Q3 2019 Earnings Call
Good morning, and welcome to the regions Financial Corporation quarterly earnings call. My name is Shelby and I'll be your operator for today's call.
I would like to remind everyone that all participant phone lines have been placed on listen only.
The end of the call there will be a question and answer session. If you wish to ask a question. Please press star one on your telephone keypad.
Now I'll turn the call over to Dana Nolan to begin.
Thank you Shelby welcome to <unk> third quarter 2019 earnings conference call.
John John will provide highlights of our financial performance data turnover will take each or even over the quarter.
For like a documents, including forward looking statements are available under the Investor relations fraction of our website.
Disclosures cover our presentation materials prepared comments as well, thank you and I expect that tonight's call.
I'll now turn the call over to John .
Thank you Dana and thank you all for joining our call today.
Good morning, we reported earnings from continuing operations of $385 million, a 9% increase over the third quarter of last year.
Thing in earnings per share 39 cents, an increase of 22% over the prior year.
This quarter. We also delivered the highest pretax pre provision income that we produced a nearly a decade ball 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 core.
Over the last two years, our core messaging has reflected our intention to generate consistent.
Sustainable long term performance through all phases, the economic cycle.
We've been planning for the time, when we 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.
A little stronger and more resilient balance sheet.
And improve returns on capital.
We executed a robust hedging strategy that will protect us in 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 in the last 10 years fundamentally changing and proving our credit risk management framework.
Today, we have a robust and dynamic process syneron 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 de risking and repositioning.
Just as importantly, we launched our continuous improvement initiative called simplify and growth.
Focusing on our desire to make banking easier for 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 seven 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.
Sample through our digital platform year to date checking and credit card production have increased 24 and 91% respectively.
Don't applications have increased 55% and with mortgage in particular, approximately 60% of all applications or completed on a lot.
Mobile deposits have increased 60% now represent 13% of all deposits.
These efforts are paying off and positively impacting the performance of our businesses.
Simplified grow has allowed us to make investments in talent improved services and capabilities.
And in our 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 well assets under management.
We're also succeeding in our priority growth markets Atlanta, Houston Orlando in Saint Louis.
Consumer deposits and checking accounts in these markets are growing more than two times 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're 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.
They are 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 our 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 things we can control.
Meeting the needs of our customers with best in class service, while leveraging technology, and making the easier for 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 and that order of priority and we believe our efforts will keep the company positioned to deliver consistent sustainable results through every economic cycle. Thanks.
For your time attention. This morning, I'll now turn the call over to David.
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 the consumer lending.
I guess at average business loans decreased 1% and were impacted by our continued focus on client selectivity and overall relationship profitability.
Average business lines 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.
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 one 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 costs and the benefits of repositioning strategies and the investment portfolio that were executed in the second quarter.
Net interest income also benefited from one additional day in the quarter, which negatively impacted net interest margin.
As expected total deposit costs declined four basis points compared to the second quarter to 49 basis points and interest bearing deposit costs declined five 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 experiencing 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 reduced our exposure to mortgage backed securities by approximately 7%.
And our related but 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 to 25 basis point reductions and the fed funds rate 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 and deposit costs.
Net interest margin is expected to move in the high three thirtys in the fourth quarter. However, we expect the first quarter margin to expand into the low three fortys as the benefits of our hedging strategy began.
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 can mortgage.
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 from Thailand 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 increase 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.
A declining 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 CBVA adjustments during the quarter.
Looking ahead, we expect capital markets to finish this year on a strong that 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 and 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 one 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 costs and our continued success in reducing overall third party spin.
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 billion to $65 billion by 2021.
They 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 well 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 through the first nine months and our expectations for the fourth quarter. We expect full year 2019, adjusted expenses to be relatively stable with 2018.
For the spec to our effective tax rate, we tightened the full year 2019 range to 20% to 21%.
So let's shift asset quality.
Overall credit results remained in line with our risk expectations during the quarter.
Saw improvement in several categories, while experiencing some normalization and others.
Net charge offs were unchanged at 44 basis points inline 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 non accrual 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 and non accrual and special mentioned 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 credits 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 Cecil.
In our second quarter 10-Q, we disclosed in the expected increase our allowance for credit losses of approximately $400 million to $600 million due to the implementation of Cecil.
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 and dividends.
Our common equity tier one ratio is estimated at 9.6%.
In line with our target level of 9.5%.
We anticipate managing at this approximate level going forward.
The loan deposit ratio within the third quarter was 88% and as of quarter end, we remain 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. The do asset each caller ask only one question to allow for more cars.
I'll open the line for your questions.
Thank you the floors now open for questions. If you have a question. Please press star key followed by the number one and or telephone keypad.
Is that any point. Your question is at Sir you may remove yourself from the Q by pressing the pound key.
Pause for just a moment to compile the Q and a roster.
Your first question comes from Ryan Nash of Goldman Sachs.
Right.
Good morning, guys How's it going.
Good.
So I wanted to ask that handful of questions. Maybe just first on deposit cost. 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 Thats based on September and the potential for an October and I guess, you know you're one of the only banks, we saw 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 above across both consumer and commercial and if the fed.
To cut in October beyond a couple of times next year is there further room to bring down deposit costs.
Yeah, Ryan this is David so.
We've we've talked an awful lot about how to manage net interest interest income than margin, then changing rate environments and deposit cost being a key input is important to manage.
Both and so I'll, let me start with consumer we've done a really good job of.
Adjusting our deposit costs, while staying competitive in the markets and we.
Our competing in.
And that's been a big driver of our of our deposit cost declining I think what's you will 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 indexed.
If you recall in the first quarter.
We increased deposit cost because we had above average loan growth that we had to use deposits to fund.
To fund that loan growth, that's clearly subsided.
And we're looking at.
Adjusting those deposit cost on the way down.
So we have a beta of 25% to 30% that we are giving you guidance for.
And we think that applied to the two two great potential rate cuts if we see for the remainder of the year.
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 simplifying grow and you can have a handful more done before the end to be hearing you talked about.
Upside some of the areas that.
The three big areas that you're saving on costs. So as you think ahead you know 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 continued to hold expenses flat beyond 2019. Thanks.
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 RMS wealth advisors.
We've continued to make investments in technology, 42% of our $625 million spent on news things. If we need to have continued 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 control costs, we have to get better.
At literally everything we do so John has asked all of US all 20000 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 investments to be able to hold our costs.
Relatively stable like we've done for the last couple of years, we will continue to seek to hold our costs down and we have a goal of efficiency to get to the 55% range, we mentioned that at Investor day.
You are 57 for today.
He is very challenging and low rate environment, but we are not giving up but we're going to continue to seek becoming more efficient as we go forward. So there's still room to control.
Control cost into 2020.
Got it thanks, taking my question.
Your next question comes from Matt O'connor with Deutsche Bank.
Good morning, Matt.
Hi, guys I was wondering if you could just talk about kind of big picture. How you think about balancing protecting the profitability ratios first grown the balance sheet, you've been keeping deposits relatively stable, it's helping them, you're obviously seeing good growth in service charges. So there's some puts and takes but talk about the trade off between.
Focused approach protect profitability, but then also thinking about trying to grow the balance sheet.
Yes, I think it is a great question. It is very much a balance we're focused on building a business that is going to be consistently performing thats going to be resilience is going to be sustainable and that means we've got a gold balance sheet that is resilient through every economic cycle, we've clinic trade off some growth for quality and will contain.
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 classical activity is really important to us.
Early identification of problems exiting relationships to that may become problematic really important to our future. So we talk often about imports of soundness first then profitability and growth last we're not going to grow just to grow we don't need novel growth. We think the balance sheet is positioned to.
Deliver consistent and sustainable performance and the profitability that we believe will adequately risk reward our shareholders and that'll continue to be our focus.
Now I admit 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 were up about 4.8% year to date on an adjusted basis.
And.
And so what we're saying is we do expect to grow we're just not going to.
Forced growth.
On the balance sheet to generate nominal revenue the nominal income if the return gets arms.
And I guess just following up I mean, you obviously had a really nice loan growth in the first half of the year little bit of run off this quarter and I think.
One of your other portfolios might start to run off identity.
Just as you kind of put all that together in the comments that you made.
What's kind of more medium term outlook in terms of grow loans.
And also just comment on deposits as well thank you.
Well was with respect to loan growth. Thanks, 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 set some increase we 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.
Tapping our exposure to too.
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 and allow us to continue to grow the asset so bill balance sheet and with respect to deposits were focused on core relationships. When you look at our consumer business, we believe that 90.
Three 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 in most of our peers consumer demand deposits and consumer low cost deposits growing over time.
Similarly, with a focus on small to medium sized businesses, winning their operating business. We think we can still continue to grow low cost deposits, which is.
Which is really the core of our business in the strength of our franchise.
Okay. That's helpful. Thank you.
Your next question comes from Ken is done of Jefferies.
Good morning, Ken.
Good morning, guys.
David can talk a little bit about the balance sheet protection, a little bit more just reading in the deck yet you added.
Little bit more on the hedging side to impact.
Pact of lower long term rates. So we said the programs 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 will cascade on its own throughout the year. Thanks.
Yes, so I'll start kind of within in mine.
Talked about the.
Going into next year, we think are our margin could increase into the.
Low to mid 340 range.
We have a chart with regards to our sensitivity our short term sensitivity is take it close to zero by the beginning of the year through all the hedges and kick in and.
Starting a little bit in the fourth quarter, but primarily the first part of the year. We want to do is we had more exposure on the long end.
There's a lot of our peers. So we wanted to kind of neutralized out of that so we've we've entered into.
Couple billion dollar for the hedges.
That would really be.
Kind of got tied in one that the 10 year, whereas in the mid.
Low oneseventy range to help us.
From the long end and Thats really manifest itself and reinvestment of cash flows that come off the business.
Every month so.
Thats baked into the guidance that we're giving you.
And we believe.
That we were not going to have a disproportionate correlation to the 10 year relative to our peers. After this.
Okay got it and on the on the left side of the balance you can you just discuss the the.
Yes, repositioning that you did and what premium am was and how does this change that magnitude that you'd expect thanks David.
So premium amortization was relatively stable in the quarter about $28 million in the quarter. We did is we took some low yielding.
Investment Securities that.
We could sell.
It took those we reposition those into longer a little more duration, Ella little more Kerry to help us.
And just again boost a little bit from an Eni standpoint would they were really lower yielding.
Mortgage backed securities that we sold it and as reinvested.
Thanks, a lot David.
Your next question comes from Betsy Graseck of Morgan Stanley .
Good morning Betsy.
Thanks.
Okay. So couple of questions you know the background for the question just has to do with the longer term outlook for Razzi, which I know you put out it I think it was like.
15% to 18% separate.
At the Investor day.
And it's actually.
20 to 20.
20, sorry, little that's an interest rate.
Yeah exactly so the question that I have is how are you thinking about that you know when I'm looking at it I'm hearing okay, you've got a lot more opportunity on the.
Ben side, and maybe that expense.
Operating leverage improved.
We go through the next couple of years, but then Im also wondering about the capital side of the equation here and how you're thinking about that I know you have your nine half percent target, but given the tailoring rule that came out and everything else that's been happening for.
Thanks in your size is nine have still the right number for you.
Yes, so I'll start with your last question.
Yes, 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 in the capital planning and management, we still have every other year see CCAR submission.
So for the time being 9.5% was our target.
Try to put that in our prepared comments to.
Even though our math really says we can 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 uncertain in economic conditions continue to decline a bit.
As it relates and 9.5% was going to allow us to get to the kind of returns. We think are appropriate given the circumstances that were under now the 18 to 20 was as John was was saying in the middle of your question that we had.
That's very different interest rate environment, we all thought rates were going to go up this year and.
They clearly are are down and they are forecasted to be down through the through the the the period of time, we have covered by the Investor day, So getting to 18% to 20% would be very difficult do without taking some unusual risk, which we will not do so we're going to come out and we'll update the exact Tom.
Targets for you later.
But clearly.
There has been.
Some decline in terms of return expectations I think thats what are 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 to baked in for this year, probably another when coming in 20 as well so more to come Betsy.
Okay. Thank you.
Your next question comes from John 10 cars with Evercore ISI.
Good morning, John .
Morning.
I wanted to see if you could talk a little bit more on the on the investments you're making in IP. I believe you are currently evaluating replacing your core deposits system and and so I Wonder if you can give us some details around that in terms of what's what's the timeframe around that type of project, what's the cost impact that we should be.
Considering here could impact next year's numbers and then.
And then is there are other systems.
Are you looking at the core system on the loan side as well as or just the deposits system issue. Thank you answer John It's great question. We just had our strategic planning Offsite, maybe when the board spent a lot of time talking about the topic concise johnno into to address.
Yes, just to go back Investor day, we spend about $625 million a year on technology, how about 1600, plus technology professionals at the bank and.
Every year at our strategic annual planning process. We go through about a three to five year view and find out and talk about what systems need to be upgraded consolidated or replaced in each year. There is about 15 systems that we identify that.
Go out and either upgrade replay. So this is just a normal case those this normal calls the 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 deposits system, we will get those results back probably mid year, and we'll make a choice on what's the right platform for us.
The timeframe for that is probably a three to six year journey for this.
What you'll find with US we do upgrades, we don't do very many big Bang upgrades. This will be an incremental approach over a multiyear Tom period. So again this is a probably a four to six year.
System exchange in this particular case, but I would tell you we do about 15 days a year, how this would be a larger volume of course.
But again should go back to our wealth platform. We did Sci a couple of years ago, We consolidated 14 systems into one and we're fortunate to operate on one consumer platform and we're in the point of implementing and see no at this point in time, so what I would tell you it is large.
During the RFP process, but this is nothing that we don't do 15 to 17 of every year.
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 outsized sort of allocation to expense associated with any of the core system changes.
Okay. Thank you Thats helpful and then one.
I apologize this little bit off the radar little bit this question, but on Friday, you issued an 8-K that.
You announced the you're expanding your change control provisions to an additional component of the.
Management team beyond the C suite executives can you give us just whether the color what that relates to and how common is it the year yes.
Yes. Thank you for the question I guess, so we really did two thing. So both were were intended to standardize you can imagine.
With the truest announcement.
A lot of concern about what are our future is what our intentions are lot of questions about.
About what may happen going forward it caused us to look at our change 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 control and severance and so we asked our board to consider.
Hey change in the or.
Modifications to change of control and severance to to make them more consistent so they applied to both.
An appropriate group and they applied similarly to that group and so it's simply was the house cleaning sort of initiative for us to get everything in order.
No real significant change for our shareholders are frankly for our associates, but it does create some consistency.
Got it that's helpful. Thank you.
Your next question comes from Erika Najarian of Bank of America.
Hi, good morning, Erica good morning.
But given your outlook for continued for mid single digit loan growth.
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.
Well.
We don't want to give guidance yet on what next years, we had 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 we've talked a lot about being able to grow the balance sheet.
Consistent with the with GDP and then some then a low.
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 an absolute loan growth there but.
We we.
I expect to growth.
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 from it.
Gives us going into next year lower rates, obviously put some pressure on us.
Got it and as they think about.
Your earlier response is clearly the Razzi 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 on that because if rates and these potentially peaking this year.
Is there room for expenses on an absolute basis actually being down if you get to continued and efficiency improvement.
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 expenses so.
Where igs revenue continues to be challenge will continue to work even harder on expense management, Phil that we can do that so.
I think that clearly revenues going to be challenged kind of back to the last part last question is.
Revenue will be challenged because 65% of our revenue comes from spread and we had higher rates in the first half a year versus.
The back half and so on a comp 19 to 20 will be very hard to grow revenue in that.
At least in I.
So loan growth will help us they're a bit.
See what the rate environment is but.
We have good in IR, 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 to help and control expenses. We believe will generate positive operating leverage and continues to work our efficiency ratio down at the same time.
Got it.
Just wanted to be clear.
Even in an environment that you mentioned, where it's very hard to grow revenue regions is still committed to deliver positive operating leverage.
That's correct.
Thank you so much.
Your next question comes from Saul Martinez Libya.
Good morning saw Hey, Hi, good morning, guys.
Two questions first more of a clarification.
The 25% to 30% deposit beta in the fourth quarter.
Is that what's the denominator on that is that on too is that on two cuts in 10 to 12 to 15 basis point reduction in deposit costs, it's not.
I'm just trying to make sure it's not on an average.
The.
Average fed funds rate, because obviously added July and September cut thats fully in the fourth quarter I just wanted to make sure I understand the numerator and denominator there.
So it's based on two rate cuts that are baked in October in December right now.
Okay. So would be a 12 to 15 basis point reduction.
Round numbers that's right.
Okay got it.
I guess more important question.
On 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 quick and hopefully then some but if I look at it.
Your loan growth this quarter period, and it was up I think 1% year on year.
Going forward do you have indirect vehicles rolling off.
Maybe a few hundred.
On a quarter or do you have green skies, a headwind home equity still little bit of a headwind. Your CRT book is it really growing.
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 offset.
Where I know, you're not giving guidance for 2020, but how do I think about it conceptually given you pretty material headwinds from in multiple loan lines.
Yes so.
Yes, there's lot of stories in inside loan, but let's just kind of started at the top so our big driver loan growth has.
Traditionally been our are seeing ibook.
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 happened in this year maintenance, we had a lot of growth in the first quarter and and no growth in the second the third quarter, how we feel good about our pipelines we feel good about our conversations we're having with our with our.
With our clients.
They are cautious or off they're optimistic but they're watching.
This uncertainty with regards to trade Terra clearly puts some pressure and downward sentiment in terms of wanting to make the next dollar fixed capital investment.
But that being said, we still think theres going be some growth there from an investor real estate standpoint.
Weve, probably have the second Lois concentration investor real estate of our peers, we have some opportunities there, we're being very careful and selective clients. So from time to time.
You'll see that move up and then pay offs will move it back down, but I think investor real estate as a as an opportunity.
Resi mortgage continues to be an opportunity we had a little bit of growth this quarter production was up.
You know about a third of that was refinanced and two thirds of it was purchase and and we keep about almost half of what we what we produce so.
That'd be a plus.
Our direct consumer we think is going to be a plus.
Making investments in.
Unsecured.
Even though greenhouse gas running off we have other avenues.
John mentioned, we're going to cap unsecured but.
We continue to see opportunities for a little bit growth. There now home equity has been on quite a bit of decline over time and.
We think that'll that'll slowed down a bit.
So I think that.
When you and you had mentioned indirect vehicles being down.
Those are really that the key drivers again, we're not looking for a lot of loan growth.
But I think we'll have solid loan growth that will be profitable for the company.
Can you remind the green Sky is roughly 2 billion in your mind I believe and how quickly does it what's the average the weighted average life event.
So about a billion nine actually it has low right at two years.
In terms of duration Dolby pieces of this linger for awhile, but the bulk of Thats two year.
And.
So all its a.
Yes to run off Weve modestly increased our commitment to to so far 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 run off in the increase in so far with unsecured lending capabilities, all of which should should help us.
So on the consumer side in addition to growing mortgage joint bank card and the growing direct lending.
Got it thank you very much.
Your next question comes from Gerard Cassidy of RBC.
Good morning Gerard.
Good morning, how are you John .
Can you guys share with US we here 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 could remain competitive with the bigger banks what does some of the metric should we outsiders look to determine whether you're keeping up with these bigger banks.
Yes, just real quick on that as Jon Cohen.
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 do we maintain the bank maintain systems and really our infrastructure going forward.
10%, so cyber risk the way, we think about our we're keeping up and keeping pace. We use a few external factors number one would be JD powers JD powers ranks all the top 20.
Up 23 banks are on their list and they come out with a quarterly ranking and they rank everything from how we're performing the branch all the way through to our online banking and mobile banking. So that's a data point, we use consistently where in the top quartile for branch and online mobile moves between.
Portal and second core tile. So again, that's an area, where we're trying to always keep that in the top quartile EUV source would be Gallup Gallup also gives us good insights from our customers on how we're performing at digital in areas, where we need to advance.
The thing I would point to is just the rapid growth of our digital at the bank over the last three years, our digital log ins to our all automobile properties are up 90% you heard John talked about earlier on digital sales. Our digital sales are up 90% year over year and credit card, our digital sales and savings accounts are up 30.
5%.
Okay accounts about 24%. So we kind of look at it from a couple of factors how to our external parties validate what we're doing it also our internal growth rates.
I'd just add draw the other thing I look at as are we grow and consumer checking accounts or we growing low cost deposits and who are our new customers and roughly half of our new customers are are under the age of 30 and so all of those things for me are indicators that.
That that we are in fact, competing and having success offering compelling technology to our customers.
Very good.
And David you talked a bit about the Cecil increase you mentioned you guys put out the number in the second quarter two are they use it $4 million to $600 million.
If you compare that to your existing level of reserves over a 50% increase.
Everybody can appears to be able to handle yourself included the day one impact that you. Just described how can you frame out for us. If you can what the day two 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 one impact was for everybody.
Or how you guys looking at that at this stage.
I would not I would not say that day to would be anything remotely close to day. One. They wanted just kind of level sets and we're well see what other peers are coming out and what their for their numbers are really is dependent on portfolios those with consumer or longer dated loans are going to have higher seasonal.
Charges than those that are business services oriented have.
Shorter shorter term duration of their loan books.
You know day to you need to think about you still have charge offs and come through you have to provide cecil reserves and provisioning on loan growth those have the tends 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.
So mix makes a big difference.
So if you're growing mortgages versus commercial real estate mortgages are going to carry a higher provision then commercial real estate.
As on is 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 put in our prepared comments.
We've given you a four to 600, there's really dependent on what it looks like.
So were 31 last January the first what do we think the the forecast looks like going forward that makes a big differences in day to win that change occurs things getting better or worse.
You see in particular, when they get worse are forecasted to get worse, you can see much bigger provisions then than you do other they incurred model and that's what the standard was supposed to do it was trying to.
To have you reserve much quicker and that's why we've talked about pro cyclicality.
The standards is pro cyclical as you can get because in a downright cycle, you're going to be reserving more for loan growth.
Which is.
Which causes one to.
To be concerned about the cost and availability of credit in a downturn.
Very good thank you.
Q.
Your next question comes from Brian for end of autonomous.
Brian Good morning.
Hi, Hi, everyone.
I guess I'd say a couple of questions on your slide Appendix first of all thank you for this level of detail on the commercial loan portfolio or some of the key areas you're highlighting it is it is quite a lot.
I guess as I look to slide 14, really maybe 15 through.
17, because the energy you've talked about before.
The restaurant the retail the manufacturing transportation.
Were you positioning. This is this just being responsive to investor questions are these areas you're actively concerned.
Are there any sub portfolios, where you're seeing an opportunity to to maybe take some market share I.
I guess, how should I interpret all this detail why you highlighting restaurant retail manufacturing and transportation.
Brian This is far battle.
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, a little bit 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 okay.
We see within 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 is the time to be as I said much more transparent, particularly as we go into.
Actually it looks like a credit cycle that'll happen in the next couple of years.
And then maybe in a similar vein on slide 12, I mean, obviously to asked this but it's always a little bit of a lightning rod for investors the leverage loan balances.
Certainly recognizing the 6 billion is much bigger number than the standard definition of which would produce 2.5 billion.
To highlight in the slides.
But I think when you first gave this it was about five and a half billion. So why is it kind of crept up a little bit over the past six to nine months is that you participating more or is that just some credits tripping into your leverage definition why is the number down a little bigger.
Yeah, we do have a number of credits that again based on the way we define it.
We will become leverage even though they started office not leverage. Additionally, we've got Granny Smith here runs that portfolio and I'm going ask him to me.
Yes, just.
Couple of comments and one of your responses is exactly on target we had a couple of.
Really long term relationships publicly traded company.
That had positive credit events that push to over into our definition of leverage lending and if you combine those two is just over $400 million we.
We feel good about those particular companies and 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.
Theres not really a focus on growing that portfolio other than than continuing to support our existing relationships, where we can build broad and deep relationships outside of the lending transaction online.
I'd just add we actively manage it as a concentration risk like we do every other part of our portfolio.
That's great and thank you for all the detail. Thank you.
Your next question comes from Christopher Marinac of Janney Montgomery Scott.
Good morning, Christopher.
Hey, good morning.
I wanted to ask further on the credit.
Explanation that you just gave it should we see a higher level of total criticized than we do now or will that number kind of very I know you had to step change driving a lot of this quarterly ship.
Yes, it's part of again in the criticized portfolio in particular classified I think it's such a pointing to a chat drove that number.
Now let me first start with strong despite all that our credit metrics for the quarter are within our broader risk expectation, we express experienced improvement in several areas that you know delinquencies were down 4% Pdrs down, 7% Mpls down 13% and charge offs were flat. So we feel good there and as well as you mentioned David did our.
Shared national credits were included and just comment on the shared national credits, we weren't agent on any of those credits that way.
I speak specifically to our classified loan category I'm going to categorize what happened this quarter as follows which is really over half.
The increased five energy credits that moved into the category, but since quarter end. One of these credits just totally this all and the other three credits or to a large energy services customer that stays with us for well over 50 years and they have to proven ability to perform through the cycle.
For energy and general I'll make a comment that our book right now is only 13% oilfield services and we also have gone through in a stressed our price deck on which we both Lantus wireless service our account staff to $39.20 and that's against today's price last I looked this morning it was about.
The $4 a barrel give or take so based on all the pass and 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.
Just to energy next three year. Sorry addition to energy. We also had some asset based laws that mean this to classify 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.
Lastly, we also reviewed the top 80% of credits that move to our classified category this quarter and again based on this we're comfortable both our loss range of 40 to 50 basis points, but this year and 40 to 65 over the next year based on a slowing economy. So I'd summarize by saying, we don't see what happened this quarter was being a systemic issue we are.
We're coming off a period of historically low numbers and as such we believe that some increased less to be expect.
Oh, and all that the 40 to 65 loss rate was over the next three years I'm sorry.
Yes.
Okay, Great. That's that's helpful background, and again with the inclusion of additional categories does that imply that restaurants in ABL and others had deterioration in the quarter or again, you just giving more transparency to those in general.
There is some marginal deterioration, but we're really are just trying to get much more transparency.
Okay, great. Thank you Bob appreciate it.
Your final question comes from Stephen Scouten of Sandler O'neill.
Morning, Steven.
Hey, good morning. Thanks.
At a follow up question, maybe Tibet. These earlier question around the ROTC guidance and kind of.
Maybe more specifically why that would move down I just remember from your Investor Day, you guys had a pretty.
Negative, but may be muted view on the economy kind of where GDP was going to go fed funds reverting to a zero range policy and even the tenure I think around 150, so granted a lot of what we're seeing today, it's kind of what you guys predicted so I'm wondering what specifically is driving the changing expectations relative to what you said that.
I think Steve and our expectation that 10 year was closer to 3%.
Then than the 150.
Time, we gave that out so.
Two things that drive return is the numerator and denominator and that denominator impact on lower rates is pretty tough.
When you have falling rate environment clearly the the fair value of the investment portfolio and therefore book value increases in the same thing on all the derivatives that we've added.
The fair value those obviously increased putting pressure on the denominator so.
So that's a that's more meaningful then you might think when you go through the calculation from a net income standpoint, clearly we had.
Rate expectations and margin guidance it had been as high as Threeseventy.
Down to a low 340, that's where we are and so.
18 to 21 predicated on being at the low end of the range. So.
I think if you if you look at our industry and you think of just good core commercial banking.
At 20% return on capital can get you can get there when you have a rising rate environment margins are continuing to expand we don't have that we have low rates.
Relatively flat yield curve and no at least the market, saying no real expectations for rates change over the next couple of years. So.
It's really hammering out net income growth and return through.
Making good investments to grow and I are watching expenses keeping credit your tabs on credit quality and that's what we're doing but it's all it it's up you can't get to those type of returns in this this environment if it persists.
Got it very helpful. Thanks, Dave.
Okay.
Since we have no further questions. Thank you all for your interest I appreciate it very much.
Good day.
This concludes today's conference call you may now disconnect.