Q2 2019 Earnings Call
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.
I would like to remind everyone that all participant phone lines have been placed on listen only at 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.
I will now turn the call over to Dana no one to begin.
Thank you Shelby welcome some 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 Entre line on our income from that are available under the Investor Relations section of our website.
Our forward looking statement disclosure and non-GAAP reconciliations are included in the appendix of todays presentation and within our FCC filing. These cover our presentation materials prepared comments as well as the question and answer segment of todays call and with that I will now turn the call over to John .
Thank you Diana and thank you all for joining our call today, let me begin by saying in the face of significant market volatility. We're pleased with our second quarter results, We reported earnings from continuing operations of $374 million.
3% increase over the second quarter of the prior year and earnings per share of 37 cents an increase of 16%.
We also delivered solid pretax pre provision income growth compared to the prior year and generated 4% adjusted positive operating leverage.
This quarter's results demonstrate our core business remains 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 includes Atlanta, Houston Orlando in St. Louis.
For example, in Atlanta, and the pace of new account and deposit growth is approximately two times that of the net of the total company.
Further we're 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 the same markets commercial banking growth has been particularly strong in Houston, where pipelines for credit and deposits are at an all time high.
Although its 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're 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 just a moment.
We also remain well positioned to prudently manage through the next credit cycle.
Because of our ongoing risk mitigation activities, including clonal activity 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 insurance and the decision to exit a point of sale relationship earlier this year.
Did 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 reposition a portion of our investment securities portfolio.
Continue to focus on clients like activity in 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.
And while our customers are more cautious and then 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 initiatives.
To make banking easier to accelerate revenue growth and importantly become more efficient and effective.
Should the market's current path 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 softened faster than we expect.
Achieving some of our long term financial targets will be challenging.
That being said, we remain committed to 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 are 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.
Thank you John during last quarter's call. We spent time talking about certain balance sheet optimization efforts and were either underway 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 end quality generated thinner spreads.
We anticipated some of these customers would choose to 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.
We reduced 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 eight 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.
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 noninterest 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 take within the quarter in May and subsequently trend down in June .
Our total deposit cost 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 and 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 the 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 floor 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 Forge, which include roughly 325 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 3.4%.
The low end of our long term range.
However.
We would expect the first quarter's margin to expand into the low to mid three fortys as the benefit of our forward starting hedges began.
Now I want to take some time and walk you through our hedging strategy and its expected financial benefit.
Slide six 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 hedge is 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 1st 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 remained low for an extended period.
Because the preponderance of our hedging program as 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 dated hedges, we have provided the 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 noninterest 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 remained relatively consistent quarter over quarter. However, as expected in a declining rate environment. We are beginning to experience an increase in prepayment 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 noninterest expense increased 1% compared to first quarter.
Furniture and equipment expense outside services and professional fees increased this quarter, but were partially offset by a 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 benefits.
The adjusted efficiency ratio was 58.3% unchanged from the prior quarter.
Despite success and managing our costs.
The challenging revenue environment necessitates, even more focus on expense management.
What 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 100000 square feet.
We also made the decision to market the sale of another large office building.
In excess of 300000 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 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 his staff wish risk appetite.
Net charge offs increased <unk>, 0.44% of average loans inline with our expected range of 40.
50 basis points for 2019.
Provision match net charge offs, resulting in 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 one ratio target.
And the third quarter.
And manage it 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.
Moving now.
Thank you the floor is now open for questions.
If you have a question. Please press the star key followed by the number one on your telephone keypad.
Yes at any point. Your question is answered you may remove yourself from the queue by pressing the pound key we'll pause for just a moment to compile the Q and a roster.
Your first question comes from Ryan Nash of Goldman Sachs.
Yes, Hi, guys, Hey, good morning, guys.
So.
Looks like you've seen an inflection in deposit costs are down 29% you had one of the lower side.
Beta cycle to date, so youre talking about the NIM approaching 340, and then increasing can you just talk about how you feel about your ability to bring down deposit cross sell a deposit costs across multiple across retail wealth and commercial and then as you think about the sensitivities youve outlined given all the changing dynamics on the balance sheet. How do you think about the sensitivity to short versus long term rates and then I have a follow up.
Okay.
David too.
We are encouraged.
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 cost.
Couple of basis points.
And to put that in the chart to show you that.
We expect that to happen already peaked and to the extent that we.
Continued to get.
Short term rates down that will give us even more ability to reduce deposit cost.
We have about 10% of our deposits our index.
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.
Really money market type deposits, if we get to address as as rates change. So we can move pretty quickly as the market changes, which gives us some confidence.
We continue to to hold our margin at that 340 level for the remainder of the year, even if we get the two roughly three cuts that the forwards imply.
Got it and.
Maybe as a.
As my follow up you talked about the environment being challenging and so.
It might be hard to hit some of your targets I guess, if the if the rate environment does improve do you think you could fill approach the low end of your efficiency and ROTC target and then second what do you expect to continue to be able to generate positive operating leverage even if you don't hit that target. Thanks.
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 puts 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 pooled 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 for me.
Got it thanks for taking my question.
Thank you question.
Comes from John Pancari with Evercore ISI.
Morning, John .
On the.
On the expense topics still just I guess longer term you had a.
Expectation for below 55% efficiency ratio in 2021 or by 2021.
Can you just they are just let us know how are you thinking about the.
That level and if it's still attainable. Despite the rate backdrop, just given your hedging et cetera. Thanks.
Yes so.
As I tried to mention to Ryan then.
Three years is a long time, if you 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 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.
But I would say John I mean, we're 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.
Let me add some to that John because we're talking about the interest rate environment.
If we have a low rate environment with 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, which is where we have would have pressure on that.
55% margin.
Got it okay thats helpful color.
Im sorry efficiency.
Right right got it.
Okay and then.
My follow up is around credit.
Just wanted to see if we can get a little bit more color on the increase in charge offs.
On the commercial front, where they came from and then also your Nonperformers.
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.
What's driving that thanks Ciaran spar.
Relative to charge offs, it's driven by one loan that was in the kind of the health care sector. It's something that we have been working on for quite a while on finally closed two to a resolution. So we don't see anything systemic in there.
Relative to the NPL Atlas three loans that really drove those numbers, if which one has since been paid off.
And the other two Leah at this point, we don't expect any loss from them. So again nothing systemic we're still seeing credit as being stable in our outlook going for the balance of the year and we're committed again to the 40 to 50 basis point range again for the balance of the year.
Okay, great. Thank you.
Thank you.
Your next question comes from Matt O'connor of Deutsche Bank.
Good morning, Matt Hi.
Hi, there is some puts and takes on the balance sheet kind of outside of loans that you talked about.
Thousands security is reinvesting them.
Just as we think about earning assets loans are those.
Relatively stable going forward with the restructuring I just want make sure I've got all the puts and takes there.
Yes, 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 what ending was so we're going to feel a little bit of pressure on earning assets from that trade into the 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 a rate reductions.
Okay. So those are the buckets of kind of non loan, earning assets will be down a bit on average threeq versus twoq you.
Level.
In particular in the investment security portfolio, because that trait happened this quarter.
Yes, yes, Okay 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.
Due to the health care alone or.
The commercial.
Inflows, one of which paid off or was that something different.
Yes part of that is seasonal.
In our 30 day buckets 90 day buckets were down three days was up marginally and there's nothing systemic in there at all that is part and parcel of our seasonality.
Okay all right. Thank you.
Thank you.
Your next question comes from Jennifer Demba of Suntrust.
Good morning.
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.
Yes. 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 of M&A in Bank M&A.
And so we're going to continue to.
To watch the market, we're going to continue to pay attention to whats occurring but our 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 recently announced the acquisition of.
Hi, Allen, which is a wealth management capability that is complementary to our health care business and one that we're excited about its 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 the customer need by adding some capabilities.
We are have been actively looking at mortgage servicing rights acquisitions, but with the rate environment those transactions.
We have become more challenging to find.
We will continue to do that and within our other businesses.
We are again always looking for opportunities to.
And our capabilities and we will remain active there.
Your next question comes from Peter Winter of Wedbush.
Good morning.
Yes.
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 in a slowdown or the investments.
Yes, 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 technology, and we have to pay for that and the way to do that is to can you continue to focus on our expenses and leverage our car simplifying grow continuous improvement program that we started in little over a year and a half ago.
You know if we're going to 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 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 as our next biggest category.
As we had in our prepared comments, we had some 400000 square feet of space that we're exiting some of it we have exited some out we just put in held for sale and.
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, what we have smaller space, we can save there as well.
No price or our fourth category would be.
Kind of purchasing of vendor spend if you will we have a.
I do have a procurement that is really put in a lot of rigor in terms of helping us from a demand management standpoint on 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 are in this type of challenging revenue environment and a commitment to positive operating leverage you just have to pull every stream that you can in terms of controlling expenses.
And I'd add Peter Weir.
We are as we've said a few times, we're really pleased with our simplified grow initiative and we're really only beginning to see the benefits of of the continuous improvement work that's occurring I asked John own who has led the initiative just briefly talk about a couple of other things that opportunities that we see through the use of our digital capabilities to drive improvement.
John .
Yes, good morning, everybody we.
We added about 17, new initiatives to our simplified road list and second quarter, bringing that number up to about 62 initiatives have already completed 13 year to date will complete another 11 initiatives in the second half of 2019.
Well I think about some of the things we'd point to go back to Investor Day, we talked about launching our digital lending platform in the consumer side of the house.
That's really taken traction, we're seeing 38% of our applications today come in through that digital channel on the east side. He closed part of this we're up to about 58% of our direct loans closing 30 sites are really good traction or digital lending capabilities on the account opening radio digital fraud thing I'd point, you to we've got a team as part of simplifying 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 quicker process.
We revised the application we've streamlined and we now are getting about 53% increase in our digital account openings and checking accounts at about a 44% increase in credit card production to the digital channel. So really good traction there on the AI front, we continue to look for use cases on how we can rollout.
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 we're 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 and having our AI virtual agent handle those password resets.
The last thing is we're having good success with AI at our quality assurance functions, where we're actually having AI virtual agent.
Quality assurance call types categories, and really go through and make sure that our reps are following the right disclosures and write scripts us reduce our expenses in that queue area by about 70%. So good traction with Aaas well.
Thank you.
Great and then if I could ask with the.
Hedging strategy really starting to kick in beginning in 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.
Yes, I think to the extent so we're all assuming that the.
The forward to actually work work there.
A way through for next year.
As you can see on the chart I think slide six were 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 to 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 having to work against say hey 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.
Great. Thanks, a lot.
Thank you.
Your next question comes from Ken is done of Jefferies.
Hey, good morning, guys. Good morning, guys. Thank you.
Just a follow up on that last question. So.
Your scenario that you put out on page five which really helpful.
It's in the three potential cuts that are in the forward curve and this might be just more of a semantic one but I'm just wondering if the fed only gives us want participating.
Potentially in terms of your.
The decline before the hedges come on like is it just strictly ends up in the same place, but from a slightly different way of getting bear.
Just wanted to get your understood just trying to understand how that might change if we don't what we get.
Three cuts that occur.
Yes, so Ken a 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 floor. We have received fixed so cuts in short term with the protection on the on the receive fixed derivatives and our ability to reduce deposit cost in that 35% deposit beta that we're talking about gives us the confidence that we have in 2020. So we've been if you have 123 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 slow to the curve even in us and a lower rate environment. If we have slope are protected as well because the reinvestments coming off the investment portfolio and alike really are tied to the long end is 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'll react appropriately as long as we can get the at the long end at least stay where it is and maybe maybe even increase a bit.
Got it so regardless of the pacing then you feel pretty good that once you 20 low to mid 320 Hadnt happened in most any circumstance, except for I mean pre flatter.
Curve environment.
That's exactly right and we had our protection weve.
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.
But we're feeling pretty good about what can take place in 2020 and going forward, we have duration on those swaps.
In floors of five years, beginning in 2020, so we have really good protection then.
Okay got it and then last cleanup on that.
But were starting swap that that you've got that fixed rate great gone there are they at least.
Are there different ones. The average is obviously to 40 for the swaps into low eight for the for the floors on on page six.
But as you put them on are they all around kind of a general average there are there thats on which one makes it could be very much in or out of the money across the book.
Yes, I think 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 there'll be 25 points here or there, but nothing that's really going to skew that.
From using the averages.
Okay got it thanks David.
Your next question comes from Erika Najarian of Bank of America.
Thanks Aaron.
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 peak in May.
Is that for the initial 25 basis points and as we think about 2020, what do you think if the forward curve is right and that will get three cuts and then maybe not anymore, what could the ultimate sort of reverse deposit data be onto a 75 basis points.
Yes, I think we're 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 thats, what you're asking.
So the 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 as either quite expensive or indexed and then it would.
Paper, the repricing would taper off in terms of percentage of cuts rather than accelerate I guess.
You are exactly right. So it starts at 35 and then.
At the end of the day, you are going to drift from that 35 down into the higher Twentys has that and that is the driver of that is the 10% indexing.
The exception pricing engine, then just looking at the market.
Of all of our deposit as we compare to our peers.
And we get the benefit of our floors and we get the benefit of our received fixed swaps.
Got it.
And John just wanted to clarify.
I hear you loud and clear that.
55, and below and efficiency is difficult in this rate environment. You Didnt you something earlier as an answer I 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.
Yes, so this David.
So the.
The.
Flat to slightly down was an answer to 2019 change in our guidance there.
I think your question is who will then what does that mean for the next three years. If we're in this challenging revenue environment, we clearly.
We have two 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 two and half percent. So that 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.
The lower rate environment, a flatter yield curve makes that very tough.
But thats, what we seek to do and we're going to do whatever it takes to to meet our fixed rate expectations, we've laid out.
The commitment was 55% three years from now we're only six months there so.
We're not we're not giving up on 55% by any stretch.
Got it thanks for that clarification.
Thank you.
Your next question comes from Sal Martinez.
Hey, good morning, everybody.
Good morning.
So.
I guess I'm still a little bit confused on the on the 35%.
Deposit beta.
And the the glide path thereafter for future cut so are you, saying that on the first 35.
The first 25 basis point cut.
You will see a declining your interest bearing deposit costs.
35, or 35% beta on the decline on your interest bearing deposit costs and over what time period that occur is that sort of an immediate.
Decline or is that something that drags on over a couple of quarters is repricing filters and because it seems like.
The commentary from some other banks has been.
There is going to be a lag in terms of.
Deposit betas and that they could accelerate not decelerate as.
Rate cuts further rate cuts habit.
Yes, so we felt like ours, we're going to happened a little quicker because of the the indexing that we have on 10% of our $60 billion of interest bearing deposits. Another 10% exception price. If we can move quickly to so we think that can be pretty.
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 of rolling 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 yes, I think so but so the 35% then you are saying is pretty immediate.
That's fine.
That's correct.
Okay.
I guess just more of a conceptual question then on anti.
And how to think about net interest income growth in 2020, and 21 and I'm certainly not asking for guidance.
Joe it's too early for that.
But.
To the extent you have stabilize your rate sensitivity neutralize that to a large degree.
When we think about.
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 doesn't necessarily independently of rates, but.
That being a much bigger driver of net interest income growth, regardless of what the rate environment does.
Well, that's that's exactly what we're trying to communicate that our hedging program gave is giving us the opportunity to not have to climb out of a hole to grow Eni margin rather neutralizes that is it was insurance protection in a 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 in eye on margin as we continue to grow earning assets watching our deposit cost our deposit franchise is still our.
And still our number one competitive advantage and we think thats going to help us.
Continued to grow.
Eni with appropriate balance sheet growth.
Okay. No thats helpful. 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 got it green sky or exited non renewed commitment there how do we think about can you remind us what your expectations are for balances there and.
How much.
Finally, with the other consumer might balance should do.
And so you should 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 were not not renewing that.
It will take it will take some time.
The at the whole average for the year will be about $800 million on indirect auto.
Next time.
I'm sorry on.
Sorry.
Other than that all meant greenhouse gas.
Okay, great Okay.
Great. Thank you.
Yes.
Maybe clarify that I think it's 800 million on average on the indirect auto portfolio.
Full year.
Right.
That's correct.
And then.
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.
Comic expected to two two and a half years sort of weighted average payout.
On that portfolio.
Great very helpful. Thank you.
Thank you.
Your next question comes from Christopher Marinac of Janney Montgomery Scott.
Thanks morning morning.
I wanted to ask about the environment for either late this year or next year about hiring teams of of producers as this environment, where you invest in that or perhaps few new a few new markets come into the regions footprint because of external opportunities.
Yes, I mean, we're we're.
All of our business leaders well.
Commercial corporate real estate are actively recruiting all the time, our consumer business. Similarly.
One of our one of their task is to always know who the best bankers are in their markets and in contiguous markets through the best bankers are in their specialized businesses and so we're always actively recruiting we've had good success recruiting already this year across particularly our priority markets, where we are investing Saint Louis Atlanta.
Houston and in Orlando, and we will continue to do that.
Okay, great John Thanks, very much.
Your next question comes from Kevin Barker of Piper Jaffray.
Good morning, good morning.
I was hoping you could give us a little more color on the 9.5%.
One ratio target for the third quarter.
It would seem that would imply a pretty aggressive buyback this quarter.
And then maybe a tail off through the rest of the C car cycle, maybe just help us out with the cadence of the buyback.
In the near term and then through the cycle.
Yeah, Kevin So you're exactly right. We put in our prepared comments were that we were going to get to our 9.5%.
In the third quarter.
Actually we have loan growth that use up some of that and dividends.
Yeah, and then buying back to get us.
To that nine and a half 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've 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 for organic loan growth.
And then we'll use the rest will buy stock back to keep us at that nine and a half 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.
Okay. So given the authorization that you have.
For this cycle.
It would imply that.
Well it would seem.
Imply that.
We keep the loan growth relatively.
Low single digits or some were 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 nine and a half a percent.
Given the buyback authorization you have in place.
No wait where we our teams are out there growing loans when it makes sense from a from a risk adjusted return standpoint, we grew the first quarter little quicker than we had expected we slowed that down a bit this quarter, we still have the load of mid single digit growth expectation for the year.
Again, any given quarter you can see a pace change in the third quarter for us.
Over the last couple of years haven't has not been as strong of a growth even though our pipelines look pretty good the fourth quarter on the other hand, it's actually been pretty strong. So we're sticking to our to 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 make sense.
Yes. It does all right. Thank you for taking my question.
Thank you your final.
Your final question comes from Gerard Cassidy of RBC.
Morning Bernard.
How are you.
Good.
Question.
Can you guys share with us we've seen a lot of commentary on about the strength of the consumer businesses 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 et cetera.
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 325 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.
Well the second to answer the second half of your question no. We cannot tied into the forward curve I would tell you that our business customers.
Our still.
Cautiously optimistic was clearly over the last 90 days or so.
Assets more caution on the part of our business owners, but theres still optimistic they're 2018 results were very good most of them are having really good 2000, nineteens as we look at our credit quality across a variety of industry sectors really don't see any significant issues other than within the restaurant sub sector, we've called out before fast casual.
Our don't appear to be any other stresses of any consequence that we see customers have good pipelines and so.
So I think I 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 tie our view of the economy through our customer's eyes.
To the forward rate curve.
Very good and then.
Can you guys share with us the an update on C., So where you stand and where and when we may get a.
Okay one.
We estimate on the build up of reserves in January of 2020.
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 out say 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 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.
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 Cecil adoption not as much on the on the commercial side, but.
Stay tuned here shortly on our 10-Q filing.
Great. Thank you Jon Thank you David.
Thank you. Thank you.
Thank you I will turn the call back over to John Turner for closing remarks.
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're focused on.
Things that we can control consul activity sound underwriting credit servicing effective expense management resource allocation.
And risk adjusted returns we have a good plan, we think to neutralize our interest rate 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.
This concludes today's conference call you may now disconnect.