflows, one of which paid off or was that driven something different?

Barbara I. Godin -- Deputy Chief Risk Officer and Chief Credit Officer

Yeah, part of that is seasonal. In a 30-day buckets, 90-day buckets were down, [Indecipherable] was up marginally and there is nothing systemic in there at all, that is part and parcel of our seasonality.

Matt O'Connor -- Deutsche Bank -- Analyst

Okay. All right, thank you .

John M. Turner -- President and Chief Executive Officer

Thank you.

Operator

Your next question comes from Jennifer Demba of SunTrust.

John M. Turner -- President and Chief Executive Officer

Good morning.

Jennifer H. Demba -- SunTrust Robinson Humphrey -- Analyst

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

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

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

Operator

Your next question comes from Peter Winter of Wedbush.

Peter Winter -- Wedbush -- Analyst

Good morning.

John M. Turner -- President and Chief Executive Officer

Good morning. Yeah.

Peter Winter -- Wedbush -- Analyst

You guys are putting a little bit more emphasis on the expense side. I was just wondering if you could talk about some of the levers, because it certainly doesn't seem like you're going to slow down the investments?

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

Yeah, Peter, that last statement is really important because we are continuing to look for ways to make banking easier for our customers, looking to make investments in talent and technology. We have to pay for that. And the way to do that is to continue to focus on our expenses and leverage our -- Simplify and Grow continuous improvement program that we started a little over a year and a half ago. If we're going to control our expenses, we have to really have an intense focus on our top three categories, salaries and benefits being number one, down some 300 positions at this quarter. We continue to look to opportunities to streamline operations by leveraging technology and most of that gets handled through attrition.

We've looked at occupancy, it's our next biggest category. As we had in our prepared comments, we had some 400,000 square feet of space that we're exiting, some of it we have exited, some are we just put in held for sale, and we will be getting out of that space to save us on run rate occupancy. Also furniture fixtures and equipment, our third category, as we have fewer people, we have smaller space, we could save there as well. And our fourth category would be kind of purchasing a vendor spend if you will.

We have a new head of procurement that has really put in a lot of rigor in terms of helping us from a demand management standpoint in controlling what we need from a purchasing standpoint, whether it be consulting hours or products or whatever the case may be. And so where we -- in this type of challenging revenue environment and a commitment to positive operating leverage, you just have to pull every string that you can in terms of controlling expenses.

John M. Turner -- President and Chief Executive Officer

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

John B. Owen -- Chief Operating Officer, Senior Executive Vice President

Yeah, good morning everybody. We had about 17 new initiatives to our Simplify and Grow list in the second quarter bringing that number up to about 62 initiatives. We've already completed 13 year-to-date, we'll complete another 11 initiatives in the second half of 2019. When I think about some of the things we point to, I'll go back to Investor Day. We talked about launching our digital lending platform in the consumer side of the house. That has really taken traction. We're seeing 38% of our applications today come in through that digital channel.

On the e-side, e-close part of this, we're up to about 58% of our direct loans, closing [Indecipherable] signs, a really good traction on our digital lending capabilities. On the account opening in a digital front, I think I'd point you to -- we've had a team as part of Simplify and Grow working now for about a year on how do we streamline account opening? How do we make the credit card process more smooth process and a quicker process? We've revised the application. We've streamlined and we now are getting about 53% increase in our digital account openings and checking accounts and about a 44% increase in credit card production to that digital channels. So really good traction there.

On the AI front, we continue to look for use cases on how we can rollout AI across the bank. You're all familiar with what we've done in the contact center. We've expanded a couple of things in the contact center with AI. One of those is now where we launched password resets, which is one of our top calls into the center. We launched that in this month and we're seeing really good traction in having our AI virtual agent handle those password resets.

The last thing is we're having good success with AI and our quality assurance functions. Where we're actually having AI virtual agent, quality assurance call types categories and really gone through and made sure that our reps are following the right disclosures and right scripts has reduced our expenses in that QA [Phonetic] area by about 70%. So good traction with AI as well.

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

Good. Thank you.

Peter Winter -- Wedbush -- Analyst

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

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

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

Peter Winter -- Wedbush -- Analyst

Great, thanks a lot .

John M. Turner -- President and Chief Executive Officer

Thank you.

Operator

Your next question comes from Ken Usdin of Jefferies.

John M. Turner -- President and Chief Executive Officer

Good morning, Ken.

Ken Usdin -- Jefferies -- Analyst

Good morning, guys. Thank you. Just a follow-up on that last question. So, your -- scenario that you put out on Page 5, which is really helpful, picks in the three potential cuts that were in the forward curve, and this might be just more of a symantec one, but I'm just wondering if the Fed only gives us one, how does that cadence change potentially in terms of the decline before the hedges come on. Like, is it just like you end up in the same place, but from a slightly different way of getting there. I just wanted to get -- just trying to understand how the cadence might change if we don't fully get the free cuts in the curve?

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

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

Ken Usdin -- Jefferies -- Analyst

Got it. So regardless of the pacing then you feel pretty good that that 1Q '20 [Indecipherable] can happen most -- any circumstance, except for meaningfully flatter curve environment?

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

That's exactly right. And we had our protection. We put -- started putting this on over a year and a half ago with the expectation that we're going to be in this environment. We just thought it would be beginning in 2020, which is why we did forward starting. We did -- we thought they were going to be rate increases through '19 and we want to stay asset-sensitive. So we've caught -- been caught a little bit exposed in the latter part of '19 as have every peer of ours, but we're feeling pretty good about what can take place in 2020. And going forward we have duration on the swaps and floors of five years beginning in 2020. So we have really good protection then.

Ken Usdin -- Jefferies -- Analyst

Okay, got it. And then last, just clean up on those forward starting swaps that you've got the fixed rate strike on there, are they at -- are they meaningfully different ones, the average is obviously 2.48% for the swaps and 2.08% for the floors on Page 6. But as you put them on, are they all around kind of a general average there or are there hedged on which one they could be very much in or out of the money across the book?

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

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

Ken Usdin -- Jefferies -- Analyst

Okay, got it. Thanks David.

Operator

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

John M. Turner -- President and Chief Executive Officer

Good morning, Erika.

Erika Najarian -- Bank of America -- Analyst

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

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

Yeah, I think we are going to start at 35%. I think over time -- we're at 29% cumulative going up. So if you're starting at 35%, you would expect that to drift down a bit as time goes through. I think that's what you're asking.

Erika Najarian -- Bank of America -- Analyst

So the initial -- just to clarify, the initial impact is immediate in terms of the 35%, especially on the 20% of your interest-bearing deposits that you are identifying is either quite expensive or indexed, and then it would taper -- the repricing would taper off in terms of percentage of cuts rather than accelerate? I guess...

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

You're exactly right. So it starts at 35% and then at the end of the day, you're going to drift from that 35% down into the higher 20%s as that -- and the driver of that is the 10% indexing, the exception pricing engine -- then just looking at the market of all of our deposit is as we compare to our peers. And we get the benefit of our floors and we get the benefit of our received fixed swaps.

Erika Najarian -- Bank of America -- Analyst

Got it. And John, just wanted to clarify, I hear you loud and clear that 55 and below on efficiency isn't difficult in this rate environment. You did something earlier as an answer -- a reply to a question that flat to down slightly on expenses still a commitment and is that what we should think about over this three-year period regardless of the rate environment?

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

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

Erika Najarian -- Bank of America -- Analyst

Got it. Thanks for that clarification.

John M. Turner -- President and Chief Executive Officer

Thank you.

Operator

Your next question comes from Saul Martinez of UBS.

Saul Martinez -- UBS -- Analyst

Hey, good morning everybody.

John M. Turner -- President and Chief Executive Officer

Good morning.

Saul Martinez -- UBS -- Analyst

So, I guess I'm still a little bit confused on the 35% deposit beta and either glide path thereafter for future cut. So are you saying that on the first 35 basis points or the first 25 basis point cut, you will see a decline in your interest bearing deposit costs of -- 35% beta on the decline on your interest bearing deposit costs and over what time period does that occur? Is that sort of an immediate decline or is that something that drags on over a couple of quarters as the pricing filters in? Because it seems like the commentary from some other banks has been that there is going to be a lag in terms of deposit betas and that they are going to accelerate not decelerate as rate cuts -- further rate cuts happen.

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

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

Saul Martinez -- UBS -- Analyst

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

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

That's correct.

Saul Martinez -- UBS -- Analyst

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

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

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

Saul Martinez -- UBS -- Analyst

That's helpful. I could sneak one quick final one in. I don't know if I missed it, but the outlook for indirect auto and indirect other consumer now that you've exited GreenSky or not exited, not renew the commitment there. How do we think about, can you remind us what your expectations are for balances there and how much fines and what the other consumer balance should do?

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

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

Saul Martinez -- UBS -- Analyst

And I'm sorry, yes the others...

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

I said auto, I mean GreenSky.

Saul Martinez -- UBS -- Analyst

GreenSky, Okay. All right, thank you.

John M. Turner -- President and Chief Executive Officer

Yeah. We've made clarify that. I think it's $800 million on average on the indirect auto portfolio, full year. Right.

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

That's right.

John M. Turner -- President and Chief Executive Officer

And then -- the run-off with respect to the indirect unsecured portfolio it will top out over the next month or two, is that contract expires and then we kind of expected 2 years to 2.5 year sort of weighted average payout on that portfolio.

Saul Martinez -- UBS -- Analyst

Great. Very helpful. Thank you.

John M. Turner -- President and Chief Executive Officer

Thank you.

Operator

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

Christopher Marinac -- Janney Montgomery Scott LLC -- Analyst

Thanks, Good morning.

John M. Turner -- President and Chief Executive Officer

Good morning.

Christopher Marinac -- Janney Montgomery Scott LLC -- Analyst

I wanted to ask about the environment [Indecipherable] late this year or next year about hiring teams of producers. Is this the environment where you invest in that or perhaps a few new markets come into the regions footprint because of external opportunities?

John M. Turner -- President and Chief Executive Officer

Yeah, I mean we're -- all of our business leaders -- commercial, corporate, real estate are actively recruiting all the time, consumer business similarly. One of our -- one of their task is to always know who the best bankers are in markets and in contiguous markets. Who the best bankers are in there, specialized businesses and so we're always actively recruiting. And we've had good success recruiting already this year across particularly our priority markets, where we are investing in St. Louis, Atlanta, Houston and in Orlando and we'll continue to do that.

Christopher Marinac -- Janney Montgomery Scott LLC -- Analyst

Okay. Great John. Thanks very much.

Operator

Your next question comes from Kevin Barker of Piper Jaffray.

John M. Turner -- President and Chief Executive Officer

Good morning.

Kevin Barker -- PiperJaffray -- Analyst

Good morning. I was hoping you can give us a little more color on the 9.5% CET1 ratio target for the third quarter. It would seem that would imply a pretty aggressive buyback this quarter and then maybe to tail off through the rest of the CCAR cycle. So maybe just help us out with the cadence of the buyback in the near term and then through the cycle?

John M. Turner -- President and Chief Executive Officer

Yeah , Kevin. So you're exactly right. We put in our prepared comments where we were going to get to our 9.5% in the third quarter. So we have loan growth that use up some of that in dividends and then buying back to get us to that 9.5%, we will -- it will be exactly that every single quarter, but we're going to do what we can to keep it at that level because that's the level of capital we think we need to run the Company based on our risk profile.

That does imply a quicker buyback or more of a buyback here in the short term, it will moderate after that and we will use the repurchase ability. So we have authorization for our Board up to $1.37 billion of stock buyback and how we think about capital allocation is first and foremost, we'll pay a dividend of 35% to 45% of our earnings, then we're going to use some of our organic loan growth and then we'll use the rest, we'll by stock back to keep us at 9.5%. Should loans grow faster, buybacks will be smaller and vice versa. If loans don't grow, buybacks will increase so that we can keep the capital optimized in the Company.

Kevin Barker -- PiperJaffray -- Analyst

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

John M. Turner -- President and Chief Executive Officer

No, our change out there growing loans when it makes sense from a risk adjusted return standpoint. We grew the first quarter a little quicker than we had expected. We slowed down a bit this quarter. We still have the low-to-mid single digit growth expectation for the year. Again any given quarter you can see a page change and the third quarter for us over the last couple of years haven't -- has not been a stronger of a growth in those -- our pipelines look pretty good.

The fourth quarter on the other hand, it's actually been pretty strong. So we're sticking to our so that commitment on the loan growth. My point is that we used 9.5% and we toggle between loan growth and share buyback. We're not trying to manufacture one or the other we want all the good -- we would much rather use our capital to grow organically than to buy our stock back. But we also want to have appropriate risk adjusted client relationship type returns on the loan side and if we don't get those and we can't use our capital to grow appropriately we will buy our stock back. That makes sense.

Kevin Barker -- PiperJaffray -- Analyst

Yes it does. All right, thank you for taking my question.

John M. Turner -- President and Chief Executive Officer

Thank you.

Operator

Your final question comes from Gerard Cassidy of RBC.

John M. Turner -- President and Chief Executive Officer

Good morning, Gerard.

Gerard Cassidy -- RBC Capital Markets -- Analyst

Good morning.

John M. Turner -- President and Chief Executive Officer

How are you?

Gerard Cassidy -- RBC Capital Markets -- Analyst

Good. Question, can you guys share with us -- we've seen a lot of commentary about the strength of the consumer business and we all know how low the unemployment rate is in this country and wage growth seems to be accelerating, but there seems to be some cross currents in the business side of our economy with what's going on with the trade negotiations etc. So can you give us some insights of what your business customers are sharing with you about their business? And could you tie that into the forward curve of three 25 basis point rate cuts in 2019, just seems like the forward curve is being a little aggressive on those rate cuts, but I'm just curious to see what you guys think?

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

Well, the second -- to answer the second half of your question, no we cannot tie into the forward curve. I would tell you that our business customers are still cautiously optimistic. It was clearly over the last 90 days or so assets more caution on the part of our business owner. But they're still optimistic their 2018 results were very good. Most of them are having really good 2019. As we look at our credit quality across a variety of industry sectors, I really don't see any significant issues other than within the restaurant sub sector, we've called out before fast casual, don't appear to be any other stresses of any consequence that we see. Customers have good pipelines and so -- as I think I've said in my prepared remarks, the primary constraint we see on the economy is availability of skilled labor and that's the thing that tends to constrain businesses from investing not the interest rate environment. And so I really can't talk -- our view of the economy through our customers' eyes to the forward rate curve.

Gerard Cassidy -- RBC Capital Markets -- Analyst

Very good. And then can you guys share with us an update on CECL where you stand and when we may get a day one estimate on the build up of reserves in January of 2020?

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

Sure, Gerard. So we've been -- our teams have been working really hard to run parallel this year. We're feeling good about being prepared for the adoption also in January 2020. We're looking to put something in our 10-Q that would give some indication as to where we might be here shortly on day one. As we've mentioned before consumer portfolios get hit really hard relative to commercial portfolios and so we have about 40% of our loans -- our consumer loans versus business services loans. So mortgages, HELOCs, credit cards those unsecured credit, those get hit pretty hard in the seasonal adoption, not as much on the commercial side, but stay tuned here shortly on our 10-Q filing.

Gerard Cassidy -- RBC Capital Markets -- Analyst

Great. Thank you, John. Thank you, David.

John M. Turner -- President and Chief Executive Officer

Thank you.

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

Thank you.

Operator

Thank you. I will turn the call back over to John Turner for closing remarks .

John M. Turner -- President and Chief Executive Officer

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

Operator

[Operator Closing Remarks]

Duration: 65 minutes

Call participants:

Dana W. Nolan -- Executive Vice President and Head of Investor Relations

John M. Turner -- President and Chief Executive Officer

David J. Turner -- Senior Executive Vice President and Chief Financial Officer

Barbara I. Godin -- Deputy Chief Risk Officer and Chief Credit Officer

John B. Owen -- Chief Operating Officer, Senior Executive Vice President

Ryan Nash -- Goldman Sachs -- Analyst

John Pancari -- Evercore ISI -- Analyst

Matt O'Connor -- Deutsche Bank -- Analyst

Jennifer H. Demba -- SunTrust Robinson Humphrey -- Analyst

Peter Winter -- Wedbush -- Analyst

Ken Usdin -- Jefferies -- Analyst

Erika Najarian -- Bank of America -- Analyst

Saul Martinez -- UBS -- Analyst

Christopher Marinac -- Janney Montgomery Scott LLC -- Analyst

Kevin Barker -- PiperJaffray -- Analyst

Gerard Cassidy -- RBC Capital Markets -- Analyst

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